Understanding the basics of bond ratings

What are bond ratings?

Most people are familiar with the idea of credit scores and credit reports, which is how consumer credit is rated and evaluated by consumer credit agencies. Similarly, companies and financial institutions are also evaluated by specific agencies, which assign ratings to assess creditworthiness, or how suitable they are to receive financial credit.

There are three major rating agencies that gauge the creditworthiness of bonds: Moody’s, Standard & Poor’s and Fitch. These rating agencies use a letter-based credit scoring system to judge the quality and creditworthiness of a bond and tend to vary by agency.

These agencies determine a company’s bond rating using various indicators. For example, Moody’s uses a numerical indicator to rate the investment grade (such as Aaa, AA1, A3, Baa1), while Standard & Poor’s and Fitch use a plus or minus indicator (such as AAA, AA+, BBB+, BBB-), which is also shown in the table below.

What do the different bond ratings mean?

According to the U.S. Securities and Exchange Commission (SEC):

• Investment-grade bonds‡ include those that are believed to have a lower risk of default‡ and receive higher ratings by the credit rating agencies, namely bonds rated Baa (by Moody’s) or BBB (by S&P and Fitch), or above. These bonds tend to be issued at lower yields than bonds rated as less creditworthy.
• Alternatively, a high-yield bond‡, also known as a junk bond, are bonds that are believed to have a higher risk of default and receive low ratings by credit rating agencies, namely bonds rated Ba or below (by Moody’s) or BB or below (by S&P and Fitch). These bonds are typically issued at a higher yield (for example, a higher interest rate) than investment-grade bonds, reflecting the perceived higher risk to investors.

Bond rating comparison chart

Sources: SIFMA, Fitch, Moody’s, Standard & Poor’s‡

It’s important to remember that ratings are subjective and are not true indicators of whether your investment will increase or decrease in value or its overall safety. It is important to talk with your financial advisor before using these ratings to assess your investments and to familiarize yourself with the methodologies and criteria for any rating.

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