There is risk of default involved with corporate bonds. So how does an investor decide on which companies’ issues he has to invest in?The market participants can’t assess the risk involved as they may not have full information about corporates. They rely on credit rating agencies before taking an investment decision. These credit rating agencies give ratings to corporate issues by applying proprietary methodologies for assessing financial strength of the issuers and risks that may impair their capability to payback interest as well as principal.
There are a number of ratings service organizations that provide a breakdown of relevant factors that can impact the bond rating process. After evaluating each factor that is involved in arriving at the bond rating, the agencies provide a consolidated rating. Ratings provided by Moody’s Investors Service and Standard & Poor (S&P) are very famous in US. The other rating agencies are Fitch, Pacific Credit Rating, Egan-Jones Ratings Company. In India ICRA (Investment information and Credit Rating Agency) and CRISIL (Credit Rating Information Services of India Limited) are leading credit rating agencies. ICRA is an associate of Moody’s Investors Service.
A point to be noted here is the credit rating is specific to the issue and not issuer specific. This is because a medium scale company which got Baa rating for it’s previous issue may not get the same rating if it comes up with a new big issue. More over the credit rating agencies consider re-rating the previous issue.
The following table gives ratings and definitions of Moody’s and S&P
| Moody’s | S&P | Definition | Notes |
| Aaa | AAA | Best Quality with smallest degree of investment risk | Investment grade bonds. |
| Aa | AA | High quality by all standards | |
| A | A | Possess many favorable investment attributes | |
| Baa | BBB | Minimum Investment Grade/medium grade obligations | |
| Ba | BB | Low grade and have speculative elements | Below investment grade. |
| B | B | Very speculative. Generally lack characteristics of a desirable investment | |
| Caa | CCC | Substantial Risk. Bonds of poor standing. | |
| Ca | CC | Very poor quality | |
| C | D | Imminent default or in default |
In addition to the ratings listed above, Moody’s adds a “1″ to indicate a slightly higher credit quality. For example, a rating of “A1″ is slightly higher than a rating of “A” whereas “A3″ is slightly lower. S&P ratings may be modified by the addition of a “+” or “-”. “A+” being slightly higher grade than “A” and “A-” being slightly lower.
Occasionally you may see some bonds with an “NR” in either Moody’s or S&P. This means Not Rated and does not necessarily mean that the bonds are of low quality. It basically means that the issuer did not apply to either Moody’s or S&P for a rating. Government agencies are a good example of very high quality bonds that are not rated by Standard and Poors (S&P).
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Sathish Emmadi
Sathish Emmadi is a co-founder & editor at Lastbull.com. He is presently working in IT for one of the world’s top mutual fund companies. Handled multiple projects in BFSI (Banking,Financial Services and Insurance) domain. An Engineering Graduate from NITW.
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