What Bond Ratings Mean

The Financialist • Issue 87 • July 2005
BY CHRIS EYNON

We often hear in the news that a bond issuer’s credit rating has been upgraded or downgraded. This sounds important, but what does it mean?  Standard and Poor’s (S&P) and Dominion Bond Rating Service (DBRS) are companies often mentioned at the same time, but who are they?

S&P and DBRS are independent companies which provide credit ratings and financial research about issuers of debt instruments (bonds). They perform this analysis to provide the market with objective and reliable information.

A credit rating is a current opinion issued by a rating service regarding the credit-worthiness of a company with respect to its financial obligations. The credit rating is a valuable tool for investors to help evaluate the bond issuer’s ability to pay ongoing interest and repay the principal of the bond at maturity.

Common issuers of bonds are governments and corporations. Many investors looking for higher yielding investments use corporate bonds as part of their portfolio. Corporate bonds often have lower credit ratings than government bonds, thus corporate bonds are generally higher yielding. The lower the debt issuer’s credit rating, the greater the chance of their inability to repay the debt obligation. Thus, bonds whose issuers have lower credit ratings carry more risk.

A bond whose issuer has a very high credit rating will generally have a lower yield, and a bond whose issuer has a lower credit rating often will have a higher yield as an incentive to invest.

Investors who use bonds as part of a fixed income strategy should understand that a debt issuer’s credit rating is not fixed in stone. S&P and DBRS continuously re-evaluate issuers, and credit ratings change often.

Ford and General Motors Acceptance Corporation are major bond issuers. Ford and GMAC (the financial division and a wholly owned subsidiary of General Motors) have for many years been a staple of many investors’ fixed income strategy, providing good yields and reliable income. The recent downturn in auto sales has led S&P to downgrade the automakers’ credit ratings from “investment quality” (BBB or better) to "speculative" (BB). DBRS still rates the companies as BBB.

Just as credit ratings are downgraded, they can also be upgraded.  This occurs when a debt issuer’s credit-worthiness increases and their ability to repay debt stabilizes. An example of an upgrade can be found close to home. Over the past year DBRS and Standard and Poor’s and both upgraded the Province of British Columbia’s credit ratingWhile these services are a valuable tool, it is important to note that a credit rating is not a recommendation to buy, sell or hold, nor is it a statement of fact. It is an opinion formed from rigorous analysis by rating services.

You can contact your advisor at Rogers Group Financial to evaluate which bond investments may be appropriate for your personal objectives.