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I have been constructing yield curves of different rated bonds, with the list taken from ZionsDirect, 1 to 5 year maturities, A+ or better (S&P) and Aa or better (Moody's).

Here is a comparison of the ratings. Moody's A rating is not equivalent to S&P's A rating. Moody's A is equivalent to the lowest investment grade of S&P, BBB.


Moody's S&P
Aaa AAA
Aa1 AA+
Aa2 AA
Aa3 AA-
Aa A+
A1 A
A2 A-
A3 BBB+
A BBB


I had a problem constructing the yield curve because S&P and Moody's give very different ratings to the same bonds. Look at the following list. You will see that Moody's A1 bonds have S&P ratings from AA down to A+.


Hsbc Hldgs Plc Listed 12/12/12 3.463 A1/ A+
International Business Ma Listed 06/15/13 3.39 A1/ A+
National Rural Utils Coop Make Whole Call Only 07/01/13 4.073 A1/ A+
Unilever Capital Corp Make Whole Call Only - Conditional Calls 02/15/14 3.313 A1/ A+
National Rural Utils Coop Make Whole Call Only 03/01/14 4.23 A1/ A+
Bhp Billiton Fin Usa Ltd Conditional Calls 04/01/14 3.714 A1/ A+
Wachovia Corp New Listed 10/15/11 3.858 A1/ AA
Wachovia Corp New Listed 10/15/11 3.805 A1/ AA
Wells Fargo & Co New Listed 10/23/12 4.236 A1/ AA
Wells Fargo & Co New Listed 10/23/12 3.896 A1/ AA
Wells Fargo & Co New Listed 01/31/13 4.387 A1/ AA
Wells Fargo & Co New Listed 01/31/13 4.226 A1/ AA
Wachovia Corp Global Mtn Listed 05/01/13 5.176 A1/ AA
Wachovia Corp Global Mtn Listed 08/01/13 5.176 A1/ AA
Allstate Life Global Fdg Listed 04/30/13 4.676 A1/ AA-
Allstate Life Global Fdg Listed 04/30/13 4.6 A1/ AA-
Medtronic Inc Make Whole Call Only 03/15/14 3.514 A1/ AA-
Medtronic Inc Make Whole Call Only 03/15/14 3.406 A1/ AA-
Northern Trust Corp 05/01/14 3.896 A1/ AA-
Boeing Cap Corp Make Whole Call Only - Listed - Conditional Calls 02/15/12 3.404 A2/ A+
Boeing Cap Corp Make Whole Call Only - Listed - Conditional Calls 01/15/13 3.778 A2/ A+
Target Corp Make Whole Call Only - Conditional Puts - Change of control 01/15/13 3.556 A2/ A+
Boeing Co Make Whole Call Only - Listed - Conditional Calls 02/15/13 3.401 A2/ A+
Boeing Co Make Whole Call Only - Listed - Conditional Calls 02/15/13 3.356 A2/ A+
Bristol-Myers Squibb Make Whole Call Only - Listed 08/15/13 3.312 A2/ A+
Boeing Co Make Whole Call Only - Listed 03/15/14 3.64 A2/ A+
Boeing Co Make Whole Call Only - Listed 03/15/14 3.464 A2/ A+
Midland Bk Plc Listed - Conditional Calls 03/15/11 4.746 A2/ AA-
Protective Life Secd Trs Listed 04/01/11 4 A2/ AA-
Wells Fargo & Co Listed 08/01/11 3.588 A2/ AA-
Protective Life Secd Trs Listed 09/28/12 6 A2/ AA-
Wells Fargo & Co New Listed 10/16/13 4.446 A2/ AA-
Wyeth Make Whole Call Only - Coupon Rate Adjusts When Quality Rating Changes 03/15/13 3.64 A3/ A+
Wyeth Make Whole Call Only - Coupon Rate Adjusts When Quality Rating Changes 03/15/13 3.459 A3/ A+
Wyeth Make Whole Call Only 02/01/14 3.94 A3/ A+
Wyeth Make Whole Call Only 02/01/14 3.836 A3/ A+
Wyeth Make Whole Call Only 02/01/14 3.77 A3/ A+
Baxter International Make Whole Call Only - Listed - Conditional Puts - Change of control 03/01/14 3.364 A3/ A+
