Corporate credit and rating agencies — Credit Module 7

When a corporate or a government issues a bond, rating agencies assign a credit rating that summarises their view of the issuer's default risk. The rating becomes a market-coordination device: investment mandates often forbid holding bonds below a certain rating; the rating directly affects the interest rate the issuer pays. Understanding ratings is non-negotiable for anyone working in credit.

The rating scale

text

  S&P / Fitch          Moody's    Category         Default rate (10y, historical avg)
  ─────────────────────────────────────────────────────────────────────────────
  AAA                  Aaa        Highest grade    <0.1%
  AA+, AA, AA-         Aa1, Aa2, Aa3                ~0.5%
  A+, A, A-            A1, A2, A3                   ~1.5%
  BBB+, BBB, BBB-      Baa1, Baa2, Baa3 INVESTMENT  ~4%      (split here ↓)
  BB+, BB, BB-         Ba1, Ba2, Ba3    GRADE       ~10%
  B+, B, B-            B1, B2, B3       HIGH        ~25%
  CCC+, CCC, CCC-      Caa1, Caa2, Caa3 YIELD /     ~45%
  CC                   Ca               SPECULATIVE
  C                    C                              ~80%
  D / SD               D                Default      100%

The split between BBB- and BB+ (S&P/Fitch) or Baa3 and Ba1 (Moody's) is the investment-grade / high-yield boundary. Many institutional investors are mandated to hold only investment grade.

What the rating actually measures

Rating agencies analyse: business risk (competitive position, sector dynamics, scale), financial risk (leverage ratios, cash flow stability, liquidity), management quality, governance, and the macro/regulatory context. They produce a 'corporate family rating' for the issuer and may rate specific instruments differently based on seniority and structure.

Sovereign vs corporate ratings

Sovereign ratings: rate countries. Kenya is currently rated B (S&P), B (Fitch), B3 (Moody's) — all in the speculative grade, reflecting fiscal pressures and high external debt.
Corporate ratings: rate companies. Typically capped at the sovereign rating (the 'sovereign ceiling') because a company can't have lower country risk than its country.
Issue ratings: rate specific bonds, which can differ from the issuer's overall rating based on subordination, security, and covenants.

The 2008 lesson — ratings can fail spectacularly

In 2007, the major agencies rated thousands of mortgage-backed securities (MBS) and collateralised debt obligations (CDOs) AAA. By 2009, most were defaulted or worthless. The structural flaw: agencies were paid by issuers, the rated products had no track record, and the models assumed correlations that broke under stress. Senior credit analysts now treat ratings as one input among many — not the answer. The agencies have reformed (some); the structural conflicts (paid by issuers, dominant oligopoly) remain.

Reading a corporate credit profile

Start with the issuer's most recent rating action (upgrade / downgrade / affirmation / on watch) — that's the agency's current view.
Read the 'rationale' paragraph — usually 200–400 words explaining the rating. This is where the agency states what would trigger an upgrade or downgrade.
Compare to peer ratings in the sector — outlier ratings (high or low) deserve investigation.
Check the issue-level ratings if there are bonds outstanding — these can differ from the corporate family rating.
Look at the spread the bonds trade at — the market's view of credit risk often diverges from the rating, and the divergence is informative.

Exercise

A Kenyan corporate has a B+ rating from S&P. They want to issue a 7-year USD Eurobond. US Treasuries of 7 years yield 4.5%. What spread should they expect, roughly? What factors could push the spread higher or lower? How would the bonds trade differently from sovereign Eurobonds?