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RATING

The rating is a measure of the issuer’s ability to meet its obligations (ability to redeem the issue or pay coupons). A credit rating is a measure of expected losses resulting from a likelihood of default together, where appropriate, with the severity of the loss. Another important element in assigning a rating is forecasting. “We don’t look at what a company’s worth today, but ‘where’ – according to us – it will be in three and five years from now,” explains Moody’s.

At the issuer’s request, the agency analyses and undertakes throughout the duration of the issue to check the validity of its assessment at least once a year. It also reserves the right to place the issue in question under observation if it considers that new data may prompt an upward or downward revision of the rating (see Watchlist, Outlook).

Moreover, there are two types of ratings – the rating assigned to the issuer and the rating assigned to each specific issue. Indeed, it is enough for an issue to come with specific guarantees (or, on the contrary, for it to be subordinated) for the issue’s rating to be different from that of the issuer (see Bond Ranking).

Moody’s, Standard & Poor’s and Fitch are the three best-known companies engaged in judging the quality of the issuer.

WATCH LIST

Following a particular event (merger, acquisition, etc.) that may have an impact on the issuer’s financial situation, a rating agency can place the issue on a watchlist, which can either be downgrade (a lowering of the rating is expected), upgrade (a rating improvement is expected) or ‘uncertain’ (when the direction of the impact is unclear). In most cases, placement on a watchlist is followed by a new rating within three months. In any case, a rating can be changed without first placing the issue on a watchlist .

OUTLOOK

When a rating agency uses a change in outlook to give a signal, this means that the decision is based on cyclical changes or changes in the economy .

For a simple change of outlook, the chances of changing the issue’s rating range between 25% and 50%, and a possible decision will generally occur within a period of twelve to eighteen months. Changes in outlook are described using four adjectives: positive, stable, negative or developing.

RATING SCALES

There are several rating agencies, although the two best known are indisputably Moody's and Standard & Poor's (S&P).

INVESTMENT GRADE

S&P		Moody’s
AAA	Ability to pay interest and redeem the capital is extremely high.	Aaa
AA+	Ability to pay interest and redeem the capital is very high.	Aa1
AA		Aa2
AA-		Aa3
A+	Ability to pay interest and redeem the capital is high, but the issuer is more sensitive to unfavourable economic changes or events.	A1
A		A2
A-		A3
BBB+	Ability to pay interest and redeem the capital is good, but unfavourable economic conditions or a change in the environment are more able to affect the issuer’s ability to service the debt normally.	Baa1
BBB		Baa2
BBB-		Baa3

HIGH YIELD

S&P		Moody’s
BB+	Payment at maturity is uncertain due to the issuer’s vulnerability to unfavourable economic and financial conditions.	Ba1
BB		Ba2
BB -		Ba3
B+	The issuer is quite vulnerable to unfavourable economic and financial conditions, but it can nevertheless meet its commitments.	B1
B		B2
B-		B3
CCC+	Payment at maturity is doubtful and depends on favourable economic and financial conditions.	Caa1 Caa2 Caa3
CCC
CCC-
CC	Payment at maturity is extremely doubtful and highly dependent on economic and financial conditions.	Ca
C	The likelihood of fully servicing the debt on time is very small.	C
D	The issuer has already defaulted on payment of interest and/or principal.	WR

FALLEN ANGEL

A bond that had been classified under the ‘investment grade’ category and is now in the ‘high yield’ category after being downgraded.

Example : Koninklijke Ahold NV (Rating at 17.01.2003: Baa3 / Rating at 25.02.2003: B1 )

RISING STAR

A bond that had been classified under the ‘high yield’ category and is now in the ‘investment grade’ category after being upgraded.

Example :

Russia (Rating at 28.07.2003: Ba1 / Rating at 08.10.2003: Baa3)
Mexico (Rating at 02.02.2000: Ba1 / Rating at 07.03.2000: Baa3)

JUNK BONDS

Junk bonds is the name given to bonds in the high yield category. These are classic bonds issued by companies whose risk of defaulting is very high. To attract investors, these issuers must offer very high yields.

DISTRESSED

This group includes bonds whose issuers are experiencing difficulty paying as well as defaulted bonds. It corresponds to bonds with a C or lower rating. This category is a sub-class of the high yield category .

Examples : Swissair, Parmalat, etc.

RANKING OF AN ISSUE

Secured bonds :
The debt is covered by specific guarantees. In case of bankruptcy, the product of the sale of the guarantee goes first to pay back the debt .

Senior debt :
In case of liquidation of the issuer, these debts will be reimbursed (including late interest) before all other debts.

Unsecured bonds :
The debt is issued without any specific guarantee. In any case, in the event of bankruptcy, the debt can be covered by all the issuer’s assets that have not been used to meet other obligations.

Subordinated debt :
In case of bankruptcy, these debts are paid back after all priority debts have been repaid. Since the debt is issued without any special guarantees, in case of bankruptcy it must be covered by all the issuer’s assets that have not been defined as special guarantees with regard to other obligations. Indeed, the subordination clause amounts to an explicit statement of the absence of a guarantee. As the issuer’s financial situation deteriorates, the status of subordinated bonds approaches that of shares .

For priority securities, the issue of subordinated debt changes very little. But the same is not true the other way – the launching of a first-rate issue inevitably deteriorates the quality of subordinated bonds .

Example :

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