Bond Ratings

Bond Ratings Explained

Bond rating is in essence an evaluation of the possibility of default by a bond issuer. It is based on an analysis of the issuer’s financial condition and profit potential. Bond rating services are provided by, among others, Standard & Poor’sand Moody’s Investors Service.Bond ratings start at AAA (being the highest investment quality) and usually end at D (in payment default).
Moody’s S&P Definitions
Aaa AAA
AAA-
Prime. Maximum Safety. Bonds, which are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as “gilt edged.” Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues.
Aa AA+
AA
AA-
High Grade. High Quality. Bonds, which are judged to be of high quality by all standards. Together with the Prime group they comprise what are generally known as high-grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in Prime securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long-term risk appear somewhat larger than the Prime securities.
A A+
A
A-
Upper Medium Grade. Bonds, which possess many favorable investment attributes and are to be considered as upper-medium-grade obligations. Factors giving security to principal and interest are considered adequate, but elements may be present which suggest a susceptibility to impairment some time in the future.
Baa BBB+
BBB
BBB-
Medium Grade. Bonds, which are considered as medium-grade obligations (i.e., they are neither highly protected nor poorly secured). Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well.
Ba BB+
BB
BB-
Speculative. Bonds, which are judged to have speculative elements; their future cannot be considered as well-assured. Often the protection of interest and principal payments may be very moderate, and thereby not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds in this class.
B B+
B
B-
Highly Speculative. Bonds, which lack characteristics of the desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small.
Caa CCC+
CCC
CCC-
In Poor Standing. Bonds, which are of poor standing. Such issues may be in default or there may be present elements of danger with respect to principal or interest.
Ca CC+
CC
CC-
Extremely Speculative. These bonds represent obligations which are speculative in a high degree. Such issues are often in default or have other marked shortcomings.
C C+
C
May be in Default. The lowest rated class of bonds, and issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing.

SOURCE


In investment, the bond credit rating assesses the credit worthiness of a corporation’s or government debt issues. It is analogous to credit ratings for individuals. The credit rating is a financial indicator to potential investors of debt securities such as bonds. These are assigned by credit rating agencies such as Moody’s, Standard & Poor’s, and Fitch Ratings to have letter designations (such as AAA, B, CC) which represent the quality of a bond. Bond ratings below BBB/Baa are considered to be not investment grade and are colloquially called junk bonds.
Moody’s S&P Fitch
Long-term Short-term Long-term Short-term Long-term Short-term
Aaa P-1 AAA A-1+ AAA F1+ Prime
Aa1 AA+ AA+ High grade
Aa2 AA AA
Aa3 AA- AA-
A1 A+ A-1 A+ F1 Upper medium grade
A2 A A
A3 P-2 A- A-2 A- F2
Baa1 BBB+ BBB+ Lower medium grade
Baa2 P-3 BBB A-3 BBB F3
Baa3 BBB- BBB-
Ba1 Not prime BB+ B BB+ B Non-investment grade
speculative
Ba2 BB BB
Ba3 BB- BB-
B1 B+ B+ Highly speculative
B2 B B
B3 B- B-
Caa1 CCC+ C CCC C Substantial risks
Caa2 CCC Extremely speculative
Caa3 CCC- In default with little
prospect for recovery
Ca CC
C
C D / DDD / In default
/ DD
/ D
[edit] Credit rating agencies
See also: Credit rating agency.

Credit rating agencies registered as such with the SEC are known as “Nationally Recognized Statistical Rating Organizations.” The following firms are currently registered as NRSROs: A.M. Best Company, Inc.; DBRS Ltd.; Egan-Jones Rating Company; Fitch, Inc.; Japan Credit Rating Agency, Ltd.; LACE Financial Corp.; Moody’s Investors Service, Inc.; Rating and Investment Information, Inc.; and Standard & Poor’s Ratings Services. Under the Credit Rating Agency Reform Act, an NRSRO may be registered with respect to up to five classes of credit ratings: (1) financial institutions, brokers, or dealers; (2) insurance companies; (3) corporate issuers; (4) issuers of asset-backed securities; and (5) issuers of government securities, municipal securities, or securities issued by a foreign government.[1]

S&P, Moody’s, and Fitch dominate the market with approximately 90-95 percent of world market share.
[edit] Credit Rating Tiers

Moody’s assigns bond credit ratings of Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C, with WR and NR as withdrawn and not rated.[2] Standard & Poor’s and Fitch assign bond credit ratings of AAA, AA, A, BBB, BB, B, CCC, CC, C, D.

