A bond credit rating helps investors determine the credit worthiness of debt investments sold by a company. When companies seek external financing for their business operations, they issue stocks or bonds. The latter can be risky, as they are essentially a portion of the company’s debt. Credit ratings from third-party brokerage houses, investment exchanges or other groups can provide a thorough and trustworthy analysis of bonds. Credit ratings generally range from AAA to D, noting that bonds can fall into groups such as prime all the way to in default.
The bond credit rating also determines which overall group into which a company’s bond will be classified. The two groups are investment grade and junk bonds, also called high-yield bonds. In general, investment grade bonds will have a rating of BBB- or higher. Ratings are important in the bond market, as companies gain access to the market based on the interest paid on the investment. The rating helps investors determine if the company can and will repay the debt investment while the bond’s specifics, such as maturity date and interest rate, provide access to the market.
International firms selling bond investments will often have to meet the specific criteria for the government agency in the company where they sell the bonds. Some governments or rating agencies may be able to provide an internationally accepted bond credit rating. This is more beneficial to companies, as they can attempt to woo more investors into purchasing the bonds for financing purposes.
The bond credit rating system is not infallible. While the ratings indicate the company’s ability to repay the investment, they do not certify that the investment is secure. This was the problem found during the subprime mortgage crisis during 2007-2009. Companies created collateralized debt obligations — investments similar to traditional bonds — that often had a high bond credit rating. However, many of these investments turned out to be extremely risky and not worth very much, as the loans behinds the bond investments turned out to be worthless.
Government municipalities often issue bonds that are similar to corporate bonds. However, the terms of agreement for these investments and the rating systems will vary. These bonds typically have ratings from AAA to C, with investment grade bonds rated BBB or higher, in general. Historically, municipal bonds have a much lower default rate than corporate bonds, making them a safer investment for both long- and short-term purposes.