Credit Suisse Usa Inc Make Whole Call Only - Listed - Conditional Calls 11/15/11 3.698 Aa1/ A+
Credit Suisse Usa Inc Make Whole Call Only - Listed - Conditional Calls 11/15/11 3.686 Aa1/ A+
Credit Suisse Usa Inc Make Whole Call Only - Listed - Conditional Calls 11/15/11 3.595 Aa1/ A+
Credit Suisse Usa Inc Make Whole Call Only - Listed - Conditional Calls 01/15/12 3.616 Aa1/ A+
Cs First Boston Ny Brh Sr 05/15/13 4.576 Aa1/ A+
Credit Suisse Usa Inc Conditional Calls 08/15/13 4.499 Aa1/ A+
Credit Suisse Usa Inc Conditional Calls 08/15/13 4.026 Aa1/ A+
Credit Suisse New York Br Conditional Calls 05/01/14 4.94 Aa1/ A+
Bp Capital Markets Plc Conditional Calls 05/08/14 3.655 Aa1/ AA
Bp Capital Markets Plc Conditional Calls 05/08/14 3.606 Aa1/ AA
Hydro-Quebec 02/01/13 4.001 Aa2/ A+
Hydro-Quebec 02/01/13 3.94 Aa2/ A+
Pepsico Inc Make Whole Call Only - Listed 03/01/14 3.32 Aa2/ A+
Bottling Group Llc Make Whole Call Only - Listed 03/15/14 3.701 Aa2/ A+
Bottling Group Llc Make Whole Call Only - Listed 03/15/14 3.665 Aa2/ A+
Wal Mart Stores Inc Listed 06/01/13 3.48 Aa2/ AA
Novartis Capital Corp Make Whole Call Only - Conditional Calls 02/10/14 3.314 Aa2/ AA-
Statoilhydro Asa Make Whole Call Only - Conditional Calls 04/15/14 3.602 Aa2/ AA-
Bank Of New York Mellon 05/15/14 3.925 Aa2/ AA-
Arden Rlty Ltd Partnershi Make Whole Call Only 11/15/10 3.558 Aa2/ AA+
General Elec Cap Corp Mtn Listed 11/15/11 3.697 Aa2/ AA+
General Elec Cap Corp Mtn Listed 11/15/11 3.35 Aa2/ AA+
General Elec Cap Corp Listed 02/15/12 4.386 Aa2/ AA+
General Elec Cap Corp Listed 02/15/12 4.15 Aa2/ AA+
General Elec Cap Corp Mtn Listed 03/03/12 3.5 Aa2/ AA+
General Elec Cap Corp Mtn Listed 04/10/12 4.368 Aa2/ AA+
General Elec Cap Corp Mtn Listed 04/10/12 4 Aa2/ AA+
General Elec Cap Corp Mtn Listed 04/10/12 3.883 Aa2/ AA+
General Elec Cap Corp Mtn Listed 06/15/12 4.512 Aa2/ AA+
General Elec Cap Corp Mtn Listed 06/15/12 4.476 Aa2/ AA+
General Elec Cap Corp Mtn Listed 06/15/12 3.6 Aa2/ AA+
General Elec Cap Corp Mtn Listed 06/15/12 3.552 Aa2/ AA+
General Elec Cap Corp Mtn Listed 10/19/12 4.523 Aa2/ AA+
General Elec Cap Corp Mtn Listed 10/19/12 4.44 Aa2/ AA+
General Electric Cap Corp Listed 01/15/13 4.75 Aa2/ AA+
General Electric Cap Corp Listed 01/15/13 4.706 Aa2/ AA+
General Electric Cap Corp Listed 01/15/13 4.486 Aa2/ AA+
General Electric Co Listed 02/01/13 3.946 Aa2/ AA+
General Electric Co Listed 02/01/13 3.914 Aa2/ AA+
General Electric Co Listed 02/01/13 3.743 Aa2/ AA+
General Electric Capital Listed 05/01/13 4.74 Aa2/ AA+
General Electric Capital Listed 05/01/13 4.426 Aa2/ AA+
General Elec Cap Corp Mtn Listed 09/20/13 4.676 Aa2/ AA+
General Electric Cap Corp Listed 05/13/14 5.446 Aa2/ AA+
Bear Stearns Cos Inc Listed 02/01/12 4.146 Aa3/ A+
Bear Stearns Cos Inc Mtn 08/10/12 4.176 Aa3/ A+
Jpmorgan Chase & Co Listed 05/01/13 4.19 Aa3/ A+
Jpmorgan Chase & Co Listed 05/01/13 3.776 Aa3/ A+
Southtrust Bk Birmgham Su 03/01/13 6.182 Aa3/ AA
Cme Group Inc Make Whole Call Only - Conditional Puts - Change of control 02/15/14 3.709 Aa3/ AA
U S Bancorp Mtns Bk Ent 05/15/14 4.023 Aa3/ AA
U S Bancorp Mtns Bk Ent 05/15/14 3.925 Aa3/ AA


