Factors affecting bond rating

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Factors affecting bond rating
Bond ratings are largely a reflection of a company's creditworthiness. (savings bonds image by judwick from Fotolia.com)

Major bond rating companies, such as Moody's, Standard and Poor's and Fitch, assess, among other things, a company's financial stability and standing for the purpose of issuing a bond rating. Major bond rating companies issue ratings from AAA to C, with AAA being the best rating or grade for a bond and a C being the worst. Investors consider bonds rated in the top A and B tiers as those that carry the least amount of investment risk. Bonds rated below C are what investors refer to as junk bonds a carry higher investment risk.

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Creditworthiness

One of the biggest factors that affect bond rating is a company's credit risk. Credit risk primarily refers to the company's ability to pay back its debts to its creditors. These debts include principal and interest payments on loans, dividends and insurance payments. Because a bond is a debt instrument, when investors purchase bonds, they become creditors of the company from which they bought the bond. A company that is less likely to default on its outstanding debt, meaning it demonstrates a high level of creditworthiness, generally has a higher credit rating. As the creditworthiness of a company decreases, the bond rating falls.

Future Performance

Bond rating agencies do not claim to be fortune tellers, but, like most investment instruments, bonds are forward looking. Credit rating agencies conduct extensive research as to the plausible future performance of a bond. This assessment affects a company's bond rating. Companies that have a history of good financial standing and demonstrate that its current financial standing is unlikely to change generally have high credit ratings. Companies that have experienced financial instability or financial difficulties generally receive a lower credit rating.

Major Corporate Events

When a positive major corporate event occurs, such as the launch of an innovative product, or a negative corporate event occurs, such as a corporate scandal, bond rating agencies often place the bond rating of that company on review. Such events can affect a bond rating. In the case of a negative corporate event, the bond rating is often downgraded, because the company poses an increased risk of credit default and a drop in creditworthiness. A positive corporate event may upgrade the company's bond rating.

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