1. Corporate Financial Policy Rating Agencies
Professor André Farber
Solvay Business School
13/08/2019
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2. References
Bodie, Kane and Marcus, Investments, 4th ed. McGraw-Hill 1999
Moody’s, The Evolving Meaning of Moody’s Bond Rating – August 1999
Standard & Poors, European Default Rates Inch Closer to the Global Average, April 2002
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3. Rating Agencies Investment-grades Speculative-grades
Moody’s (
Standard and Poors (
Fitch/IBCA (
Letter grades to reflect safety of bond issue
Very High Quality
High Quality
Speculative
Very Poor
S&P
AAA AA A
BBB BB B
CCC D
Moody’s
Aaa Aa
Baa Ba
Caa C
Investment-grades
Speculative-grades
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4. Determinants of Bonds Safety
Key financial ratio used:
Coverage ratio: EBIT/(Interest + lease & sinking fund payments)
Leverage ratio
Liquidity ratios
Profitability ratios
Cash flow-to-debt ratio
Rating Classes and Median Financial Ratios,
Rating Category
Coverage Ratio
Cash Flow to Debt
Return on Capital %
LT Debt to Capital %
AAA
6.34
0.49
24.2
11.7 AA
4.48
0.32
18.4
19.1 A
2.93
0.17
13.5
29.4
BBB
1.82
0.04
9.7
39.6 BB
1.33
0.01
9.1
51.1 B
0.78
(0.02)
6.3
61.8
Source: Bodies, Kane, Marcus Table 14.4
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5. Standard&Poor’s European Rating Distribution
1985
1990
1995
2000
2002
AAA 20 37 52 49 42 AA 14 59
117
171
185 A 6
159
315
350
BBB
141
244
Investment-grade 40
110
370
676
821 3 2 7 71
103 B 1 8 75 81
CCC 12 23
Speculative-grade 16
158
207
Total 43
113
386
834
1028
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6. Default Rate Calculation
Incorrect method:
Number defaults/Total number of bonds
Ignores growth/reduction of bond market over time
Ignores aging effect: takes time to get into trouble
Correct method: cohort style analysis
Pick up a cohort
Follow it through time
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7. Moody’s:Average cumulative default rates 1920-1999 %3 4 5 10 15 20
Aaa
0.00
0.02
0.09
0.20
1.09
1.89
2.38 Aa
0.08
0.25
0.41
0.61
0.97
3.10
5.61
6.75 A
0.27
0.60
1.37
3.61
6.13
7.47
Baa
0.30
0.94
1.73
2.62
3.51
7.92
11.46
13.95
Inv. Grade
0.16
0.49
0.93
1.43
1.97
4.85
7.59
9.24 Ba
3.45
5.57
7.80
10.04
19.05
25.95
30.82 B
4.48
9.16
13.73
17.56
20.89
31.90
39.17
43.70
Spec. Grade
3.35
6.76
9.98
12.89
15.57
25.31
32.61
37.74
All Corp.
1.33
2.76
4.14
5.44
6.65
11.49
15.35
17.79
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8. S&P: Average One-Year Transition Rates - Europe
Rating at Jan. 1
AAA AA A
BBB BB B
CCC D NR
91.20
6.21
0.26
0.00
2.33
0.25
88.57
7.99
0.37
2.83
2.21
88.47
4.47
0.29
0.05
4.51
5.13
85.88
0.77
0.13
7.57
0.30
3.34
78.42
5.78
1.82
0.91
9.42
0.74
3.68
69.12
6.25
7.35
12.50
15.22
63.04
6.52
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