How to get a Bond Rating
A bond rating is similar to a credit rating for personal borrowers. In essence a bond rating indicates credit quality and the company’s ability to pay a bond’s principal (maturity value) and interest (coupon) in a timely fashion (www.investopedia.com).
In order to get that rating the business would need to approach a ratings company such as Standard & Poor’s or Moody’s Investors Service or Finch to apply for a rating. The ratings agency would then examine the deal being proposed and then give a rating based upon their analysis and the perceived risk (Lucchetti & Ng, 2010). This rating will then be granted and used to sell the bond by the underwriter or broker appointed.
The procedure that Moody’s in particular adopts when assigning a rating is (v3.moodys.com):
- Introductory meeting between Moody’s analyst and the new bond issuer to explain the rating process and the methodology to follow.
- Collection of the new bond issuer relevant data:
- Background and history of the company
- Industry/sector trends
- National political and regulatory environment
- Management quality, experience, track record, and attitude toward risk-taking
- Management structure
- Basic operating and competitive position
- Corporate strategy and philosophy
- Debt structure, including structural subordination and priority of claim, and
- Financial position and sources of liquidity, including cash flow, operating margin and balance sheet.
After all the relevant data is collected and analysed, a decision is made by the Ranking Committee to assign the best suitable ranking. The ranking is informed to the new bond issuer and published in Moody’s periodic ranking report.
If the organisation applying for the bond rating does not like the rating being offered by the rating agency they are not compelled to take that rating. Instead they can take it to another agency and not disclose the previous rating being proposed (Lucchetti & Ng, 2010). This is known as ‘rating shopping’ and is commonplace within the market today. Once the organisation is comfortable with the rating this can be adopted and then sold to the market.
The analysts who issued the rating will from time to time make any changes to the ranking based on what is occurring in the market and at the firm.
Many companies prefer US$ bonds as may US investor would prefer this, including:
- Reduction in exchange rate risk
- A lower US interest rate means higher bond yields. The Euro Loan rate is 1.75% (European Central Bank, 2010) whereas the US Cash Rate is lower at 0.25% (Trading Economics, 2010)
- Some European countries eg Greece, have large debts and there is a chance that they default on their bonds. This could cause a crisis in the Euro and risk the investment of the US investor. In essence a ‘risk return trade-off’ (The Economist, 2010)
- The US $ is an accepted trading currency and therefore would be more acceptable to a US investor