Bond Ratings

By Kevin Chambers

One of the metrics that we watch very closely in our bond positions is credit quality. As part of our quarterly due diligence, we report the quality breakdown of the holdings of each of the mutual funds we follow. There are three main independent rating companies that use a letter grades to give investors information about the risk of default: Standard & Poors (S&P), Moody’s, and Fitch. We use the rating system from S&P:

‘AAA’—Extremely strong capacity to meet financial commitments. Highest Rating.
‘AA’—Very strong capacity to meet financial commitments.
‘A’—Strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances.
‘BBB’—Adequate capacity to meet financial commitments, but more subject to adverse economic conditions.
‘BB’—Less vulnerable in the near-term, but faces major ongoing uncertainties to adverse business, financial, and economic conditions. 
‘B’—More vulnerable to adverse business, financial, and economic conditions, but currently has the capacity to meet financial commitments. 
‘CCC’—Currently vulnerable and dependent on favorable business, financial, and economic conditions to meet financial commitments.
‘CC’—Currently highly vulnerable.
‘C’—Currently highly vulnerable obligations and other defined circumstances.
‘D’—Payment default on financial commitments.

These ratings also have ‘plus’ (+) and ‘minus’ (-) ratings that indicate sub-ratings. For example, AA+ is slightly higher than AA and AA- is slightly lower.  

Ratings of BBB- and higher are considered investment grade; bonds below BBB- are considered speculative grade or ‘junk bonds.’

The credit agencies give ratings for bonds issued by governments around the world and for bonds issued by individual companies. S&P rates 14 countries AAA, including Canada, The United Kingdom, and Germany. The United States was downgraded to AA+ in August 2011.   Only 3 corporations in the United States have bonds with an AAA rating: Microsoft, Johnson & Johnson, and Exxon Mobil.