Bond Rating Confusion

Abstract

Bond ratings are becoming confusing because rating agencies have adopted inconsistent rating definitions for different kinds of securities. Standard & Poor's rating definitions illustrate the issue most vividly. S&P's rating symbols correspond to different default probabilities for 1) corporate bonds, 2) mortgage and asset backed securities, and 3) collateralized bond obligations. At Moody's, the rating scale for U.S. municipal bonds is calibrated to different levels of expected loss than is the rating scale for all other types of bonds. Inconsistent rating definitions undermine the comparability of bonds from different sectors of the fixed income markets. Moreover, regulations that rely on private credit ratings often presume that each rating agency's rating definitions are constant across market sectors (and also constant over time). Inconsistent rating definitions contradict that presumption and cast doubt on the effectiveness of the regulations.

TOPICS: Asset-backed securities (ABS), information providers/credit ratings, credit risk management