Money Lessons with Andrew Temte, PhD, CFA

Episode: What Are Credit Ratings & Why Do They Matter?
Date: February 7, 2026

Episode Overview

In this bite-sized episode, host Dr. Andrew “Andy” Temte breaks down the world of credit ratings—explaining how they were invented, how they function, and why they form the backbone of modern bond markets. Drawing on financial history and practical application, Andy connects the dots from the rise of American railroads to the rating agencies that dominate global finance today, while highlighting how credit ratings influence everything from investment decisions to the cost of borrowing.

Key Discussion Points & Insights

1. The Problem: How Do Investors Judge Bond Safety?

[00:06]

• Andy sets the stage by pointing out the historical difficulty investors faced in assessing the riskiness of different bonds, especially in the complex railroad era of early 20th-century America.
  • “How do you evaluate which ones are safe and which might end up in default? You could hire analysts…but this requires expertise, time and resources most investors lack.” – Andy Temte [01:00]

2. Moody’s Revolutionary System

[01:35]

• Introduces John Moody, the pioneer who created the first systematic credit rating system for bonds in 1909.
• Moody adapted the letter-grade concept (e.g., AAA, B) from existing mercantile credit firms and applied it to nearly 1,300 railroad bonds.
  • “The genius was in the simplicity. Instead of wading through pages of financial data, an investor could glance at a rating and immediately understand a bond’s relative quality.” – Andy Temte [02:30]
• The market immediately responded: bonds with worse-than-expected ratings saw yields rise and prices fall due to increased perceived risk.

3. The Growth of Credit Rating Agencies

[03:50]

• Competition arrived: Poor’s Publishing, Standard Statistics, and Fitch entered between 1916–1924.
• The consolidation of Standard and Poor’s formed the landscape still in place today.
  • The “Big Three”—Moody’s, Standard & Poor’s (S&P), and Fitch—control 95% of the global ratings business.

4. Understanding the Ratings Scale

[05:00]

• Each agency uses a similar but slightly different notation. For clarity, Andy uses the S&P scale for the episode.
• Ratings explained:
  • AAA: Lowest risk—exceptionally strong capacity to meet commitments.
    • “As of 2025, only two American companies, Microsoft and Johnson & Johnson, maintain AAA ratings from Standard and Poor’s.” – Andy Temte [05:32]
    • Note: Apple has top marks from Moody’s but only AA from S&P, showing agency variation.
  • AA: Very low risk.
  • A: Low risk, somewhat more vulnerable to adverse conditions.
  • BBB: Lowest investment-grade; risk rises under adverse conditions.
  • BB and below: High-yield territory with elevated to significant risk.
  • CCC and below: Substantial credit risk.
  • D: Default.
  • Memorable quote: “If you got a D on the exam, you’re already in default.” – Andy Temte [07:08]

5. How Credit Ratings Are Determined

[07:12]

• Agencies blend quantitative and qualitative factors.
  • Quantitative: Debt levels, equity ratios, interest coverage, cash flow stability.
  • Qualitative: Management quality, market position, regulatory risks, payment track record, and broader economic factors.
  • “The rating reflects the agency’s forward-looking opinion about the issuer’s ability and willingness to make payments on time.” – Andy Temte [08:10]
• Ratings evolve as circumstances change, with upgrades and downgrades impacting bond prices (especially when crossing the investment grade threshold).

6. Outlooks and Market Impact

[08:35]

• Agencies assign “outlooks” (positive, negative, stable, developing) indicating the direction ratings might move in the future.
• Market impact:
  • Upgrades generally cause prices to rise (yields fall).
  • Downgrades can cause prices to drop sharply, especially if bonds fall below “investment grade.”

7. Default Rates: Proof That Ratings Matter

[09:00]

• Andy presents historical default rates as validation of the ratings system:
  • AAA: ~0.52% default rate over 10 years.
  • BBB: ~1.6% over 5 years.
  • B: Up to 24% over 10 years.
  • CCC: Up to 50% over long periods.
  • “These statistics validate what the rating system promises. Higher ratings genuinely correspond to lower default risk.” – Andy Temte [09:38]

8. Limitations and Looking Forward

[10:00]

• Credit ratings are foundational for the bond market but are not without flaws.
• Teases the next episode: deep-diving into major historical failures—Penn Central, Enron, and the 2008 financial crisis—to dissect the limitations and conflicts of interest present within the rating system.
  • Light-hearted moment: “We’ll do a lot of examinating then.” – Andy Temte [10:26]

Notable Quotes & Memorable Moments

• On Moody’s innovation:
  “The genius was in the simplicity.” [02:30]

• On ratings as financial shorthand:
  “Instead of wading through pages of financial data, an investor could glance at a rating and immediately understand a bond’s relative quality.” [02:33]

• On agency differences:
  “Apple holds Moody’s top AAA rating but is rated only AA by S&P, illustrating how agencies can reach slightly different conclusions.” [05:50]

• Humorous take on bond default:
  “If you got a D on the exam, you’re already in default.” [07:08]

• Summation on importance:
  “Ratings have become essential infrastructure for bond markets, but they’re not perfect.” [10:08]

Timestamps for Key Segments

• 00:06: Setting the stage—how investors used to evaluate bonds
• 01:35: Introduction to John Moody and the letter grade system
• 03:50: The rise of the Big Three rating agencies
• 05:00: Breaking down the rating scale with examples
• 07:12: How ratings are determined: Quantitative and qualitative analysis
• 08:35: Rating outlooks and market impacts
• 09:00: Historical default rates by rating
• 10:00: Flaws in the rating system; preview of next week’s topics

Summary

With clear language and engaging historical storytelling, Andy Temte explains how credit ratings revolutionized investing by distilling complex financial analysis into a standardized, comparable score. Moody’s initial creation evolved into the modern system, now dominated by three major agencies whose ratings govern trillions of dollars in bonds worldwide. Credit ratings remain a critical tool for investors, influencing borrowing costs, market access, and investment decisions. Yet, as Andy foreshadows, they are not infallible—setting up the listener for a follow-up episode on the cracks in the ratings system, revealed most dramatically in financial crises.

For listeners new and experienced alike, this episode offers foundational knowledge on a topic that affects everything from corporate loans to your retirement portfolio, all delivered in Andy’s accessible and story-driven style.