Investment Grade Corporate Bonds

When investing in bonds, the first thing to learn is that bonds are actually rated on the financial stability (creditworthiness) of a company or government issuing the bond. This is much like you and I would be rated by the credit bureau in terms of a credit score. If our score is sufficiently high we can buy a home, a car and have the privilege of carrying several plastic cards in our wallets. In like manner, investment grade corporate bonds signify that the company goes beyond being solvent and has considerable equitable assets with relatively little debt.

Three Major Credit Rating Agencies
If you are considering investing in bonds, take a look at the ratings in the three major rating agencies which are Moody, Fitch and Standard & Poor’s. All three agencies rate both long-term and short-term bonds and each company has a slightly different grading system. Notice that anything below a BBB is no longer considered to be an investment grade corporate bond and would then be referred to as a ‘junk bond.’ The four ‘levels’ of investment grade corporate bonds are Prime, High Grade, Upper Medium Grade and Lower Medium Grade.

Moody’s Ratings for Investment Grade Corporate Bonds
Moody has its own peculiar system of bond credit rating which is unlike Fitch or Standard & Poor’s. Although it is alphanumeric, the symbols differ significantly from the other two agencies. Moody’s ranks their long-term investment grade corporate bonds from Aaa (Prime) to Baa3 (Lower Medium Grade). Moody’s rating system also differs between long-term and short-term. Long-term investment grade corporate bonds are graded Prime (Aaa), High Grade (Aa1, Aa2, Aa3), Upper Medium Grade (A1, A2 A3), and Lower Medium Grade (Baa1, Baa2, Baa3) while short-term bonds are graded P-1, P-2 and P-3. Anything lower than a Baa3 long-term or short-term P-3 is not considered to be investment grade and would be speculative.

Fitch and Standard & Poor’s Grading System
Both Fitch and Standard & Poor’s use the same codes for grading bonds. Their system is also alpha/alphanumeric but differs significantly than the codes used by Moody’s. Prime long-term investment grade corporate bonds for both agencies are graded AAA whereas High Grade are scored AA+, AA or AA-. Then long-term Upper Medium Grade bonds are classified as A+, A or A- while Lower Medium Grade follows suit with BBB+, BBB or BBB-. Fitch and Standard & Poor’s grade short-term investment grade corporate bonds as F1+, F1, F2 and F3. Anything below those grades would range from Non Investment Grade Speculative a series of ‘Speculative’ grades to ‘In default with little prospect for recovery’ and finally the lowest possible grade, ‘In Default.’

Understanding Those Ratings
One of the things that consumers/investors need to be aware of is that those grades, by no means, are a guarantee that an investment will pay off. They are simply indicators as to the likelihood of the issuer going into credit default. Also, keep in mind that these ratings can be downgraded (or upgraded!) from time to time as ratings do change based on the issuer’s credit history. Understandably, the company will lose on two fronts should their score drop to any degree. First they will be subject to higher interest rates when taking out loans or perhaps even be denied credit altogether: and secondly, because investors will see the value of their bonds dropping, few new investors will be found. This is why it is so important for issuers of investment grade corporate bonds to keep their credit ratings high and why we, as investors, should keep an eye on their scores!

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