Standard & Poor’s (S&P) Rating is a classification system for evaluating the creditworthiness of stocks, bonds, and other financial instruments. This system, issued by Standard & Poor’s Corporation, provides an assessment of the risk involved in the timely payment of interest and the return of principal for corporate and municipal bond issues.
Overview of S&P’s Rating System
Investment Grade Ratings
S&P’s top four grades indicate a minimal risk of default:
- AAA (Triple-A): Highest rating, indicating an extremely strong capacity to meet financial commitments.
- AA (Double-A): Very high quality with a very strong capacity to meet financial commitments.
- A: High-capacity to meet financial obligations but somewhat more sensitive to adverse economic conditions.
- BBB (Triple-B): Adequate capacity to meet financial commitments, but more susceptible to adverse economic conditions.
Speculative Grade Ratings
Ratings below BBB are considered speculative and are associated with higher risk:
- BB (Double-B): Less vulnerable in the near term but faces major uncertainties.
- B: More vulnerable to adverse business, financial, and economic conditions but currently has the capacity to meet financial commitments.
- CCC: Currently vulnerable and dependent upon favorable business, financial, and economic conditions to meet financial commitments.
- CC: Highly vulnerable; default has not happened yet but is expected.
- C: Default is imminent or inevitable.
- D: In default or expects to enter default soon.
Historical Context
S&P’s rating system dates back to the early 20th century. Over the decades, it has become one of the most widely recognized credit rating systems globally, used by investors, issuers, and regulators to assess credit risk.
Applicability and Use
Investment fiduciaries often rely on S&P ratings in making portfolio decisions. Investments are typically restricted to bonds rated BBB or higher (investment grade), as these bonds have a lower risk of default. Conversely, bonds rated BB or lower are deemed speculative and present higher risks, often avoided by conservative investors.
Special Considerations
Impact of Downgrade
When an entity’s credit rating is downgraded by S&P, it can lead to higher borrowing costs and a decline in investor confidence. Conversely, an upgrade can enhance an entity’s borrowing conditions.
Legal and Regulatory Framework
Certain regulations restrict fiduciaries from investing in non-investment grade bonds (BB and below), aimed at protecting investors from exposure to high-risk securities.
Comparisons with Other Rating Agencies
S&P is one of the three major credit rating agencies, alongside Moody’s and Fitch:
- Moody’s Ratings: Uses similar nomenclature but with slight differences in grading (e.g., Aa for AA, A1, A2, A3 for various levels of A).
- Fitch Ratings: Uses the same grading system as S&P, with slightly different criteria.
Related Terms
- Credit Rating Agency: An institution that assigns credit ratings to debtors.
- Default Risk: The likelihood that a borrower will fail to meet financial obligations.
- Bond Rating: Similar to credit rating but specifically for bond issues.
FAQs
What is the purpose of S&P's Rating?
Can S&P ratings change over time?
How does S&P determine its ratings?
References
- Standard & Poor’s. “Understanding Ratings.” S&P Global Ratings.
- “Credit Ratings Seven Years after Dodd–Frank: Accessing Credit Ratings for Purchase Use.” International Journal of Central Banking.
Summary
Standard & Poor’s Rating is a critical tool for assessing and understanding the risk associated with various financial instruments. By classifying securities from AAA to D, investors and fiduciaries gain insights into the creditworthiness and investment potential of corporate and municipal bond issues, enabling informed financial decision-making.
