Bond Ratings
by MaestriSince the early 1900s, bonds have been assigned quality ratings that reflect their probability of going into default. The three major rating agencies are Moody’s Investors Service (Moody’s), Standard & Poor’s Corporation (S&P), and Fitch Investors Service. Moody’s and S&P’s rating designations are shown in Table 4-1.14 The triple- and double-A bonds are extremely safe. Single-A and triple-B bonds are also strong enough to be called investment grade bonds, and they are the lowest-rated bonds that many banks and other institutional investors are permitted by law to hold. Double-B and lower bonds are speculative, or junk bonds. These bonds have a significant probability of going into default. A later section discusses junk bonds in more detail.
Bond Rating Criteria Bond ratings are based on both qualitative and quantitative factors, some of which are listed below:
1. Various ratios, including the debt ratio, the times-interest-earned ratio, and the EBITDA coverage ratio. The better the ratios, the higher the rating.15
2. Mortgage provisions: Is the bond secured by a mortgage? If it is, and if the property has a high value in relation to the amount of bonded debt, the bond’s rating is enhanced.
3. Subordination provisions: Is the bond subordinated to other debt? If so, it will be rated at least one notch below the rating it would have if it were not subordinated. Conversely, a bond with other debt subordinated to it will have a somewhat higher rating.
4. Guarantee provisions: Some bonds are guaranteed by other firms. If a weak company’s debt is guaranteed by a strong company (usually the weak company’s parent), the bond will be given the strong company’s rating.
5. Sinking fund: Does the bond have a sinking fund to ensure systematic repayment? This feature is a plus factor to the rating agencies.
6. Maturity: Other things the same, a bond with a shorter maturity will be judged less risky than a longer-term bond, and this will be reflected in the ratings.
7. Stability: Are the issuer’s sales and earnings stable?
Taken From : Five-Minute MBA – Corporate Finance
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