Evaluating a company’s ability to repay its bonds and make all of the required payments on them is a difficult task for individual investors. Corporate Bond Rating agencies were created in order to solve this problem by providing investors with a professional evaluation of the company’s ability to pay both its investors and its principal. The lower the risk of a company, the higher its bonds are rated and the less likely that a company will run out of cash to pay its creditors and default on its bond payments. Higher corporate bond ratings means a lower interest rate because the company is less likely to default on its bonds and investors will therefore demand less compensation for their funds. The lower a company’s bonds are rated (whenever the debt is considered riskier), the higher the rate of interest that investors will demand on their money.
The SEC lists 10 nationally recognized statistical rating organizations in the U.S. However, most credit ratings are generated by three rating agencies: Fitch, Moody’s and Standard & Poor’s (S&P). Each company has its own scale of rating as described in the following. Some levels of the rating scale have an inner rating of +/-, or 1,2,3.
|AAA||AAA||Aaa||The smallest risk of default.|
|High quality: The risk is much lower than average.|
|A lower than average risk|
|An average risk level.|
|A higher than average risk|
|The risk is much higher than average.|
|High risk, poor quality.|
|CC||CC||Ca||Highly speculative: A serious chance of default.|
|C||C||C||The issuer is on the verge of insolvency.|
|D||For a borrower in default, the sub-level reflects the chances for future improvement.|