Using the Rankings of Credit Ratings Agencies to Evaluate a Bond
A bond is a loan. So the first question to ask before you buy a bond is the same question you'd ask before you agreed to lend money to your brother-in-law: "Will I get my money back?"
In bonds, there's an entire industry dedicated to answering that question. Welcome to the world of Wall Street's credit rating agencies.
There are a handful of companies that evaluate and rank bonds -- offering simple-to-follow codes that describe the credit-worthiness of a bond issuer.
A high ranking such as AAA indicates that the entity looking to borrow money in the bond market is extremely unlikely to default on its debts. By contrast, a low ranking such as C indicates that the risk of default is quite high. (Bonds with exceptionally low ratings are referred to as junk bonds.
There are three major players in the industry.
In bonds, there's an entire industry dedicated to answering that question. Welcome to the world of Wall Street's credit rating agencies.
The players and the game
There are a handful of companies that evaluate and rank bonds -- offering simple-to-follow codes that describe the credit-worthiness of a bond issuer.
A high ranking such as AAA indicates that the entity looking to borrow money in the bond market is extremely unlikely to default on its debts. By contrast, a low ranking such as C indicates that the risk of default is quite high. (Bonds with exceptionally low ratings are referred to as junk bonds.
There are three major players in the industry.
- Moody’s, or Moody’s Investors Service, is probably the best known of the bond rating agencies. Moody’s, founded in 1900, ranks debt and provides risk analysis from offices around the globe. The company also offers a slew of reports, services and training, but costs are generally prohibitive for average investors.
- S&P, or Standard & Poor’s, also offers a ranking service, but uses a slightly different letter code than does Moody’s. S&P also provides reports and services for investors. But of particular interest to smaller investors are the free Webcasts featuring S&P analysts.
- Fitch, or Fitch Ratings, is probably the least-well-known of the major players. But that’s more likely a function of poor marketing rather than anything else. Fitch offers the same sorts of services as Moody’s and S&P. And for smaller investors, Fitch offers a free RSS feed of its news releases.
- The second tier of bond-rating agencies consists of A. M. Best, Japan Credit Rating Agency, Ltd., Ratings and Investment Information, Inc. and Dominion Bond Rating Service.
The scores and the scorecards
The highest ranking accorded to any bond is AAA. The three major credit ratings agencies all use that three-letter code to denote that a bond is as safe as any bond can be.
A chart of the codes used by the three major agencies can be found here.
Moody’s ranks bonds with the following codes: Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C. Fitch and S&P use these codes: AAA, AA, A, BBB, BB, B, CCC, CC, C, D.
The three major agencies also sometimes use “intermediate” scores such as BBB or BBB-.
And the agencies sometimes issue a “credit watch” to suggest that a bond rating may soon be lowered (downgraded) or raised (upgraded.)