To rephrase the question: what do bond rating agencies and similar organizations provide an assessment of the creditworthiness of issuers and the security of debt securities? It is common practice for institutional investors to look to these agencies' published ratings to determine the likelihood that a given debt will be repaid.
Investors can save money on due diligence by relying on the bond rating agencies, which also supply valuable market data. At the turn of the millennium, bond rating agencies came under fire for their supposedly inaccurate ratings, particularly mortgage-backed securities.
Methods Used by Credit Rating Agencies
Regarding bond ratings in the United States, Standard & Poor's Global Ratings, Moody's Investors Service, and Fitch Ratings are the big three. Both use a different alphabetic rating system to inform bond buyers whether the issuer is financially stable. Standard & Poor's has determined that bonds rated BB+ or lower are no longer considered safe for investors because they fall below the agency's minimum requirements for this classification, AAA. Default is assumed for bonds rated D or lower. This indicates that the issuer has fallen behind on interest and principal payments owed to bondholders.
Moody assigns bond ratings on a scale from AAA to A.A. to A to B.B. to B.B. to C to W.R. to N.R. Standard & Poor's and Fitch give bond issuers credit ratings of AAA, A.A., A, BBB, B.B., B, CCC, CC, C, and D, with D indicating a bond issuer in default.
Independent from one another, the top three bond rating agencies rank the relative safety of corporate and municipal bonds. They sell the ratings after they are published in business and mainstream media. Additional United States-based bond rating agencies include a
Using bond rating agencies with several benefits
Bond rating agencies are still helpful to investors despite receiving a lot of criticism from early 21st century critics. Many exchange-traded funds (ETFs) will only invest in bonds with high credit ratings. An investment-grade bond exchange-traded fund (ETF) may buy or sell bonds based on the advice of bond rating agencies. The agencies' work is similar to money managers tasked with purchasing high-quality securities.
Financial markets would struggle to function without the information provided by bond rating agencies. It's not the fault of the investors or the funds if they overreact to news. The policy of many managed mutual funds is only to sell bonds that meet a certain minimum credit quality standard. Investors can find "fallen angel bonds" at deep discounts after a bond's rating declines because of the influx of forced sellers into the market.
Critics attack bond-rating agencies
Since the financial crisis of 2008, rating agencies have been criticized for making insufficient efforts to identify and evaluate risks to a security's creditworthiness. They took the flak for allowing high-risk investments such as mortgage-backed securities (MBS) to pass muster. Possible conflicts of interest continue to be a source of worry for shareholders. Each bond issuer pays a rating agency to assign a grade, and no one wants to shell out the cash for a poor evaluation. Because of these and other limitations, investors should look elsewhere to gauge the risk associated with a bond purchase.
However, bond rating agencies have been criticized for causing financial losses due to speculative downgrades. The U.S. government's credit rating was famously lowered by S&P from AAA to AA+ during the debt ceiling crisis of 2011. The Federal Reserve can always print more money to cover interest payments, and this is true. Moreover, during the subsequent decade, the United States government showed no indications of defaulting. Nonetheless, the stock market experienced a severe decline in 2011. It's a shame that some firms that played by the rules had to pay more interest on their loans. Instead, prices for U.S. Treasury bonds went up, suggesting that investors did not believe S&P's downgrade.
The agencies' varying approaches to the bond rating are another factor that adds unneeded volatility to the markets. The worst possible outcome is for rating agencies to downgrade a country's debt from "investment grade" to "junk" status. For example, Standard & Poor's decision to downgrade Greece's national debt to junk status in 2010 exacerbated the European sovereign debt crisis. If the system were more continuous, the markets would have more time to adjust to the changes. To prevent declines from becoming catastrophes, it would be helpful to use a scale from 0 to 1,000 when rating debt and to update ratings more frequently.
