Bond Ratings and Agencies Di Tian May/07/2013

AGENDA What are Bond Ratings? Bond Ratings graph Who determines? S&P Corporation Bond Ratings graph Why company want to have bond ratings? Who care Bond Ratings? Ratings Adjustment?

What are Bond Ratings? Independent assessment Market participants do not do their own credit analysis of a debt obligation A grade given to bonds indicated the relative credit quality & risk Ratings indicate the likelihood of the borrowed money being paid back The higher the rating, the less likelihood of default, and the lower the interest rate the issuer needs to offer to sell all the bonds

Who determines Bond Ratings? The major US credit rating agencies Moody Investors Service Standard & Poor Corporation Fitch Ratings They use the same letter grades and the same key criteria But use various combination of upper and lower case letters

Standard & Poor Corporation 1860-1940: Beginnings Henry Varnum Poor founded Poor Co.1860 Publish and sell the financial products of US railroads to buyers 1941-1965: Merger & Development “Xerox” developed copy machine in 60’s ← product killer Poor Co. met financial problems Standard Statistics merged with Poor Publishing and enters the age of computer automation 1966-2005: Expanding Role in Global Markets Indexes like the S&P 500 6,500 employees located in 22 countries $5.00/per 2,500 copies of the first issue

What’s these ratings mean? The highest grade bonds are AAA. Any grade lower than Triple B are said to be noninvestment grade bonds or junk bonds. Typically, the corporate bond market can be divided into two sectors: the investment grade and noninvestment grade market. First, Originally, they have AAA, AA, A and BBB. They want to distinguish in each group, then they developed AA+/AA- Bonds in Default: Technique default: have missed payment on interest

In Default How many defaults @ each ratings? How much additional cost @ each ratings? Before go through default probabilities.

Default Probabilities What is Coverage Level mean? A high bond rating such as AAA indicates low credit risk to investor Borrowing will be less costly for an issuer with higher rating For each drop in ratings, bond issuers pay additional basis points (a basis point is 1/100 of a percentage point). When in millions, a few basis points can translate into thousands of dollars.

   

Example: BJ issues 30-year bond with a 10 million face value    

Why its important to investors & issuers? Indicate the risk of default for a particular bond investment Influence the price and the yield of a bond Issuers The higher the rating, the lower their borrowing costs Independent verification of their credit worthiness They are a marketing tool that can be used to attract investors Why company must pay to be rated in the bond ratings? (Why company want to have bond ratings?) Higher ratings = lower cost of borrower money Investors do not have information, they rely on rating companies If not rated, what happened? Individual spend lots of time to do research, to check the financial sheet, management team……..

What factors effect bond ratings? Ratings of bonds change over time Financial performance Debt ratio & current ratio Economic Outlook Tax base, employment & income Regulatory Environment Management Team Ratings are much more likely to be downgraded: Industrial accident or some regulatory change/ Recapitalization Other reasons – Fallen Angels Bond Issuer requests that a rating company determine a rating Rating Company forms an analytical team that make decision based on the report of the analytical team. The factors effects bond ratings are: see slide.

SUMMARY Bond ratings Three major agencies Investment grade VS noninvestment grade market Default Probability Important to Investors & Issuers Rating of bonds change over time

Thank You! Q&A Fabozzi, Modigliani, and Jones, Foundations of Financial Markets and Institutions. Pearson Prentice Hall, 2010 http://www.investinginbonds.com/learnmore.asp?catid=7&subcatid=72&id=53 http://www.standardandpoors.com/about-sp/timeline/en/us http://en.wikipedia.org/wiki/Bond_credit_rating http://www.kiplinger.com/article/investing/T052-C000-S001-what-bond-ratings-mean.html http://finance.zacks.com/bond-ratings-determined-2859.html http://www.bondsonline.com/Todays_Market/Corporate_Bond_Spreads.php Alan Probst, Local Government Specialist, UW-Extension Local Government Center, PPT in Financial Management Series Number 12 BONDS & BOND RATINGS Mitchell Dietrich, Bond Ratings, 05/06/2013, online PPT