Standard and Poor's, the Company and Its Ratings
How S&P Ratings Protect You
Standard & Poor's is a business intelligence corporation. Its corporate name is S&P Global. It provides credit ratings on bonds, countries, and other investments. S&P Global also calculates more than 1 million stock market indices. The most well-known is the S&P 500. The company provides customized analyses using its data.
Standard and Poor are the names of the 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.” Poor was concerned about the lack of quality information available to investors. His book began a campaign to publicize details of corporate operations.
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 five different types of bonds, all of which vary in their ratio of risk versus return.
You can use S&P ratings to help you decide whether to buy a bond. It will also tell you how a country's economy is doing. That can help you in 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 sold their reports to investors. S&P changed that policy when copy machines were invented. The company worried that investors would copy the reports and distribute them to their friends. Instead, it started charging the companies it was rating.
Standard & Poor's has come under criticism for that change. Critics doubt that S&P can adequately evaluate its paying customers.
How the Ratings Scale Works
An S&P 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.
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 loans with low interest rates.
The table below shows the specifics for long-term bonds. Letter grades of BB+ or lower are speculative. The company has to pay more in interest to offset the increased risk. Some buyers like these "junk bonds" because, as long as they don't default, they offer higher returns.
Ratings Scale for Long-Term Bonds
|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|
(Source: "About Credit Ratings," Standard & Poor's.)
S&P also 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. It bases this on its analysis of four factors:
- It looks at whether the country's government is stable and follows sustainable fiscal policies.
- It reviews the country's economic strength and its growth prospects.
- It takes a look at foreign direct investment.
- The analysts give an opinion on 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 rated mortgage-backed securities "Investment Grade" even though they held many tranches from subprime mortgages. The critics note that S&P was reluctant to give a low grade to its customers. What caused the 2008 financial crisis was the policy of deregulation of the financial industry. This allowed banks to invest in risky hedge funds and engage in too much subprime lending.
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. S&P helped cause the recession. It then punished the government for the debt created by that same recession. U.S. debt rose 40% thanks to lower revenue and higher spending generated by the recession.
Its goal is to represent the entire stock market. It does this by reflecting the risk and return of all large-cap companies.