Credit Rating Agencies

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Credit Rating Agencies

Credit rating agencies rate bonds based on the creditworthiness of the bond issuer. Agencies publish letter grades for bonds to indicate the quality of the security and the ability of the issuer to repay the debt. In other words, a credit rating agency determines the degree to which a bond issuer will be able to repay their debt. Well-known credit rating agencies include Fitch, Moody’s, and Standard and Poor’s.

Credit Ratings Definitions

Credit rating agencies rate bonds as investment grade corporate bond (high quality) or non-investment grade (low quality; junk bond) based on the creditworthiness of the issuer. A bond is given a grade, and the grades are typically ranked like this: AAA, AA, A, BBB, BB, B, CCC, CC, C, and at the bottom is D.

The highest quality corporate bonds will have a rating of AAA. (US government bonds are considered risk-free and are ranked above AAA.) The lowest quality corporate bonds are rated D, or already in default. Anything rated BBB or above is investment grade. Anything rated BB or below is non-investment grade corporate bond. Different bond rating firms may use different variations of the above rating system. For example, a rating agency may include plus (AA+) and minus (BBB-) signs to add levels to the bond rating system.

Lower quality bonds return higher yields than high-quality bonds. The higher yield compensates the investor for the greater risk of default associated with the lower quality investment.

Bond Rating Systems

Here are some examples of bond rating systems:

Fitch’s Rating System:

Investment grade corporate bond:

AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-

Noninvestment grade corporate bond:

BB+, BB, BB-, B+, B, B-, CCC+, CCC, CC-, CC, C, D, NR

Moody’s Rating System:

Investment grade corporate bond:

Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3

Noninvestment grade corporate bond:

Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, C

For details regarding Standard and Poor’s credit rating system:

standardandpoors.com

credit rating agencies

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