What is a Corporate Credit Rating?
A corporate credit rating is an opinion of an independent agency regarding the likelihood that a corporation will fully meet its financial obligations as they come due. A company’s corporate credit rating indicates its relative ability to pay its creditors. It is important to keep in mind that corporate credit ratings are an opinion, not a fact.
- Corporate credit ratings are the assessment of a company's ability to pay its debts according to an independent credit rating agency.
- The three biggest credit rating agencies are: Standard and Poor's (S&P), Moody's, and Fitch.
- Corporate credit rating trends, over time, may allow an investor to compare the credit-worthiness of competing corporations.
- Credit rating agencies are notoriously criticized for potential bias and their role in the financial crisis of 2008.
Understanding Corporate Credit Ratings
Standard & Poor's (S&P), Moody’s, and Fitch are the three main providers of corporate credit ratings. Each agency has its own rating system that does not necessarily correspond to the other agencies' rating scale, but they are all similar. For example, Standard & Poor’s uses "AAA" for the highest credit quality with the lowest credit risk, "AA" for the next best, followed by "A," then "BBB" for satisfactory credit.
These ratings are considered to be investment grade, which means that the security or corporation being rated carries a quality level that many institutions require. Everything below "BBB" is considered speculative or worse, down to a "D" rating, which indicates default or "junk."
The following chart gives an overview of the different ratings that Moody's and Standard & Poor's issue:
|Moody's||Standard & Poor's||Fitch||Grade||Risk|
|Ba, B||BB, B||BB, B||Junk||High Risk|
Corporate credit ratings are not a guarantee that a company will repay its obligations. However, the long-term track record of these ratings is reflective of the variations in creditworthiness among rated companies, especially when compared within the same industry. In one study, for example, Standard & Poor’s found that “the average five-year default rate for investment-grade corporate issuers was 1.07%, compared to 16.03% for speculative-grade (junk-rated) companies.”
Since the ratings are opinions, ratings of the same company can differ among rating agencies. Investment research firm Morningstar also provides corporate credit ratings that range from AAA for extremely low default risk to D for payment default.
Criticism of Corporate Credit Ratings
A key criticism is that the issuers themselves pay the credit rating agencies to rate their securities. This became particularly important as the surging real estate market peaked in 2006-2007, and a significant amount of subprime debt was being rated by the agencies. The potential to earn high fees created competition between the three major agencies to issue the highest ratings possible.
During the financial crisis of 2008, companies that had received glowing ratings previously from various credit rating agencies were downgraded to junk levels, calling into question the reliability of the ratings themselves.
The lingering criticism that has plagued rating agencies is that they are not truly unbiased because the issuers themselves pay the rating agencies. According to critics, to secure the job to conduct a rating, a rating agency could give the issuer a rating that it wanted or could sweep under the rug anything that would negatively impact a positive credit rating. Credit agencies came under intense fire, for good reason, when the post-mortem on the credit crisis was performed.