Credit Rating

Rating agencies and some banks assign grades to governments, companies and individual bonds, using financial statements, industry position, management quality and the terms of the debt. External scales run from high-grade categories, where default is very unlikely, down to speculative and default levels. The line between investment grade and speculative grade is widely used in investment rules. Banks also build internal ratings for their borrowers, which feed pricing, limits and capital calculations. Ratings are opinions rather than guarantees, and they can change through upgrades, downgrades or outlook changes. Critics point out that ratings can lag events, and the 2008 crisis showed how heavily structured products had been over-rated. Users are expected to do their own analysis and not lean on a grade alone. Investors and lenders read it when setting price, limits and the collateral they will accept.

A logistics company plans to issue bonds. An agency assigns it a rating one notch above speculative grade after reviewing its debt levels and cash flow. Some pension funds can only hold investment grade bonds, so the company must offer a higher interest rate to attract buyers. A year later, a downgrade raises its borrowing cost and triggers a clause requiring extra collateral on a bank loan.