Bond Credit Rating. An Overview

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Bond rating is a process undertaken by the rating companies, whose primary aim is assessment of the likelihood of the issuer repaying principal and interest. A rating code or rating grades used by credit rating agencies are key letters that represent the risk on the debtor and thus allows a simple assessment of creditworthiness.

The rating code is a result of the rating process, the higher the CDS spreads, the lower the rating. Corporate rating which pertains to the financial strength refers to a company’s overall and specific issue rating, it examines the ability to repay a specific debt.

Corporate bonds are held mainly by institutional investors (insurance companies, provident funds and pension funds). Such entities make massive investments in bonds, hence the importance of ratings. The issuing companies’ rankings are important, due to a significant reduction in the cost of capital raised by them.

Business risk assessment framework examines the company’s industry environment, including competitive position in the industry, this is one of the main parameters in the ranking. Another looks at the management structure and ownership of the company, which is a parameter that can indicate the ability and willingness of a society to extricate itself in case of a cash flow problem.

Financial risk is checked on the basis of the company’s financial reports, with emphasis on revenues and profitability, capital structure (especially equity and liabilities). In addition to the company’s cash flow and other financing sources. It also examines lawsuits, guarantees, and exposure to currency.

Specific bonds rated securities also are checked. If they exist, the scope of the bond series with total company liabilities, and order of priorities of creditors.

Grading scale (Standard & Poor’s) includes ten degrees divided into two groups: investment grade and speculative. Complex combinations of ranking A, B, C (in addition to the main levels can be added to rank plus or minus for refinement).

Investment Rating

    – AAA: issuer has excellent ability to repay compared to other issuers.
    – AA: ability to repay is far beyond average.
    – A: ability to repay the payments is relatively beyond the average.
    – BBB: ability to repay is average.

Speculative rating

    – BB:  Issuer’s ability is below average compared to other issuers.
    – B: far below average.
    – CCC: a chance of non – compliance with the repayments.
    – CC: non-compliance with the repayment of most payments most likely.
    – C: the bond issuer is highly likely to default on interest payment and / or principal.
    – D: ability to pay in serious doubt.

 

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