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About Corporate Bond
Ratings
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Rating agencies such as Moody’s Investors Service and Standard & Poor's
perform in-depth financial strength analyses of corporations that raise
funds by issuing bonds or similar credit instruments. The company being
rated pays for the analysis because it needs the rating to sell its bonds.
So you won’t find bond ratings for companies that raise funds strictly by
selling stock.
Don’t confuse bond ratings with stock analysts’ buy/sell ratings. Unlike
stock analysts who are concerned mainly with earnings growth prospects,
bond analysts concentrate on a company’s ability to service its debt. They
evaluate financial statements, management quality, the competitive
environment, and overall economic conditions. Where stock analysts are
optimists, bond analysts focus mostly on what can go wrong.
Bond ratings reflect the agencies’ view of the risk that a company will
default on its bond payments. That information is important to stock
investors as well as bond investors because a bond default always destroys
the issuing company’s stock price. Also, the company’s rating determines
its access to, and its cost of borrowing. A lowered bond rating can impact
the company’s earnings by increasing its interest expenses, and lack of
access to new borrowings can stifle a company’s growth, or even drive it
into bankruptcy.
Rating Codes
The agencies use a combination of letters, numbers, and plus or minus
signs such as ‘AAA,’ ‘BA1,’ ‘B-‘ and the like to rate corporate bonds. The
combination of symbols used by each rating service varies somewhat, but
‘AAA’ always indicates the highest quality rating, and any rating starting
with ‘A’ signifies high quality debt. Three letter ratings starting with
‘B’ such as ‘BAA’ or ‘BBB’ indicate lower quality debt than ‘A’ ratings,
but are still considered investment quality. Companies with ‘A’ or three
letter ‘B’ ratings will probably be able to raise additional funds without
problems.
Two letter ‘B’ ratings such as ‘BB’ or ‘Ba1’ signify “non-investment
grade,” or “junk bond” securities. Corporations with bonds in the junk
category may be able to raise additional funds, but it’s problematic, and
they will have to pay higher interest rates.
Single letter ‘B’ ratings such as ‘B1,’ and ‘CCC’ and ‘CC’ rated bonds
signify substantial risk. Companies with bonds carrying these ratings will
probably not be able to raise funds from normal sources.
Single letter ‘C’ ratings indicate that the company has filed bankruptcy,
and “D” ratings signify that the company has defaulted on its bond
payments.
S&P often adds a “+” or a “-“ to the rating to indicate that it falls at
the top or bottom of its rating group. Moody’s adds the numbers 1,2, or 3
to fine-tune their ratings.
Rating agencies frequently place a rating on “credit watch” or “under
review” if they are considering changing a rating.
Overall Credit Ratings
Rating agencies also publish ratings that apply to the issuer’s general
credit worthiness, instead of to a specific bond issue. Moody’s uses the
same rating codes for corporate credit as for specific bond issues, but
S&P uses different codes for corporate credit:
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A-1, A-2, and A-3: Best or good quality.
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B: Risky credit
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C: Riskier than ‘B’
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D: Already in default
You can see bond ratings on sites such as Finra (www.finra.org),
BuySellBonds (www.buysellbonds.com),
or the Securities Industry and Financial Markets Association website (www.investinginbonds.com).
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