When companies and governments issue bonds, they typically receive a credit rating for their debt repayment capacity from each of the three major credit rating agencies: Standard & Poor’s, Moody’s, and Fitch.
Rating Factors
Credit rating agencies consider specific factors that focus on the entity’s ability to meet its financial obligations by looking at:
- The strength of the issuer’s financial schedule
- The issuer’s ability to repay its debts
- The condition of the issuer’s operations
- The issuer’s future economic outlook
- The current business conditions, including profit margins and earnings growth (for companies)
- The strength of their economies (for governments)
How to Interpret Ratings
Standard & Poor’s rates bonds by placing them into 22 categories from AAA to D. Fitch essentially matches the credit ratings of these bonds, while Moody’s uses a different rating system. A plus (+) or minus (-) symbol can be assigned to investments within each S&P category between AA and CCC, indicating their standing within that category, for example, AA-, AA+.
What Do Ratings Really Mean?
Overall, there is no way to know how bonds will perform based solely on their rating, as ratings heavily rely on historical financial data. Moreover, past performance does not necessarily reflect future financial results or investment returns. Ratings merely indicate the level of risk perceived by some investors in the investment.
The Changing Landscape
In 1992, there were 98 U.S. companies with an AAA credit rating from Standard & Poor’s, according to the Financial Times. By the fourth quarter of 2021, there were only two U.S. companies with an AAA rating. In recent years, large companies have become more willing to utilize debt as part of their efforts to enhance shareholder value.
Frequently Asked Questions
What is a good credit rating for bonds?
What methods are used to determine credit ratings on bonds?
Source: https://www.thebalancemoney.com/what-are-bond-credit-ratings-417074
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