For example:
Issue: Wachovia Corp Global Mtn Sr Nt 5.5% 2013 Listed
CUSIP/ISIN: 92976WBJ4/ US92976WBJ45
Price: 101.133 YTM: 5.176

Moody's Ratings Information
Long Term Rating: A1 effective 03/25/2009

S&P Ratings Information
Long Term Rating: AA effective 01/05/2009 13:55:38

CreditWatch: NEG effective 05/04/2009 14:39:31

Moody's rating is 3 rungs below S&P's. Although S&P has a negative credit watch on this, dropping it 3 rungs in just a few months seems...extreme.

I'm not sure what to make of this, or how to judge the risks.
Comments?

Wendy
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Wendy,

I'm not sure what to make of this, or how to judge the risks.

The pessimist would assume the worst is most likely true. This approach certainly has more tail covering ability.

Charlie would tell you to listen to what the market is saying. With a premium price and YTM of 5.176% it seems the market is pricing this as quality. One could theorize, as you already have, that at least in the near term these bonds are in essence insured by the US Treasury and the market is pricing them assuming this to be true.

I would suggest doing the eyebleeding reading and some number crunching to see which you agree with.

I would take a list like this and look for all the disparities, ratings difference and yield oddities and probably toss the rest. Then I would look for the cheaper disparities and try and figure out if I agree with the markets cheap price or disagree.

For instance why is Southtrust yielding 6.182 when both agencies are pretty much in agreement.

As for how many rungs things get dropped, I'm of the mind there are too many rungs to begin with, what is the significant difference between A1 and A2? As a private investor buying in small increments does this nuanced difference really mean anything. For our purposes we probably need a scale like A B C and F, A-B-C being all potentially investment worthy on a descending scale while almost completely ignoring the published ratings. F = run away.

I would brake it down like this:

A = Above average return/low risk
B = reasonable return/low risk or above average return/moderate risk
C = above average return/high risk or reasonable return/moderate risk
(note: there is no low return/low risk if this is your bond choice buy a CD and avoid the all the trouble)

Using the above methodology we use published ratings as a screening tool and as one analytical metric among many. This means we could find BBB+ companies that are A's on the above scale and AA companies that are B's and A's that are C's.

jack
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Charlie would tell you to listen to what the market is saying.

So I guess I'd ask you, or Charlie, or anyone else who's done this for a while:

Has there always been this kind of disparity among bonds of different issuers with the same ratings?

Or did there used to be more uniformity, until recently when the whole rating process has gotten called into question?

Just wondering if this is a new phenomenon related to the financial crisis or if it's always been this complicated and confusing!

thanks,
dan
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It's always been complicated and confusing...er, "challenging".

If it were easy, everyone would pile in. There would be no difference between those who pick by formula and the best bond fund managers.

Picking stocks or bonds well is hard work. A lot is emotional. You have to know when to hold 'em and when to fold 'em. Not easy.

Best wishes, Chris
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Dan,

I would say recently there is more disparity. The previous ratings debacle plus recent events has created a messier looking ratings system. The ratings houses rate 1000's of companies, how are they suppose to keep up in an environment that is rapidly shifting? S&P is going to come up with their priority list, Moody's is going to come up with theirs and Fitch is going to come up with theirs. This alone is going to create some disparity. A bunch of companies that deserve a ratings shift are going to be missed as well.

Often the 3 majors have been pretty close to lock step. Some of this unity is based simply in the numbers, some of the unity was tied to, for lack of a better term, politics. The ratings agencies are paid by the firms, if one firm tends to be too conservative they will likely find their revenues diminishing.

The odd thing is that it may benefit us. When things were pretty uniform many folks, pros and a little investors alike, didn't dig very deep. Why would they? The 2 or 3 big house all seem to agree that Company XYZ is AA plus or minus a minor step.

