Credit Rating Agencies: Moody's, S&P, and Fitch
Everybody likes a good grade. In debt markets, there are multiple grades better than A+.
S&P and Fitch have the same rating system, and Moody's is similar. For high-quality-grade investments, the top ratings for each are:
| Grade | Moody's | S&P | Fitch |
|---|---|---|---|
| High-Quality Grade | Aaa | AAA | AAA |
| High-Quality Grade | Aa1 | AA+ | AA+ |
| High-Quality Grade | Aa2 | AA | AA |
| High-Quality Grade | Aa3 | AA- | AA- |
What would you say is the benefit for an issuer's debt in having one of these top ratings?
No, this isn't a benefit. It's good for debt to be highly liquid, and debts with the top credit ratings generally are.
No, this is a little tricky, but a higher credit rating only indicates a higher price with all other variables held equal. It's easy to find two debt issues where the higher-rated debt has a lower price due to the features of the bond or some other factors.
Exactly!
For top-rated debt, a higher yield isn't demanded by investors, and so the debt represents a lower cost for the issuer.
Here's what the medium-grade ratings look like:
| Grade | Moody's | S&P | Fitch |
|---|---|---|---|
| Upper-Medium Grade | A1 | A+ | A+ |
| Upper-Medium Grade | A2 | A | A |
| Upper-Medium Grade | A3 | A- | A- |
| Low-Medium Grade | Baa1 | BBB+ | BBB+ |
| Low-Medium Grade | Baa2 | BBB | BBB |
| Low-Medium Grade | Baa3 | BBB- | BBB- |
And that's just for _investment-grade_ ratings.
Then there's the _non-investment-grade_ debt ratings, also known as _junk_ bonds or _high-yield_ debt:
| Grade | Moody's | S&P | Fitch |
|---|---|---|---|
| Low or Speculative Grade | Ba1 | BB+ | BB+ |
| Low or Speculative Grade | Ba2 | BB | BB |
| Low or Speculative Grade | Ba3 | BB- | BB- |
| Low or Speculative Grade | B1 | B+ | B+ |
| Low or Speculative Grade | B2 | B | B |
| Low or Speculative Grade | B3 | B- | B- |
| Low or Speculative Grade | Caa1 | CCC+ | CCC+ |
| Low or Speculative Grade | Caa2 | CCC | CCC |
| Low or Speculative Grade | Caa3 | CCC- | CCC- |
| Low or Speculative Grade | Ca | CC | CC |
| Low or Speculative Grade | C | C | C |
| Default | C | D | D |
Okay, so the ratings starting with A are the best, followed by B, then C. That's clear.
What seems consistent in comparing different ratings which start with the same letter?
That's right!
For any rating starting with B, for example, a rating with three letters like Baa3 is better than a rating with two letters like Ba1.
No, that doesn't quite work. The rating of BB- is better than the rating of B+, for example.
No, that doesn't quite work. The rating of Baa2 is better than the rating of B1, for example.
So without looking back, what's the highest rating of these three?
No, anything starting with "A" is better than anything starting with "B."
Yes!
The two top ratings here are A1 and Aa2, since they both start with "A." But the Aa2 rating has more letters. These three are all Moody's ratings, where numbers are used to differentiate from there. For S&P and Fitch, pluses and minuses are used instead of numbers, but they provide the same third-level differentiation.
Beyond these ratings, the ratings agency will also sometimes hint of an impending change by announcing some sort of positive outlook or review for an upgrade or downgrade, which gives investors further clues as to how the creditworthiness in question compares to others.
No, consider the rule of thumb about having the most letters for ratings starting with the same letter.
To summarize this discussion:
[[summary]]
There are also ESG ratings in order for investors to consider corporate activity related to environmental themes, social themes, or governance themes. Suppose that the MSCI ESG rating for a firm was AAA. What might you assume from this?
Not necessarily. That would be true for a credit rating of AAA, but it's not as clear for an ESG rating of AAA.
Right. The MSCI ESG ratings have seven tiers, from AAA (best) to CCC (worst). You might assume that it is related to sustainability, and in that way it could be related to credit. But that's unclear.
It's more relevant for matching investment objectives related to ESG issues with debt issuers who demonstrate consistent behavior.
Perhaps it's another way to give credit where credit is due.
No, a AAA rating is great; this would likely suggest _lower_ than average risks related to governance.
Lower yield
Higher price
Less liquid
More letters are better than fewer letters
A "+" is better than a "–"
Having a "1" is better than having a "2"
A1
Aa2
Baa1
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Default is less likely
The business seems to be operating responsibly
There are greater than average risks related to governance
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