As of April 2011, there were 4 companies rated AAA by S&P: [3]

Automatic Data Processing (NYSE:ADP)
Johnson & Johnson (NYSE:JNJ)
Microsoft (NASDAQ:MSFT)
ExxonMobil (NYSE:XOM)

Moody’s, S&P and Fitch will all also assign intermediate ratings at levels between AA and CCC (e.g., BBB+, BBB and BBB-), and may also choose to offer guidance (termed a “credit watch”) as to whether it is likely to be upgraded (positive), downgraded (negative) or uncertain (neutral).
Moody’s Standard & Poor’s Fitch Credit worthiness [4][5]
Aaa AAA AAA An obligor has EXTREMELY STRONG capacity to meet its financial commitments.
Aa1 AA+ AA+ An obligor has VERY STRONG capacity to meet its financial commitments. It differs from the highest rated obligors only in small degree.
Aa2 AA AA
Aa3 AA- AA-
A1 A+ A+ An obligor has STRONG capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.
A2 A A
A3 A- A-
Baa1 BBB+ BBB+ An obligor has ADEQUATE capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitments.
Baa2 BBB BBB
Baa3 BBB- BBB-
Ba1 BB+ BB+ An obligor is LESS VULNERABLE in the near term than other lower-rated obligors. However, it faces major ongoing uncertainties and exposure to adverse business, financial, or economic conditions which could lead to the obligor’s inadequate capacity to meet its financial commitments.
Ba2 BB BB
Ba3 BB- BB-
B1 B+ B+ An obligor is MORE VULNERABLE than the obligors rated ‘BB’, but the obligor currently has the capacity to meet its financial commitments. Adverse business, financial, or economic conditions will likely impair the obligor’s capacity or willingness to meet its financial commitments.
B2 B B
B3 B- B-
Caa CCC CCC An obligor is CURRENTLY VULNERABLE, and is dependent upon favourable business, financial, and economic conditions to meet its financial commitments.
Ca CC CC An obligor is CURRENTLY HIGHLY-VULNERABLE.
C C The obligor is CURRENTLY HIGHLY-VULNERABLE to nonpayment. May be used where a bankruptcy petition has been filed.
C D D An obligor has failed to pay one or more of its financial obligations (rated or unrated) when it became due.
e, p pr Expected Preliminary ratings may be assigned to obligations pending receipt of final documentation and legal opinions. The final rating may differ from the preliminary rating.
WR Rating withdrawn for reasons including: debt maturity, calls, puts, conversions, etc., or business reasons (e.g. change in the size of a debt issue), or the issuer defaults. [2]
unsolicited unsolicited This rating was initiated by the ratings agency and not requested by the issuer.
SD RD This rating is assigned when the agency believes that the obligor has selectively defaulted on a specific issue or class of obligations but it will continue to meet its payment obligations on other issues or classes of obligations in a timely manner.
NR NR NR No rating has been requested, or there is insufficient information on which to base a rating.
[edit] Investment grade

A bond is considered investment grade or IG if its credit rating is BBB- or higher by Standard & Poor’s or Baa3 or higher by Moody’s or BBB(low) or higher by DBRS. Generally they are bonds that are judged by the rating agency as likely enough to meet payment obligations that banks are allowed to invest in them.

Ratings play a critical role in determining how much companies and other entities that issue debt, including sovereign governments, have to pay to access credit markets, i.e., the amount of interest they pay on their issued debt. The threshold between investment-grade and speculative-grade ratings has important market implications for issuers’ borrowing costs.

Bonds that are not rated as investment-grade bonds are known as high yield bonds or more derisively as junk bonds.

The risks associated with investment-grade bonds (or investment-grade corporate debt) are considered noticeably higher than in the case of first-class government bonds. The difference between rates for first-class government bonds and investment-grade bonds is called investment-grade spread. It is an indicator for the market’s belief in the stability of the economy. The higher these investment-grade spreads (or risk premiums) are, the weaker the economy is considered.
[edit] Criticism

Until the early 1970s, bond credit ratings agencies were paid for their work by investors who wanted impartial information on the credit worthiness of securities issuers and their particular offerings. Starting in the early 1970s, the “Big Three” ratings agencies (S&P, Moody’s, and Fitch) began to receive payment for their work by the securities issuers for whom they issue those ratings, which has led to charges that these ratings agencies can no longer always be impartial when issuing ratings for those securities issuers. Securities issuers have been accused of “shopping” for the best ratings from these three ratings agencies, in order to attract investors, until at least one of the agencies delivers favorable ratings. This arrangement has been cited as one of the primary causes of the subprime mortgage crisis (which began in 2007), when some securities, particularly mortgage backed securities (MBSs) and collateralized debt obligations (CDOs) rated highly by the credit ratings agencies, and thus heavily invested in by many organizations and individuals, were rapidly and vastly devalued due to defaults, and fear of defaults, on some of the individual components of those securities, such as home loans and credit card accounts.

SOURCE

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