Mission Viejo http://cityofmissionviejo.org/News.aspx has received an upgraded credit rating of AAA from Standard & Poor's. This makes us feel good, but what does it mean?
Some people believe that AAA ratings mean there cannot be a default, that Standard & Poor's is a "rating agency" that is chartered by the government, and that ratings are absolute.
Let's start with Standard & Poor's (S&P). http://www2.standardandpoors.com/portal/site/sp/en/us/page.category/ratings/2,1,1,0,0,0,0,0,0,0,0,0,0,0,0,0.html S&P is a company (not a government agency or entity!) registered as a nationally recognized statistical rating organization (NRSRO) under the US Credit Rating Agency Reform Act of 2006. NRSRO companies are governed by the Securities and Exchange Commission (SEC) http://www.sec.gov/divisions/marketreg/ratingagency.htm S&P has been owned by McGraw-Hill since 1966. McGraw-Hill is a publishing company. S&P sells information.
Credit ratings are relative, not absolute, rankings, although S&P does attempt to make the ratings comparable over different sectors at different times. In other words, S&P grades on a curve, not a straight scale. Like in any grading system, there can be grade inflation over time.
S&P measures creditworthiness as a combination of the chances of priority payment (getting paid first is best), chance of recovery if something goes wrong, and how stable the creditworthiness of the entity being rated is.
Companies and other entities needing credit pay to be rated, and there are several ratings agencies. The credit rating determines the interest rate which can be charged or received on bonds and loans. A better rating means a lower rate. Higher rating, higher interest rate. Like any pay for play system, there is upward pressure on ratings at times. It's against the self-interest of the ratings firms to "be a tough grader."
Ratings also require a great deal of financial modeling, which is complicated and based on statistics. S&P has retooled their ratings modeling after last fall's market meltdown. The new model is supposed to include hypothetical stress conditions and other factors like performance of other debt issued by the entity being rated. Unfortunately, the only way to find out if a financial market model is any good is if it predicts behavior in a down market. For some reason, it always seems that financial market models work better at predicting at up markets than in down markets. Maybe no one wants to think about what happens when markets head south for the year.
So, how sound is a AAA rating for Mission Viejo? The rating means that during this marking period, Mission Viejo is doing well, relative to peers. Grading on a curve is always a challenge.
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