Bond Ratings

What are Bond Ratings?

Bond ratings are representations of the creditworthiness of corporate or government bonds. The ratings are published by credit rating agencies and provide evaluations of a bond issuer’s financial strength and capacity to repay the bond’s principal and interest according to the contract.

The three private independent rating agencies – S&P, Moody’s, and Fitch – control almost 95% of the market share of the bond rating business. Each rating agency uses its own grading system. However, all rating systems classify bond investments by quality grade (investment grade/non-investment grade/not rated) and risk (from default to highest quality). Investment-grade bonds are considered safe investments with minimal default risk but provide minimal yields. Non-investment grade bonds are riskier, but they offer a higher yield.

Bond ratings prepared by professional analysts provide institutional and individual investors with a reliable source for making investment decisions.

S&P Global Bond Ratings

Standard & Poor’s (S&P) is the oldest credit rating agency and one of the three Nationally Recognized Statistical Rating Organizations (NRSRO) accredited by the U.S. Securities and Exchange Commission. The company covers more than one million credit ratings on government and corporate bonds, structured finance entities, and securities.

S&P issues both long-term and short-term bond ratings. The main goal of the S&P credit rating is the assessment of a security’s default probability.

Moody’s Investors Service Bond Ratings

Moody’s is another credit and bond rating agency accredited by NRSRO. The company covers more than 135 sovereign nations, 5,000 non-financial corporate issuers, 4,000 financial institutions, 18,000 public finance issuers, 11,000 structured finance transactions, and 1,000 infrastructure and project finance issuers. Unlike S&P and Fitch, the primary purpose of Moody’s ratings is the evaluation of projected losses in case of a default.

The numerical modifiers can be added to the existing rating categories from Aa to Caa. The number 1 indicates that the obligation is ranked at the higher end of the rating category, 2 indicates a mid-range ranking, and 3 indicates the lower end of the rating category.

Fitch Ratings

Fitch is the smallest credit rating agency among the “Big Three” agencies. The firm covers several different sectors, including financial institutions, insurance companies, sovereigns, corporate finance, structured finance, Islamic finance, and global infrastructure. However, Fitch’s market share is limited relative to that of its bigger rivals.

Similar to S&P, the main purpose of Fitch’s rating is the assessment of a security’s default probability. It also uses a bond ratings scale similar to that of S&P.

Importance of Credit Ratings

Credit rating agencies play an important role in credit laws and regulations in the United States and a number of European countries. Moreover, rating agencies significantly affect global capital markets by providing an assessment of securities to investors. Credit ratings remain one of the essential sources of information regarding credit analysis and credit risk for investors.

However, investors must not solely rely on the credit ratings provided by credit agencies. The global financial crisis in 2007-2008 proved that the close relationship between credit rating agencies and large financial institutions could cause conflicts of interest. For example, credit rating agencies gave the highest ratings to many mortgage-backed securities that, in reality, were close to the status of junk securities.

Related Readings

We hope you’ve enjoyed reading CFI’s explanation of bond ratings. To help you advance your career, the additional resources will be helpful:

• Bond Issuers
• Equity vs. Fixed Income
• Fixed Income Glossary
• Investing: A Beginner’s Guide
• See all fixed income resources