What Are Standard and Poor's Credit Ratings?
How the ratings scale works and its role in the 2008 financial crisis
Standard & Poor's is a business intelligence company that falls under the corporate umbrella of S&P Global. Standard & Poor's specializes in providing credit ratings for bonds, countries, and other investments, but that's just one of the thousands of financial market services offered by S&P Global. The company uses its vast access to data to provide customized analysis and establish market indexes. The most well-known index offered by S&P Global is the S&P 500.
The names "Standard" and "Poor" come from two financial companies that merged in 1941. There is a level of irony in a company called "Poor's" measuring wealth, but that name came from one of the company's founders, Henry Varnum Poor. In 1860, he published the “History of Railroads and Canals of the United States.” The book was a product of Poor's concern about a lack of quality information available to investors. His book planted the seeds of corporate transparency, and over the following 160 years, those seeds grew into an advanced system of corporate and national credit ratings.
Standard & Poor's Ratings
The S&P rating is a credit score that describes the general creditworthiness of a company, city, or country that issues debt. The Standard and Poor's company rates how likely debt will be repaid from the entity in question. The ratings are for informational purposes only—they aren't investment recommendations, nor do they predict the probability of default. S&P also rates the creditworthiness of individual bonds. There are several different types of bonds, all of which vary in their ratio of risk to return.
You can use S&P ratings to help you decide whether to buy a bond. It will also give you a sense of how a country's economy is doing. That can help you with other investments like forex trades or foreign stocks.
How S&P Creates the Ratings
S&P analysts create the ratings. They get information from published reports such as annual reports, press releases, and news articles. They also interview the management of the company they are rating. Using these resources, the analysts assess the company’s financial condition, operating performance, and policies. Most importantly, they form an opinion about the company's risk management strategies.
In the beginning, Standard & Poor's charged a subscription fee for access to their credit reports. In 1968, it changed its revenue structure and started charging the companies it was rating, instead of the investors using the ratings.
In a 2002 Congressional hearing, S&P said it changed its revenue structure to address rising costs and increased demand for credit ratings, though that hasn't stopped critics from speculating about the ability of S&P to adequately evaluate its paying customers.
How the Ratings Scale Works
An S&P credit rating is a letter grade. The best is "AAA." This rating means it is highly likely that the borrower will repay its debt. The worst is "D," which means the issuer has already defaulted.
Standard & Poor's uses multiple letters (sometimes accompanied by pluses or minuses) to indicate strength. In total, there are 17 ratings, even though Standard & Poor's only uses four different letters. This is achieved by doubling or tripling letters—the more the better. Ratings can also include a plus sign (which is better than standalone letters) or a minus sign (which is worse than standalone letters).
S&P is just one of the three major credit rating agencies in the U.S. All three use similar ratings systems, though you may notice some small differences between the way those ratings are conveyed. For instance, a "BBB+" rating from S&P is the same as a "Baa1" rating from Moody's.
A bond that receives a high letter grade can pay a lower interest rate than one with a lower grade. That's because it isn't as risky, according to S&P. In exchange for the relatively safe investment, investors will settle for smaller returns. Companies, cities, and countries work hard to keep a high letter grade so they can save money by issuing bonds with low interest rates. The safest bonds are known as "investment-grade."
The table below shows the specifics for long-term bonds. Letter grades of BB+ or lower are considered "speculative." You may also hear them referred to as "high-yield" or "junk" bonds. These companies have to pay more in interest to offset the increased risk.
Some investors like junk bonds because as long as the issuer doesn't default, the investor can make more money.
Ratings Scale for Long-Term Bonds
The following chart provides further detail on what each letter grade means for the issuing entity.
|Letter Grade||Grade||Capacity to Repay|
|AA+, AA, AA-||Investment||Very strong|
|A+, A, A-||Investment||Strong|
|BBB+, BBB, BBB-||Investment||Adequate|
|BB+, BB||Speculative||Faces major future uncertainties|
|B||Speculative||Faces major uncertainties|
|CC||Speculative||Currently highly vulnerable|
|C||Speculative||Has filed bankruptcy petition|
S&P offers ratings on short-term debt, though on a slightly different scale. S&P also provides outlook ratings, which attempt to project how the entity will be fairing in six months to two years, compared to how it's doing now. Those ratings are positive, negative, stable, or developing.
S&P publishes ratings for 130 countries. The company analyzes how likely it is that a country will default on its sovereign debt. There are five areas of assessment: institutional, economic, external, internal, and monetary. Institutional and economic assessments are combined to create an institutional and economic profile of the country. The remaining three areas of assessment are combined to create a flexibility and performance profile.
These profiles are based on the analysis of factors including:
- Whether the country's government is stable and follows sustainable fiscal policies
- The country's economic strength and its growth prospects
- Foreign direct investment
- Whether the nation's central bank is independent of its government and uses good monetary policy
S&P Ratings' Role in the 2008 Financial Crisis
Critics blame the S&P and other rating agencies for the 2008 financial crisis. S&P gave AAA ratings to mortgage-backed securities as late as 2006, but in 2007, as the housing market began its downturn, 83% of those securities were suddenly downgraded. Critics have voiced concern that perhaps S&P was reluctant to give a low grade to its paying customers.
A Congressional inquiry later determined that these risky conditions were exacerbated by decades of deregulation of the financial industry.
As the recession worsened, governments increased spending to stimulate the economy. As a result, in 2011, S&P downgraded U.S. Treasury debt 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 the Dow plummeting in August 2011.
Many analysts noted the irony in the U.S. downgrade. S&P helped cause the recession by giving good ratings to mortgage-backed securities that defaulted. It then punished the government for the debt created by that same recession.
Standard & Poor's also publishes the S&P 500. This is a stock market index that tracks the largest companies that are publicly traded in the U.S. All told, the S&P 500 represents roughly 80% of the available market capitalization. The index isn't directly related to the bond and country ratings issued by S&P.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.
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