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With all the recent drama surrounding the United States’ credit rating and it’s ultimate downgrade, you may be wondering how the Standard and Poor’s (S&P) credit ratings work.
Is the downgrade of US debt the end of the world or just a small bump in the road? What does each rating mean?
The following will help you make sense of all this.
A S&P rating is the opinion of the Standard and Poor’s company as to the general creditworthiness of a company, city, country, or some other entity. It issues ratings based on letter grades.
As you may expect, those in the A range are deemed to be the most creditworthy. Those below that are deemed to be less and less creditworthy. Each letter range has multiple options, each with it’s own standard of creditworthiness.
Let’s examine how this all works.
The highest S&P rating is AAA. This indicates a high likelihood of debt repayment. Those who are issued a AAA rating pay relatively low interest rates, as the risk of non-payment is minimal.
So, until the recent downgrade, the US was in the optimal position to borrow.
On the other end, the lowest rating is D, at which the borrower must pay high interest due to the risk of non-payment. Some investors are willing to take on this risk in order to receive high interest payments. So there is still a market out there for such debt (usually referred to as “junk” or “high yield”).
As a result of the benefits of being a AAA-rated borrower and the costs of being a lower-rated borrower, AAA is the rating any borrower should hope for. The following countries currently have a AAA rating:
- United Kingdom
Unfortunately, not every borrower is able to maintain AAA quality.
In between the AAA and D ratings are plenty of others that vary based on risk. The second highest rating is AA, which includes the following: AA+, AA, and AA-.
Now at AA+, the US is seen as a high quality borrower with very low risk. However, it’s susceptibility to long-term risks is viewed as greater than it was when it held a AAA rating.
The other 2 ratings (AA and AA-) round out this category and are both considered to be quality borrowers with more risk than AAA borrowers.
Next up in the ratings are the A’s. The ratings A+ and A are in this category. Borrowers with these ratings are viewed as quality borrowers that are susceptible to financial problems during certain economic conditions.
Following these ratings is the BBB rating. BBB rated borrowers are considered to be of medium-class and are in satisfactory standing at the moment.
Any rating below this, from BB to D (NR if it is not rated) are considered junk bonds and the borrower is considered to have a significant risk of default or some other adverse credit event.
The United States’ Downgrade
By now, most of us know that the credit rating for the United States federal debt was downgraded to AA+. At this stage, it is in the second highest category of borrowers.
In a nutshell, it is not the end of the world. However, it is believed that the US is a little more risky of a lending customer than it ever was before. Thus, even though it maintains a high rating, it will have to pay more interest to borrow money.
With a country that borrows as much as the US, that means Joe taxpayer may end up footing the bill for a lot more interest on the national debt. In addition, the market has suffered from this whole fiasco. And some, such as those who are about to retire, may have to rethink their plans, as some have lost as much as 10 percent of the value of their pension.
So, you do not have to get into the bunker quite yet. But there will be some consequences for the credit downgrade.
If it goes down any further, then there could be additional, more serious consequences. Let’s hope that does not happen!