Wall Street: Assessing Gilt

AAA may mean the American Automobile Association to millions of Americans, but to cities, states and corporations in search of money it is a supreme symbol of solvency, the highest accolade Wall Street can bestow. Armed with that much-sought but carefully dispensed rating, a borrower can attract more investors, get by with paying lower interest rates on loans, and generally profit by the blue-chip aura that prime rating bestows in the business world.

As more and more local and state governments look to bond offerings for financing — a new record of $10.3 billion in bonds will be offered this year —a high bond rating becomes all-important. Last week, for example, when the state of California offered the largest tax-exempt issue floated this year, for $150 million worth of school and general construction bonds, its AAA rating quickly attracted all the lenders it needed.

Trusted Guide. Because investors generally follow their decisions to the letter, the few bond houses that judge who will receive what ratings have become powerful and much-wooed forces in U.S. finance. Even before borrowers register their plans with the Securities and Exchange Commission, they call on one or all of the nation's three bond-rating services—Dun & Bradstreet, Moody's and Standard & Poor's. With briefcases stuffed full of balance sheets and revenue and repayment schedules, they are quizzed by committees of experts. Of the two largest services, Standard & Poor's makes 11,000 ratings a year, Moody's 9.000. "It is a judgment of analysts," says Moody's Vice President Edmund Vogelius. "No computer can come up with a rating."

After every detail is weighed, the committee hands down its decision in a terse alphabetical shorthand. At Moody's, which pioneered the rating system back in 1909, the four top grades are Aaa, Aa, A and Baa, ranging from prime quality to faintly speculative. Standard & Poor's goes in for the upper case: AAA, AA, A and BBB. Dun & Bradstreet, which also owns Moody's but makes its own independent assessments, spells out its scale: prime, better good, good, medium good.

The idea of the ratings is to provide investors with a handy, trusted guide to the borrower's ability to repay. Below the top four grades, down through the Bs and Cs, come the outright speculative bonds. A Standard & Poor's C means that the borrower is not paying interest; D is the lowest, warning investors of a default. For the borrower, the difference of one grade can mean a difference of as much as .5% in the interest rate.