An S&P rating is usually expressed as a letter grade. The best is 'AAA'. This means it is highly likely that the debt will be repaid. The worst is 'D', which means you can kiss that loan goodbye. These loans are known as junk bonds. If a company receives a high letter grade, it won't have to pay as much in interest to bondholders, because there is less risk. Lower grades means the company has to pay a lot more in interest. Some buyers like these junk bonds, because they pay higher interest.
Here's a breakdown of the S&P ratings for investment grade bonds:
- Top Quality -- AAA
- High Quality -- AA+, AA, AA-
- Upper Medium -- A+, A, A-
- Medium -- BBB+, BBB, BBB-
How S&P Creates the RatingsS&P ratings are made by analysts employed by the company. These analysts obtain information from published reports, such as annual reports, press releases and other news articles. They also interview the management of the company they are rating. The analysts then assess the company’s financial condition, operating performance, and policies. Most important, they form an opinion about the company's risk management strategies.
In the beginning, Standard & Poor's sold their reports to investors. However, when the copy machines were invented, the company became concerned that it would lose revenue as investors simply copied the reports and distributed them to their friends. It started charging the companies it was rating, instead. Standard & Poor's has come under criticism for that change. Critics doubt that S&P can effectively evaluate its paying customer. This is one reason why S&P and other ratings agencies have been blamed for the financial crisis. Many sub-prime mortgage bundles were rated as investment grade when they actually held many tranches of mortgages with poor credit risk.
This accusation was revived recently when S&P downgraded the Treasury debt of the United States from AAA to AA+. S&P was concerned that Congress and President Obama didn't put together a solid enough debt reduction plan. The credit downgrade sent theDow plummeting in August 2011.
Isn't It Ironic?Many analysts said that it was ironic that the same ratings company that helped create the sub-prime mortgage crisis was now punishing the Federal government for its debt crisis -- one that was partly created by the recession. Although the U.S. had a $10 trillion debt before the recession, it increased 40% thanks to recession-generated lower revenue and higher spending.
Here's another irony. It seems strange that a company that measures someone's wealth has the word "poor" in its title. However, the company was named after one of its founders, Henry Varnum Poor. In 1860, he published the "History of Railroads and Canals of the United States." Mr. Poor was concerned about the lack of quality information available to investors. His book was the beginning of a campaign to publicize details of corporate operations. Standard & Poor’s has been publishing its credit ratings since 1916.