Bonds Rating
Bond rating/credit rating is an evaluation of creditworthiness of a bond issuer. The ratings are published by credit rating agencies and provide evaluations of a bond issuer’s financial strength and capacity to repay the bond’s principal and interest according to the contract. The three major credit rating agencies Standard and Poor’s (S&P), Moody’s and Fitch control almost 95% of the market share of the bond rating business.
They classify bond investments by quality grade (investment grade/non-investment grade/not rated) and risk (from default to highest quality).
Investment-grade bonds are considered safe investments with minimal default risk but provide minimal yields. Non-investment grade bonds are riskier, but they offer a higher yield.
Determining bond rating
Rating agencies considers some of factors below to come up with a ratings.
Financial ratios: Agencies review, analyze, and synthesize data from the issuer’s financial statements and then issue a rating based on financial ratios and other non-financial information.
Industry and economic analysis: They assess the issuer’s industry, including its growth prospects, competitive dynamics and broader economic factors (such as interest rates, inflation and economic stability).
Credit history: They consider the issuer’s credit history and track record of meeting debt obligations as well as any past defaults or credit events.
Regulatory and political environment: They review the regulatory environment in the issuer’s home country, including compliance with regulations. Foreign issuers are subject to further assessment of the political and economic stability of their home country.
Rating agencies also consider relationships with local government agencies or a parent corporation, as well as broad economic conditions at the time of bond issuance.
Different measures are used for different industries, and other external influences play a range of roles in the intricate process. A forecasted top-down approach of the overall economic conditions, an in-depth bottom-up procedure of security specifics, along with statistical distribution estimates of the probability of default and loss severity provides investors with a few simple standardized letters to help quantify their investment.
The table below shows the ratings
Advantages of bond rating
- Bond rating helps investors stay informed about the latest standing and the strength of a company. As a result, they make well-informed investment decisions.
- It lets them select the right set of debt securities. Hence, the investors get an opportunity to have the right mix for their portfolios.
- Rating a bond helps firms approach the market players, indicating their financial standing. Through the ratings, they appeal to their prospects to investors, high-net-worth individuals (HNWIs), competitors, regulators, etc.
- Investors use the rating chart to compare the returns and credibility of two different companies and the bonds they issue.
Limitations
- The bond-issuing entities can pay the rating agencies to feature their bonds and make them reachable to investors via different media.
- Different rating agencies evaluate different factors to rate the bonds. In the process, there are chances of missing out on points that might take a bond’s rating either up or down.
- The rating system for bonds does not foresee the upcoming scenarios. This, in turn, might turn a deal negative for investors in the event of any unusual market turmoil.
It’s important to note that credit rating agencies are separate entities, and their ratings may not align perfectly. Investors should consider ratings from multiple agencies and do their own due diligence in researching when assessing credit risk.
Bond ratings help investors make informed decisions about the level of risk they are willing to take when investing in bonds. However, it’s important to note that credit ratings are just one piece of the puzzle when making investment decisions.