A bond rating is a letter grade assigned by a rating agency to a bond that indicates its credit status. A bond issuer’s financial health, or capacity to pay the bond’s principal and interest on time, is factored into the rating.
How do bonds get their ratings?
Bond ratings are assigned letters ranging from “AAA” to “D,” with “AAA” being the highest and “D” being the lowest. Different rating systems employ the same letter grades but differentiate themselves by using different combinations of upper- and lower-case letters and modifiers.
How are bonds appraised in terms of their creditworthiness?
A bond rating is a letter-based credit score system that is used to assess a bond’s quality and creditworthiness. Standard & Poor’s assigned “AAA” to “BBB-” ratings to investment grade bonds, whereas Moody’s assigned Aaa to Baa3 ratings. If all other factors are equal, a bond with a better rating will have a lower interest rate.
Is BBB superior to BB?
Standard & Poor’s and Moody’s employ separate designations to indicate a bond’s credit quality rating, which consist of the upper- and lower-case letters “A” and “B.” Investment grade is defined as “AAA” and “AA” (high credit quality) and “A” and “BBB” (medium credit quality). Bonds with credit ratings below these categories (“BB,” “B,” “CCC,” and so on) are referred to as “junk bonds” because they have a low credit grade.
What bonds have a BBB rating?
Ratings firms investigate each bond issuer’s financial condition (including municipal bond issuers) and assign ratings to the bonds on the market. Each agency follows a similar structure to enable investors compare the credit rating of a bond to that of other bonds. “Investment-grade” bonds have a rating of BBB- (on the Standard & Poor’s and Fitch scales) or Baa3 (on the Moody’s scale) or higher. Bonds with lower ratings are referred to as “high-yield” or “junk” bonds since they are deemed “speculative.”
What do AAA-rated bonds entail?
Bonds with the highest level of creditworthiness are given the highest possible rating, AAA. AAA-rated bonds are issued by companies that can satisfy all of their financial obligations and have the lowest risk of default. Companies can also be given a AAA grade.
AAA is used by rating organizations such as Standard & Poor’s (S&P) and Fitch Ratings to identify bonds of the highest credit quality. Moody’s uses a similar ‘Aaa’ to indicate a bond’s top tier credit rating.
When the term “default” is used in this context, it refers to a bond issuer failing to pay an investor the principle amount of interest due. Because AAA-bonds have the lowest risk of default, they also have the lowest payback compared to other bonds with identical maturity dates.
Microsoft (MFST) and Johnson & Johnson (JNJ) were the only two corporations in the world to receive the AAA grade in 2020. (JNJ). AAA ratings are highly prized, and many corporations lost their AAA ratings during the 2008 financial crisis. Only four corporations in the S&P 500 had the AAA rating as of mid-2009.
What is the process of Moody’s rating?
After analyzing official and other data and consulting with government officials, business leaders, and economists, credit rating organizations assign a score to a company’s financials and business models, as well as sovereign governments’ economic management. These organizations then rate corporate and government debt instruments such as bonds, debentures, commercial papers, deposits, and other debt issues in order to assist investors in making educated judgments.
A higher rating aids a company’s or government’s ability to raise finance at a lower cost. The agencies conduct this on a regular basis, upgrading or downgrading the instrument based on performance, prospects, or events that could affect a company’s balance sheet or a government’s or sub-sovereign entity’s fiscal position.
A sovereign rating drop might be triggered by political uncertainty. S&P downgraded the United States’ highest rating (AAA) in August 2011, citing rising debt levels and political risks. A government official responded by saying, “This was a ‘facts be damned’ choice.”
There are numerous notches for corporations whose financials represent a danger of defaulting on payments under the two categories of investment grade, which is for good-quality firms, and speculative, which is for speculative firms. Moody’s has downgraded India’s sovereign credit rating to Baa2, with the outlook changing from’stable’ to ‘negative.’
This could have an impact on enterprises looking to borrow money from abroad through bonds or international loans, as investors and banks in other countries may request higher interest rates because to the bleak outlook. Institutional investors, such as pension funds, endowment funds of abroad universities, and sovereign wealth funds that manage the wealth of wealthy countries, are typically impacted.
When ratings are lowered, they must reevaluate their investments. Rating downgrades are also a concern for businesses and many governments that borrow from international markets.
The issue in India may be that the downgrade comes after Moody’s raised its rating two years ago, when the economy grew two percentage points faster than it does now, implying that a change upwards is still a long way off.
According to the agency, the chance of sustained real GDP growth at or above 8% has decreased dramatically since it upgraded India’s rating to Baa2 from Baa3 two years ago. The decision to reduce the rating was based on growing risks that growth will remain considerably lower than in the past, leading to a gradual increase in the debt load from already high levels.
This is contingent on how and where governments borrow money. To raise funds, many countries turn to global debt or credit markets. Global banks and associated investment banks frequently say that diversifying their investor base, whether it be firms or governments, is vital to reduce the risk of a small group of people investing into such borrowing programs and then selling or pulling out.
In this regard, India has been an outlier. It has not yet issued a bond or raised funds directly in the international market, therefore a downgrading will have a limited impact. Rather, private or state-owned corporations that raise foreign currency financing bear the brunt of the damage.
The government indicated its desire to issue a sovereign bond in this year’s Budget, but has yet to take action due to RBI criticism and caution. Attempts to issue a sovereign bond or borrow directly from the international market have been thwarted in the past by Indian authorities with long memory. One of the causes for this has been their perception of credit rating organizations’ purported bias.
Think about it. The agencies promptly reduced India’s sovereign rating in the run-up to the 1991 balance-of-payments crisis, limiting the country’s ability to raise money overseas through public sector oil companies or banks for short periods to buy oil or pay for imports. When India declared that it had conducted nuclear tests in Pokhran in 1998, the ratings agencies reacted quickly, affecting borrowings.
The government and the RBI subsequently chose to disregard these agencies and raise billions of dollars in foreign exchange through two tranches of bonds issued by the SBI. It also helped because the government didn’t have any foreign debt. For a long time, the Indian government did not engage with credit rating firms much in an attempt to modify attitudes. This was until around 2004-05, when the upsurge in growth began and continued for well over six years.
Credit rating agencies suffered a setback following the global financial crisis of 2008, when they were exposed as a result of the failure of highly rated banks and other financial organizations. Since then, they’ve been attacked in India as well, and have faced regulatory action as well as an inquiry by government investigating agencies after they granted top ratings to IL&FS group borrowings last year.
Shaktikanta Das, who was the Secretary of Economic Affairs at the time and is now the RBI Governor, wrote to Moody’s just a year before the latest sovereign rating upgrade in 2017, raising issues about the agency’s methodology and presenting a case for reconsidering it. The point made by the Finance Ministry at the time was that India’s debt levels have decreased and that this should be reflected in the ratings metric. The government has frequently complained that countries with larger debt levels and inadequate fiscal policies have received better ratings.
This time, the government has responded to the shift in attitude by stating that India’s fundamentals are strong, and that other macroeconomic indicators such as inflation remain low, as seen by low bond yields, with strong growth prospects in the short and long term. In essence, it has stated that it does not agree with the agency’s assessment. Over the following few weeks, it will be interesting to observe if the financial markets agree with this view.
Why do businesses want a high bond rating over a lesser bond rating on their debt securities?
In general, the higher the bond rating, the better the bond issuer’s terms will be. Because investors want less compensation for the risk of default, high-rated bonds have lower interest rates. Bond issuers will have cheaper borrowing costs as a result of this.
In bond ratings, however, there is one very significant breakpoint. Bonds rated BBB- or Baa3 or higher are considered investment grade, which implies they can be owned by most institutional investors. Bonds rated BB+ or Ba1 or lower, on the other hand, are classified as high-yield bonds, sometimes known as trash bonds. Because these are considered to be more speculative, many institutional investors avoid them or have investment limits.
Bond ratings aren’t always accurate predictors of what will happen with a given bond, and ratings haven’t always worked as intended. Bond ratings, as a measure of relative strength, are an excellent place to start when researching a company’s debt.
What is the purpose of bond ratings?
The bond grading procedure is crucial since it informs investors about the bond’s quality and stability. That is to say, the credit rating has a significant impact on interest rates, investment appetite, and bond price. Furthermore, ratings are assigned by independent rating agencies based on future expectations and prognosis.
Are BB bonds worthless?
- Because junk bonds have a lower credit rating than investment-grade bonds, they must provide higher interest rates to entice investors.
- Standard & Poor’s rates junk bonds as BB or lower, whereas Moody’s rates them as Ba or lower.
- The bond issuer’s rating shows the likelihood of default on the debt.
- If you want to invest in junk bonds but don’t want to pick them out yourself, a high-yield bond fund is a good option.