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Credit Ratings-A Refresher on the ABC's!
Sunday 26, February 2017

Credit Ratings- A Refresher on the ABC’s!

LisaF

 

 

 

 

 

 

Over the last ten years we have seen investor psychology shift as the public’s knowledge as regards investments, namely bonds, has improved tremendously.  Investors are much savvier now when making their investment decisions.  They consider the bonds’ credit worthiness, just as if they were shopping or making vacation or dinner plans.  They spend time researching it online and asking others’ opinion before investing in a similar fashion to purchasing an item or choosing a resort or a restaurant.  In the same way that consumers read reviews before making a decision, similarly investors check on the credit ratings of  bonds before adding them to their portfolio.

If you are determined to stay on top of your game you must read the newspapers, watch the news on the television and check the internet for the latest information on the markets of interest to your portfolio. We should all pay attention to these key words (downgraded/upgraded) or (positive outlook /negative outlook/ stable outlook) especially in reference to companies we like and countries in general. Let’s delve further into the real meaning of the ratings assigned by the credit rating agencies.

A credit rating agency is a company that provides opinions on the credit worthiness and provides a scale or grading methodology to assess the strength of a company, a country and any financial risk that may be encountered when purchasing that particular security. The goal of the agencies is to reflect the borrowers’ capability of meeting its financial commitments on a timely basis (i.e. its ability to repay the loan including the coupon payment and the principal). Ratings are based on a number of fundamental findings such as the economic strength of the country, political system and the social environment, just to name a few.

There are three main credit rating agencies namely Standard & Poor’s (referred to as S&P), Moody’s and Fitch.  The ratings provided by these agencies  are not meant to be a recommendation to investors  to buy, sell or hold a particular security, what the investor does with the information depends on their willingness to accept  the  credit opinion and use it as a guide.

After the sub-prime mortgage crisis in the United States and its contribution to the U.S. recession of December 2007- June 2009, the credit agencies came under a lot of negative reviews regarding the ratings that they assigned to various securities prior to the crisis.  The severe downgrades came way too late after the crisis had already hit.  Despite this, these rating agencies do have a balanced system and rating scale that is quite useful like in school when you get a grade for a project handed in, it works. The rating scale that they use is easy to understand if one remembers our grading system in school.

Ratings range from as high as AAA by S&P to the lowest D which we should never be considering unless we are willing to risk it all. Each agency uses a similar scale but names the categories differently, for example AA+ by S&P or Aa1 by Moody’s’  invariably means the investment is safe and carries a low risk of failure.   

Ratings in the AAA – A; represent a strong commitment to meet its financial obligations.

Ratings in the BBB – B; represent an adequate capacity to meet its obligations on the higher end of the scale (BBB) to being vulnerable to adverse conditions towards the lower end (B).  Investment grade securities are rated BBB- and above.

Ratings in the C category are highly vulnerable and dependent on favourable business, financial and economic conditions in order to meet their commitments.

A rating of D means that the company/country has defaulted and is unable to make payments. 

In addition to the letters a plus (+) or minus (-) sign is assigned to show relative standing within the major rating categories, for example, A+ or A-.

An outlook may also be assigned to the rating which helps to predict the next possible movement that may occur. There are three possible outlooks that we need to pay attention to and they are 1). A Positive Outlook which indicates improving conditions and the rating may be raised,  2) A Negative Outlook which is telling us that a possible downgrade is on the horizon, and of course 3). A Stable Outlook which means it’s business as usual as nothing has changed or at least is not expected to change until the next assessment is due.

The rating agencies Standard & Poor’s (referred to as S&P), Moody’s and Fitch have regained wide spread acceptance since the year 2007 as a convenient tool in differentiating the credit quality of the various securities available.  While the ratings indeed provide guidance as to which instrument to invest in, other variables should be used in conjunction with those findings before making an investment decision so give us a call if you need any advice.

 

Lisa Minto-Powell is the Manager, Financial Planning at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm Feedback:  If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm

Credit Ratings- A Refresher on the ABC’s!

 

Over the last ten years we have seen investor psychology shift as the public’s knowledge as regards investments, namely bonds, has improved tremendously.  Investors are much savvier now when making their investment decisions.  They consider the bonds’ credit worthiness, just as if they were shopping or making vacation or dinner plans.  They spend time researching it online and asking others’ opinion before investing in a similar fashion to purchasing an item or choosing a resort or a restaurant.  In the same way that consumers read reviews before making a decision, similarly investors check on the credit ratings of  bonds before adding them to their portfolio.

If you are determined to stay on top of your game you must read the newspapers, watch the news on the television and check the internet for the latest information on the markets of interest to your portfolio. We should all pay attention to these key words (downgraded/upgraded) or (positive outlook /negative outlook/ stable outlook) especially in reference to companies we like and countries in general. Let’s delve further into the real meaning of the ratings assigned by the credit rating agencies.

A credit rating agency is a company that provides opinions on the credit worthiness and provides a scale or grading methodology to assess the strength of a company, a country and any financial risk that may be encountered when purchasing that particular security. The goal of the agencies is to reflect the borrowers’ capability of meeting its financial commitments on a timely basis (i.e. its ability to repay the loan including the coupon payment and the principal). Ratings are based on a number of fundamental findings such as the economic strength of the country, political system and the social environment, just to name a few.

There are three main credit rating agencies namely Standard & Poor’s (referred to as S&P), Moody’s and Fitch.  The ratings provided by these agencies  are not meant to be a recommendation to investors  to buy, sell or hold a particular security, what the investor does with the information depends on their willingness to accept  the  credit opinion and use it as a guide.

After the sub-prime mortgage crisis in the United States and its contribution to the U.S. recession of December 2007- June 2009, the credit agencies came under a lot of negative reviews regarding the ratings that they assigned to various securities prior to the crisis.  The severe downgrades came way too late after the crisis had already hit.  Despite this, these rating agencies do have a balanced system and rating scale that is quite useful like in school when you get a grade for a project handed in, it works. The rating scale that they use is easy to understand if one remembers our grading system in school.

Ratings range from as high as AAA by S&P to the lowest D which we should never be considering unless we are willing to risk it all. Each agency uses a similar scale but names the categories differently, for example AA+ by S&P or Aa1 by Moody’s’  invariably means the investment is safe and carries a low risk of failure.   

Ratings in the AAA – A; represent a strong commitment to meet its financial obligations.

Ratings in the BBB – B; represent an adequate capacity to meet its obligations on the higher end of the scale (BBB) to being vulnerable to adverse conditions towards the lower end (B).  Investment grade securities are rated BBB- and above.

Ratings in the C category are highly vulnerable and dependent on favourable business, financial and economic conditions in order to meet their commitments.

A rating of D means that the company/country has defaulted and is unable to make payments. 

In addition to the letters a plus (+) or minus (-) sign is assigned to show relative standing within the major rating categories, for example, A+ or A-.

An outlook may also be assigned to the rating which helps to predict the next possible movement that may occur. There are three possible outlooks that we need to pay attention to and they are 1). A Positive Outlook which indicates improving conditions and the rating may be raised,  2) A Negative Outlook which is telling us that a possible downgrade is on the horizon, and of course 3). A Stable Outlook which means it’s business as usual as nothing has changed or at least is not expected to change until the next assessment is due.

The rating agencies Standard & Poor’s (referred to as S&P), Moody’s and Fitch have regained wide spread acceptance since the year 2007 as a convenient tool in differentiating the credit quality of the various securities available.  While the ratings indeed provide guidance as to which instrument to invest in, other variables should be used in conjunction with those findings before making an investment decision so give us a call if you need any advice.

 

Lisa Minto-Powell is the Manager, Financial Planning at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm Feedback:  If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm

 

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