How to Compare Bond Ratings from Moody's and Fitch

A credit-rating downgrade can have calamitous corporate consequences.

Fitch Ratings is a division of Fitch Inc., Moody's Investor Service is a subsidiary of Moody's Corp., and together they are two out of the "big three" credit rating agencies. The other is Standard & Poor's (S&P), a division of The McGraw-Hill Companies. There are some differences in the way these companies rate bonds, but in each case they start with the fundamental distinction between investment grade bonds and non-investment (or speculative) grade bonds.

Investment Grade

Each of the major credity rating agencies ranks the credit-worthiness of borrowers (corporate, sovereign and other) using similar standardized scales. Each firm uses different scales for different sorts of credit instrument and issuer. The following material refers especially to corporate bonds.

Moody's distinquishes four levels of investment-grade bonds. From lowest to highest risk, they are: Aaa, Aa, A and Baa.

Fitch eschews the use of lower-case letters, but otherwise its levels within the investment grade are much the same. In the same order: AAA, AA, A, BBB.

Non-Investment Grade

Moody's recognizes five levels of what it calls speculative grade. In order of increasing risk: Ba, B, Caa, Ca, C. The final level, C, consists of bonds that are "typically in default, with little prospect of reecovery of principal or interest."

For Fitch, that is BB, B, CCC, CC and C. Although for other credit instruments, Fitch has a D rating for default, in the case of corporate bonds it has explained, "Defaulted obligations typically are not assigned 'D' ratings, but are instead rated in the 'B' to 'C' rating categories, depending upon their recovery prospects and other relevant characteristics."

Significance

Ratings are of enormous significance. Certain institutional investors, such as money-market funds, are barred from purchasing bonds unless those bonds have credit ratings above a specified threshold. Also, some corporate issuers are bound by contract (specifically by their bond indentures) to make pay-outs if their credit rating should fall below a certain threshold.

History

The credit-rating industry had its origins in the first decade of the 20th century, when John Moody, founder of the firm that bears his name, published a book ranking railroads' securities. Poor's Publishing Company--a corporate precursor of S&P--entered the same market in 1916. Fitch did likewise in 1924.

Expert Insight

In recent decades, the credit rating agencies have received payment from the issuers of the bonds they are rating, and have come under a good deal of criticism from those who regard such a business model as inherently conflicted. Claire Hill, a University of Minnesota law professor, has written in The New York Times' DealBook that the ratings agencies have come to see themselves as working "with their clients, the issuers, toward a shared goal of obtaining high ratings for the issuers' securities." This state of mind has caused the agencies to "brush away doubts" and "cling to overoptimistic models," she said.

References

• Moody's Investors Service: Moody's Rating Symbols and Definitions
• Fitch Ratings: Corporate Finance Obligations
• Find-a-Case: Stonebridge Capital v. Nomura International
• The Washington Post: Smoothing the Way for Debt Markets
• The New York Times DealBook: Reining in the Rating Agencies