Business insight credit ratings each rating agency

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ratings were medium grade: A3 (from Moody's) and A- (from S&P and Fitch). BUSINESS INSIGHT Credit RatIngs Each rating agency has its own scale to communicate its opinion about the chance of default. The two best-known and most influential rating agencies are Standard and Poor's (S&P) and Moody's Investor Services. The following summarizes these agencies' long-term issue rating scales. The Appendix discusses the two companies' rating scales in more detail. Investment Grade AAA, AA: High credit-quality A, BBB: Medium credit-quality Aaa: Highest rating Aa1, Aa2, Aa3: High-grade A1, A2, A3: Upper-medium grade Baa1, Baa2, Baa3: Medium grade BB, B, CCC, CC: Low credit-quality D: Bonds in default for non-payment of principal and/or interest Ba1, Ba2, Ba3: speculative elements B1, B2, B3: subject to high credit risk Caa1, Caa2, Caa3: bonds of poor standing Ca: highly speculative, or near default C: lowest rating, typically in default, little prospect for recovery of principal or interest Non-investment grade Why Companies Care About Their Credit Rating Credit rating agencies play an important role in credit markets because they help investors analyze credit risk. But why should companies care about their own credit ratings? There are two main reasons. First, credit ratings affect the cost of debt. Recall that the cost of debt is the market rate of interest, which is defined as the risk-free rate (the yield on U.S. Government borrowings with
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Module 4 I Credit Risk Analysis and Interpretation 4-24 _-that matches the company's own debt), plus a risk premium (also called a spread). The ~."":"'J.lll·umfor a company depends on the company's credit risk which is directly linked to the ___~"""'Y.-scredit rating: riskier bonds have a larger risk premium. This risk premium can be large. ---.-""'"ple, in 2005, Ford Credit Corporation's credit ratings deteriorated and its unsecured debt risk premium grew from 165 to 660 basis points. This cost the company millions in additional interest expense. Exhibit 4.5 shows the yield on risk-free bonds (Treasury . the yield on bonds with Moody's highest credit rating (Aaa), and the yield on bonds with credit rating (Baa). - - - ~ :X:~BIT4.5 Treasury and Corporate 10- Year Bond Yields 2000-2010 10% 8% ~~~~--~~~--------------------------~~~-----1 6% 2% -Aaa -Baa -10YTreas O%~---T----r---,r--~~--+----r---.L---~---T----r----{ 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 yields increase (shift upwards) as debt quality moves from Treasury securities (generally . red to be risk free), which is the highest-quality debt reflected in the line nearest to zero, Aaa (highest) rated corporates and, finally, to the Baa (lower-rated) corporates. That is, credit-rated issuers warrant a lower rate than lower credit-rated issuers. This difference ntial. For example, in late 2011, the average lO-year Treasury bond yield is 2.17%, me Aaa corporate bond yield is 2.72% and the average Baa yield is 5.25%. Higher cost of debt not only increases interest expense, it could limit the number of new _"~~ent projects. With a higher cost of debt, some new projects might not yield a return than their financing cost. Thus, a decrease in credit rating can restrict a company's and future profitability. Although credit ratings are only opinions, they are influential.
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