Hello
What would some of the implications be for, say XYZ plc, if Moody had rates for their debt Baa1 and S&P had rates for their debt of BBB+?
I’m struggling to understand this concept.
Thanks for all your help.
It would mean that XYZ plc is rated Baa1/BBB+. These are in fact the same rating, they just use different scales. Not sure what implications you’re looking for?
Need more clarification about what exactly you are asking.
But I can make a linkage based on some assumptions.
BBB is the lowest investment grade category. The risk of becoming a non-investment grade bond gets very high if XYZ plc is rated BBB+. This is the short answer.
Long answer is that, just one category downgrade (to BB) and the bond would become a non-investment grade and many institutional investors will dump this bond (either due to legal restrictions such as those faced by Pension Funds and Insurance comapnies or simply by choice).
It may also be thrown out of some bond indices because it will no longer the meet the criteria of investment grade.
Since many investors will start selling this bond, the price of the bond will go down and yield required on the bond will increase which will make the bond to trade at a discount.
Lenders might also ask the borrower to post additional collateral because borrower’s credit worthiness has decreased and the risk of not getting back their money has increased (credit risk).
Another extreme scenario is that borrower technically defaults on the bonds. Borrowers are made to comply with the covenants (Do’s and don’ts of the bond contract). Usually as part of covenants, borrowers are required to maintain their ratios (such as coverage and solvency ratios) above certain level.
For example, XYZ plc might be required to maintain their interest coverage ratio above the value of 5, but their EBIT decreases significantly due to some reason, which leads to a value of below 5 which will result in a technical default. This technical default will lead to a credit downgrade by the rating agencies.
So a credit rating of BBB+ puts XYZ plc in a very risky position. They don’t have any more roam for downgrades.
Geo - Thanks for your input.
Finkid - Thank you for your detailed reply, I found it extremely helpful.
– I asked the question as I needed whatever information possible regarding what, if any, implications would XYZ plc come across. You made some really good points, which have made me think more analytically, which is probably what I was struggling with to begin with.
Thank you again for your replies. It is appreciated.