07 Credit Sights Ratings & IG versus HY

Credit Rating Overview

• Credit ratings are assigned by agencies like S&P, Moody’s, Fitch, and DBRS.

• Ratings determine if bonds fall into the investment grade (IG) or high yield (HY) category.

• IG ratings range from AAA to BBB-; HY starts at BB+ and goes down to C or D.

• A D rating often follows a default event.

Watch (short-term)

signals near-term (≤3 months) rating change potential

Outlook (medium-term)

indicates expected rating trajectory over 6–12 months

Purpose

• Why is debt being raised?

• Refinancing = positive

• Share buybacks/dividends = more negative
  

Payback

• How will debt be repaid?

• Via cash flow, asset sales, refinancing, etc.
  

Risks

Includes macro/micro risks, management, financial profile, etc.

Structure

Debt covenants, seniority, legal protections.

Ratings Impact on Market Access

• Rating affects access and cost of capital.

• IG-rated companies tap into larger, cheaper capital pools.

• HY market is smaller and more expensive.

IG market

• Larger, longer maturity bonds (~10.1 years)

• Average rating: A3 (low A)

• Average coupon: 4.4%

HY Market

• Shorter maturities (~4.6 years)

• Average rating: B1 (high B)

• Average coupon: 6.5%

Yield Differences by Rating

• As rating declines, yield increases due to higher perceived risk.

• Spread increase is gradual in IG, but steep in HY.

• CCC-rated bonds often yield over 10%.

At what rating does the high yield market designation begin?

• BBB

• BB

• BB+

• CCC

• BB+

Which of the following are characteristics of investment grade companies?

• Access to larger pools of funding

• Higher average coupon than high yield

• Shorter maturities on bonds

• Lower risk fixed income securities

• Access to larger pools of funding

• Lower risk fixed income securities

Rank the following ratings from highest to lowest risk.

• BBB- (S&P/Fitch – lowest tier of investment grade)

• Baa1 (Moody’s – lowest tier of investment grade)

• AA- (S&P/Fitch – high credit quality)

• Aa2 (Moody’s – high credit quality)

• Aaa (Moody’s – highest credit rating, lowest risk)

• BBB- (S&P/Fitch – lowest tier of investment grade)

• Baa1 (Moody’s – lowest tier of investment grade)

• AA- (S&P/Fitch – high credit quality)

• Aa2 (Moody’s – high credit quality)

• Aaa (Moody’s – highest credit rating, lowest risk)