Bond Rating Agencies
What Are Bond Rating Agencies?
Bond rating agencies are companies that evaluate the creditworthiness of both debt securities and their issuers. These agencies distribute the ratings utilized by investment experts to decide the probability that the debt will be reimbursed.
Understanding Bond Rating Agencies
In the United States, the three primary bond rating agencies are Standard and Poor's Global Ratings, Moody's, and Fitch Ratings. Each utilizations a unique letter-based rating system to rapidly pass on to investors whether a bond carries a low or high default risk and whether the issuer is financially stable. Standard and Poor's highest rating is AAA, and a bond is not generally considered investment grade in the event that it falls to BB+ status. The lowest rating, D, indicates that the bond is in default. That means the issuer is delinquent in making interest payments and principal repayments to its bondholders.
By and large, Moody's assigns bond credit ratings of Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C, with WR and NR as removed and not rated, separately. Standard and Poor's and Fitch assign bond credit ratings of AAA, AA, A, BBB, BB, B, CCC, CC, C, and D, with the last option signifying a bond issuer in default.
The agencies rate bonds at the time they are issued. They periodically reexamine bonds and their issuers to check whether they ought to change the ratings. Bond ratings are important because they influence the interest rates that companies and government agencies pay on their issued bonds.
The main three bond rating agencies are private firms that rate corporate and municipal bonds based on the associated degree of risk. They sell the ratings for publication in the financial press and daily papers. Other bond rating agencies in the United States incorporate Kroll Bond Rating Agency (KBRA), Dun and Bradstreet Corporation, and Egan-Jones Ratings (EJR) Company.
Benefits of Bond Rating Agencies
Despite the fact that bond rating agencies were vigorously censured from the get-go in the 21st century, they keep on performing significant capabilities for investors. An assortment of exchange traded funds (ETFs) rely upon bond ratings for their purchases. For instance, an investment-grade bond ETF will buy or sell bonds relying upon the ratings that they receive from the bond rating agencies. Along these lines, the agencies act in basically the same manner to fund managers accused of investing in securities of adequate quality.
The bond rating agencies give helpful data to the markets. In any case, they are not responsible for the frequently irrational ways that investors and funds answer that data. Even managed mutual funds regularly have rules that expect them to sell bonds that fall below a specific credit rating. A rating downgrade can cause a descending spiral of forced selling, making bargains for investors in fallen angel bonds.
Analysis of Bond Rating Agencies
Since the 2008 credit crisis, rating agencies have been condemned for not recognizing the risks that could impact a security's all's creditworthiness. Specifically, they were faulted for giving high credit ratings to mortgage-backed securities (MBS) that ended up being high-risk investments. Investors keep on being worried about potential irreconcilable situations. Bond issuers pay the agencies for the service of giving ratings, and nobody needs to pay for a low rating. Because of these and different deficiencies, ratings ought not be the possibly factor investors depend on while evaluating the risk of a specific bond investment.
The bond rating agencies are private companies with their own plans, not independent nonprofit organizations working for investors.
Then again, bond rating agencies have likewise been censured for causing financial losses by making questionable rating downgrades. Most broadly, S&P downgraded the U.S. federal government's credit rating from AAA to AA+ during the 2011 debt ceiling crisis. In point of fact, the Federal Reserve can continuously print more money to pay interest. Moreover, the U.S. government gave no indications of defaulting during the following decade. Regardless, stock prices encountered a significant correction in 2011. A few innocent companies ended up paying higher interest on their debts. Be that as it may, the market showed its lack of confidence in S&P's downgrade by sending U.S. Treasury bond prices higher.
The moderately discrete manner by which the agencies rate bonds additionally generally makes market volatility superfluously high. The most extreme case occurs when the agencies downgrade a country's debt from investment grade to junk status. For instance, S&P's downgrade of Greece's national debt to junk in 2010 contributed to the European sovereign debt crisis. A more continuous system would give markets additional opportunity to change. Rating debt on a scale of 0 to 1,000 and refreshing the ratings on a more successive basis could prevent declines from transforming into fiascos.
Highlights
- The bond rating agencies give valuable data to the markets and assist investors with saving money on research costs.
- Bond rating agencies were vigorously reprimanded right off the bat in the 21st century for assigning imperfect ratings, especially for mortgage-backed securities.
- In the United States, the three primary bond rating agencies are Standard and Poor's Global Ratings, Moody's, and Fitch Ratings.
- Bond rating agencies are companies that evaluate the creditworthiness of both debt securities and their issuers.
