What it means
Within each rating letter the agencies use notches to separate borrowers that would otherwise look identical, and A2 is the middle of the three in the A band. Being in the middle has a practical benefit: there is a notch of headroom above and a notch below before the letter itself changes.
A move from A1 to A2 is a downgrade, but it keeps the borrower inside the same broad category that most mandates and pricing grids reference. For a business, this band usually means debt markets are open in most conditions and at a predictable cost.
The rating signals that the balance sheet can absorb a normal recession without the company's survival being in question, which is why it is common among established industrials, retailers and regulated service providers. It is strong enough to be unremarkable, and in funding terms unremarkable is valuable.
The way the rating is reached is as important as the rating itself. Agencies combine a view of the business, covering scale, market position, margin stability and the industry's cyclicality, with a view of the financial profile, mostly leverage and interest cover.
Published methodologies set out indicative ranges for the key ratios at each notch, so a treasurer can estimate where a financing decision would leave the rating before committing to it. A2 is also a common landing point after a downgrade, which is why the direction of travel is watched as closely as the level.
Investors read a fall from Aa3 to A2 very differently from a rise from A3 to A2, even though both end in the same place. The outlook attached to the rating is the agency's own signal about which way the next move is likely to go.
Split ratings are frequent in this band. One agency may assign A2 while another assigns the equivalent of A3, and documentation normally specifies whether the lower, the higher or the average applies for pricing.
Agreeing that definition before signing a facility avoids an expensive argument later.
In practice
Real-world examples.
Example
A grocery chain rated A2 issues a $400,000,000 bond to fund new distribution capacity. Insurance companies buy most of the issue because the rating fits their mandates and the maturity matches their liabilities. The chain locks a fixed coupon for ten years and removes refinancing risk from its plan.
Example
A chemicals producer slips from A1 to A2 after a weak year for volumes. Nothing changes in its existing fixed rate bonds, but the margin on its $250,000,000 revolving facility steps up by 0.20%, costing $500,000 a year on a fully drawn basis. Management responds by cutting capital spending to protect interest cover.
Example
A telecommunications group is rated A2 by one agency and the equivalent of A3 by another. Its loan documentation prices off the lower of the two, so the finance team spends six months providing additional disclosure to the stricter agency rather than chasing an upgrade from the kinder one.
Formula
Calculation
All-in borrowing cost = benchmark yield + credit spread for the rating.
Extra annual interest from a downgrade = principal x increase in spread.
Suppose a retailer rated A2 issues a $75,000,000 seven-year bond when the seven-year benchmark yield is 4.00% and the spread for its rating is 1.10%.
All-in borrowing cost = 4.00% + 1.10% = 5.10%.
Annual interest cost = $75,000,000 x 0.0510 = $3,825,000.
Now assume the retailer is downgraded one notch to A3 before it issues, and the spread widens to 1.35%.
New all-in cost = 4.00% + 1.35% = 5.35%, giving annual interest of $75,000,000 x 0.0535 = $4,012,500.
Extra annual interest = $4,012,500 - $3,825,000 = $187,500, which is the same as $75,000,000 x 0.0025.Case study
Seen in the real world.
Marrowfield Rail Components is a fictional company created for this illustrative case study. It supplied braking systems to rail operators, held an A2 rating, and funded itself with a mix of bonds and bank facilities.
A two-year slowdown in rail investment cut Marrowfield's earnings by a fifth, and its net debt to earnings ratio drifted above the level the agency associated with the A band. Rather than wait for a review, the chief financial officer presented a plan: suspend the share buyback, sell a leased property portfolio for $90,000,000, and apply the proceeds to debt. The agency confirmed A2 with a stable outlook, noting the committed deleveraging.
In this fictional story the decisive factor was timing. By acting before the review rather than after it, Marrowfield kept the notch it had, and the suspended buyback cost far less than the spread widening a downgrade would have triggered across its borrowings.
Watch out
Common mistakes.
- Treating the plain letter A and the notch A2 as different ratings, when they are the same rung expressed on two agencies' scales.
- Thinking a one-notch downgrade is harmless because the letter stays the same, and overlooking the margin step-up in a loan pricing grid.
- Managing to a ratio target at the balance sheet date only, when agencies look at the trend across the cycle rather than a single snapshot.
Questions
People also ask.
Is A2 good enough to issue bonds in a weak market?
Usually yes, since investment grade issuers at this level retain access when lower rated borrowers are shut out, though the spread they pay will be wider.
What typically drives a move from A2 to A1?
A sustained fall in leverage, stronger interest cover and greater earnings stability, demonstrated over several periods rather than promised in a plan.
Does a rating apply to the company or to the debt?
Both exist, as an issuer rating for the entity and an issue rating for each instrument, and secured or subordinated terms can place an instrument above or below the issuer level.
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