It was the year 2011, under Obama’s leadership, that the United States lost its AAA (triple A) rating in a move that sent shock waves across the world. It happened in the midst of fighting over increasing the debt ceiling so that the US could pay its bills. Having heard that news, you would wonder what it all really means and why it should matter to you.

The earliest ratings were done in 1906 by the forerunner to Standard & Poors(S&P), and were quickly followed by Moody’s and Fitch, the other well-known ratings’ agencies.

The process was refined over time and became standard beginning in the 1970s. Each company adopted a different approach but the basic principle was consistent, meaning that A’s are good and C’s are bad.

AAA is the best rating that one can achieve, after that the next best thing is AA (double A) and then A (single A). This same concept goes for BBB, CCC and D. The lowest score one can get under S&P is D which signals that the asset is in default.

Fitch’s rating system is very similar to S&P with a few minor differences. Moody’s rating system is a little different and sometimes a little confusing. Look at the table below for examples of equivalent ratings. In the table, Moody’s Aa1 is equivalent to S&P’s AA+ which is equivalent to Fitch’s AA+.

Moody’sS&PFitch

Aa1 AA+ AA+

Baa1 BBB+ BBB+

Caa3 CCC- CCC-

Ratings are used to determine credit worthiness or — to put it more simply — it provides a method of assessing how strong a company, a country, or a security is.

It is particularly useful for purposes of comparison. In fact this is probably one of the most popular uses of ratings. When you are given different bonds, for example, and they seem similar in terms of maturity and interest rate, you will choose the one with the highest rating (for the most part).

The interest rate paid is frequently tied to the rating. All things being equal, a higher rated company can borrow at a lower cost than a company with a low rating.

This makes life very difficult for investors, because selecting a highly rated company is likely to result in low interest earnings, naturally investors want the highest paying securities! This creates a dilemma which forces investors to balance ratings and earnings. An investor will go for an attractive return but probably not the highest available, because the highest number is probably associated with the lowest rated security.

Ratings are not perfect.

When I discuss ratings with some of my clients, I am quickly greeted with scepticism. Why? Because they remember the sub-prime crisis of 2008 when AAA (triple A) securities were in default because the rating companies incorrectly assigned them high ratings. This was particularly true of the complex structured products that no one really understood, least of all the rating agencies.

As a result, there is still a large distrust of what is published.

There are other challenges as most rating agencies are acting on historical information, which mostly is the same data available to investors, but to really analyse a company, you may need to be as forward- looking as possible. Even a good company may have significant challenges ahead, and conversely, a seemingly bad company may have very positive prospects.

Ratings agencies usually publish an outlook, and this can be very helpful with the decision-making progress, they may assign a positive outlook, a negative outlook, or a stable outlook. It is worth noting that these major companies do not rate every company, in fact there are lots of companies that are not rated at all.

There is one major limitation to ratings which every investor has to keep in mind. Let’s use Jamaica as an example,

Jamaica is rated B by S&P and Fitch, but Caa2 by Moody’s. This means that any company domiciled in Jamaica and rated by these agencies is unable to get a rating higher than Jamaica’s rating. This is true for other countries and is the reason that Sagicor Financial Corporation, which issued a bond last year, changed their domicile from Barbados to Bermuda, in an effort to seek a higher rating. As long as they were domiciled in Barbados, they could not get a higher rating than B (single B). Bermuda has a rating of A+.

CariCRIS is a ratings agency which rates Caribbean credits only and was created to overcome the limitations of the “doctrine of the sovereign ceiling.”

One last thing: anything BBB- and above is considered investment grade for S&P. Anything below that is considered junk. Yes, our beloved Jamaican bonds are junk. This is an important demarcation.

There are companies in the US whose business activities are actually curtailed if their ratings fall below investment grade. This forces many companies to fight valiantly to maintain their investment- grade status. Notwithstanding the limitations, ratings are still the most objective way to assess a company, and should be used along with other tools to make your investment decision.

Yanique Leiba-Ebanks is the AVP, Trading & Business Development at Sterling Asset Management. Sterling provides financial advice and instruments in US dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm