What are bond ratings?

Broadridge Investor Communication Solutions, Inc.

02/28/19

What are bond ratings?

Bond ratings measure the safety of a particular bond. Financial information companies, such as Moody's, Standard & Poor's, and Fitch Ratings compile data on the financial strength of the bond issuer and assign a rating.

Not all bonds carry ratings. Bond issuers pay a fee to financial information companies to have their bonds rated. If the total value of a bond offering is too small to justify the cost of having it rated, a bond may be issued without a rating. However, just because a bond has not been rated does not necessarily mean that it is an unsound investment.

Factors determining a bond's rating

Bond-rating scales

Moody's, Standard & Poor's, and Fitch, the three most well-known rating services, use a letter grade scale for their bond ratings.

A letter grade also may be modified to indicate relative standing within a particular letter grade. Moody's uses numbers (1, 2, or 3) as modifiers; Standard & Poor's and Fitch use pluses and minuses. For example, Aaa1 would be Moody's highest rating, while AAA+ would be the highest given by the other two services.

Ratings

Standard & Poor's Moody's Fitch Meaning
AAA Aaa AAA Lowest risk
AA Aa AA Slight long-term risk
A A A Possibly vulnerable to changing economic conditions
BBB Baa BBB Currently safe but possibly unreliable over the long term
BB Ba BB Somewhat speculative issue that offers moderate security
B B B At risk of default in the future
CCC Caa CCC Clear danger of default
CC Ca CC Highly speculative/may be in default
C C C Poor prospects for repayment even if currently paying
N/A D D In default

Classes of bonds

"Investment grade" usually refers to any bond rated Baa, BBB, or higher. Some bond mutual funds limit their holdings to investment grade bonds.

Bonds with a Standard & Poor's or Fitch rating of BB or lower (Ba by Moody's) are considered to be speculative investments. They are often called junk bonds or high-yield bonds because they have to pay higher interest rates to attract investors.

Bond ratings and bond prices

Credit ratings influence a bond's yield. Companies and governments with lower bond ratings must pay higher interest rates on the debt they issue, in order to get people to buy their bonds.

Rating services periodically review the ratings of a company or a government during the life of a bond. If the organization's financial outlook has changed, the rating service can reflect that change by either upgrading or downgrading the bond.

A change in the rating of a bond will have an effect on the bond's price in the secondary market. If the bond is downgraded, investors will demand a higher yield to compensate for the increase in credit risk. This means that the price of the bond in the secondary market will fall. On the other hand, if the bond is upgraded, the secondary market price will rise.

 

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2019.

 

What to read next...

A bond is a security that represents an agreement to repay borrowed money. Watch this video to learn more about how you may be able to use bonds to add income.

Bonds are issued by 3 entities: U.S. government, state and local governments and corporations. Read this article to learn more.

Adding bonds may create a more balanced portfolio, more diversity and reduced risk. Get started in bond investing by learning a few basic bond market terms.

Looking to expand your financial knowledge?