Rating Methodologies

rating-methodologies

Credit rating methodologies — S&P, Moody's, Fitch approaches.

When to Activate

• Assessing a company's likely credit rating or rating trajectory
• Preparing for a rating agency engagement or annual review
• Understanding the impact of a transaction (M&A, debt issuance, recap) on credit ratings
• Analyzing the difference between ratings from multiple agencies (split ratings)
• Evaluating subordination and structural considerations for instrument-level ratings (notching)
• Benchmarking financial ratios against rating category medians
• Advising on actions to achieve or maintain a target rating

Core Concepts

Rating Scales

Investment Grade vs. High Yield:

Quality        S&P       Moody's     Fitch      Category
Highest        AAA       Aaa         AAA        Investment Grade
High           AA+/AA/AA- Aa1/Aa2/Aa3 AA+/AA/AA- Investment Grade
Upper Medium   A+/A/A-   A1/A2/A3    A+/A/A-   Investment Grade
Medium         BBB+/BBB/BBB- Baa1/Baa2/Baa3 BBB+/BBB/BBB- Investment Grade
---threshold---
Speculative    BB+/BB/BB- Ba1/Ba2/Ba3 BB+/BB/BB- High Yield
Highly Spec.   B+/B/B-   B1/B2/B3    B+/B/B-   High Yield
Substantial    CCC+/CCC  Caa1/Caa2   CCC       High Yield
Default        D/SD      Ca/C        D/RD      Default

• The BBB-/Baa3 to BB+/Ba1 boundary is the critical threshold — crossing it (fallen angel) triggers forced selling by investment-grade-only mandates
• Modifiers (+/-, 1/2/3) indicate relative standing within a category

S&P Methodology

S&P's corporate rating framework combines business risk and financial risk:

Business Risk Profile (BRP):

1. Industry risk: Cyclicality, competitive dynamics, regulatory environment, growth prospects (scored 1-6)
2. Country risk: Sovereign rating, economic stability, institutional framework
3. Competitive position: Market share, scale, diversification, operating efficiency, profitability

BRP scale: Excellent, Strong, Satisfactory, Fair, Weak, Vulnerable

Financial Risk Profile (FRP):

• Core ratios: FFO/Debt, Debt/EBITDA, FFO/Interest, FOCF/Debt
• S&P adjusts reported figures for operating leases, pensions, hybrid instruments, receivables securitization
• FRP scale: Minimal, Modest, Intermediate, Significant, Aggressive, Highly Leveraged

Anchor rating: Combination of BRP and FRP on a matrix produces the anchor (starting point)

Modifiers (each can adjust up/down 1-2 notches):

• Diversification/portfolio effect
• Capital structure (debt maturity, currency, interest rate mix)
• Financial policy (management's stated leverage target, track record)
• Liquidity (adequate, strong, exceptional — or less than adequate)
• Management and governance
• Comparable rating analysis (final calibration versus peers)

Group/parent influence: Subsidiary ratings adjusted for group credit profile, strategic importance, and support likelihood

Moody's Methodology

Moody's uses industry-specific scorecards combining quantitative and qualitative factors:

Quantitative factors (typically 60-70% weight):

• Scale (revenue)
• Profitability (EBITDA margin, operating margin)
• Leverage (Debt/EBITDA, FFO/Debt)
• Coverage (EBIT/Interest, FFO/Interest)
• Cash flow (RCF/Net Debt, FCF/Debt)

Qualitative factors (typically 30-40% weight):

• Business profile (market position, barriers to entry)
• Revenue diversity (geographic, product, customer)
• Regulatory/event risk
• Financial policy (tolerance for leverage, acquisition strategy, shareholder returns)

Grid-indicated rating: The scorecard output — a starting point subject to further judgment

Adjustments from grid-indicated to actual rating:

• Ownership structure (private equity ownership often weighs negatively — aggressive financial policy assumed)
• Event risk (pending M&A, litigation, regulatory action)
• Liquidity profile
• Structural considerations (priority of claims)

Key Financial Ratios by Rating Level

Approximate medians for non-financial corporates (varies by industry):

Metric              AAA    AA     A      BBB    BB     B      CCC
FFO/Debt            >60%   45-60% 30-45% 20-30% 12-20% 5-12%  7.0x
FFO/Interest        >15x   10-15x 6-10x  4-6x   2.5-4x 1.5-2.5x 30%   20-30% 15-20% 10-15% 5-10%  0-5%   30%

Notching Table

Instrument                      | Recovery | Notch from ICR | Instrument Rating
Senior Secured Term Loan A      | 1+ (95%) | +1             | BBB+
Senior Secured Term Loan B      | 1 (90%)  | +1             | BBB+
Senior Unsecured Notes          | 3 (55%)  | 0              | BBB
Subordinated Notes              | 5 (15%)  | -2             | BB+
Junior Subordinated / Hybrid    | 6 (5%)   | -3             | BB

Quality Gate

• [ ] Correct agency methodology identified and applied for the sector
• [ ] Financial statements adjusted using agency conventions (leases, pensions, hybrids, off-balance-sheet)
• [ ] Key ratios calculated on the agency's definitions and compared to published medians
• [ ] Business risk / qualitative factors assessed with supporting evidence
• [ ] Grid-indicated or anchor rating derived and modifiers applied with justification
• [ ] Notching applied correctly for each instrument based on priority of claims and recovery analysis
• [ ] Peer comparison completed against similarly rated companies in the same sector
• [ ] Split rating analysis performed if multiple agency ratings differ
• [ ] Outlook and CreditWatch status incorporated into the assessment
• [ ] Sensitivity analysis models rating impact under at least two scenarios (upside, downside)
• [ ] Rating agency engagement timeline tracked (annual review date, expected actions)

Source & license

This open-source skill is cataloged on AgentStack and links to its original source — we do not rehost the code.

• Author: brainbytes-dev
• Source: brainbytes-dev/everything-claude-finance
• License: MIT

Install and usage instructions live in the source repository linked above.