One disparity that has been constant and that has been mispricing; some debt has been too expensive for the quality, some debt has been too cheap for the quality. If we are patient and diligent we can spot these traps and opportunities. It may be easier with all this messiness to spot the good and the bad.

jack
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Wendy wrote:

Here is a comparison of the ratings. Moody's A rating is not equivalent to S&P's A rating. Moody's A is equivalent to the lowest investment grade of S&P, BBB.

Moody's S&P
Aaa AAA
Aa1 AA+
Aa2 AA
Aa3 AA-
Aa A+
A1 A
A2 A-
A3 BBB+
A BBB

I had a problem constructing the yield curve because S&P and Moody's give very different ratings to the same bonds. Look at the following list. You will see that Moody's A1 bonds have S&P ratings from AA down to A+.


I think you have a couple of extra Moody’s ratings in there (“Aa” and “A”). Here are equivalent ratings I have used for corporate bonds:

Moody's S&P
Aaa AAA
Aa1 AA+
Aa2 AA
Aa3 AA-
A1 A+
A2 A
A3 A-
Baa1 BBB+
Baa2 BBB
Baa3 BBB-

http://en.wikipedia.org/wiki/Bond_credit_rating

For example:
Issue: Wachovia Corp Global Mtn Sr Nt 5.5% 2013 Listed
CUSIP/ISIN: 92976WBJ4/ US92976WBJ45
Price: 101.133 YTM: 5.176

Moody's Ratings Information
Long Term Rating: A1 effective 03/25/2009

S&P Ratings Information
Long Term Rating: AA effective 01/05/2009 13:55:38

CreditWatch: NEG effective 05/04/2009 14:39:31

Moody's rating is 3 rungs below S&P's. Although S&P has a negative credit watch on this, dropping it 3 rungs in just a few months seems...extreme.



So, with the corrected ratings, Moody’s is now 2 rungs lower, and with an S&P negative credit watch outstanding, possibly only 1 rating difference.

Moody’s being 1 or 2 ratings lower is consistent with what I have found during the 6 weeks that I've been doing regular scans (I purchased 11 issues so far).

I’m finding Moody’s the more conservative rating agency, even though I don’t trust either.

As an aside, I’m finding big differences in yields (and prices) from day to day and for different maturities (within the same issue). It looks to me like prices (and yields) depend on the liquidity of the particular issue and how bad someone needs (or wants) to sell.

I’ve learnt, “it pays to be patient” at this game.

Howard
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So I guess I'd ask you, or Charlie, or anyone else who's done this for a while:
Has there always been this kind of disparity among bonds of different issuers with the same ratings?
Or did there used to be more uniformity, until recently when the whole rating process has gotten called into question?
Just wondering if this is a new phenomenon related to the financial crisis or if it's always been this complicated and confusing!


Dan,

Bond ratings are predictions. How good are human beings at making predictions about anything that involves as many complex variables as financial markets?

Viewed in that light, the rating agencies do good job, as a review of their track records will show. Dig through the research they themselves have done about the accuracy of their ratings. Yes, that’s a bit like asking the fox to guard the hen house, but nobody else is rating the raters in any meaningful way. So their own self-evaluations have to trusted. But, by my eye, they’ve done a very thorough and impartial job it of.

For sure, on occasion, the rating agencies have screwed up majorly, and everyone likes to chortle over their failure with Enron and a few other egregious examples. But I challenge any of those who laugh to do a better job. They can’t. So the whiners should be ignored, which isn’t to say that bond ratings can be trusted as they are without proper interpretation.

Bond ratings are useful tools, and present circumstances haven’t changed that. What people constantly forget is that ratings aren’t created for the use and convenience of retail investors. Those that pay to have themselves rated are the intended users of that info. If the ratees weren’t being well served, would the agencies continue to do business? No, they’d fold for lack of customers. The current brouhaha on the part of congress and the financial press is merely a cover-up of their own massive failures. Blaming the rating agencies and threatening to “regulate them” shifts the blame, but it corrects none of the society-wide economic problems, and it does nothing to enhance “rating reliability”.

If you truly want reliable bond ratings –meaning, ratings that are as reliable as market predictions can be— learn how to rate bonds. Then use agency ratings as confirmations of your own due diligence. When you agree, well and good. When you disagree, then also well and good. In each instance, you’ve gained useful information that you can convert into profits for yourself. Where should you begin your learning to rate bonds? With Justin Mamis’ book, The Nature of Risk.

Best wishes, Charlie
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