Definition of a Bond Rating Agency
Bonds and bond issuers have credit ratings that give investors guidance on the safety of the debt securities and the probability of whether the issuer will default on interest or principal payments. Credit ratings are letter grades such as AA, Baa1 or CC. The different bond rating agencies provide these ratings.
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Identification
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The U.S. government's official term for the rating agencies is Nationally Recognized Statistical Rating Organizations--NRSRO. These firms are approved and used by the federal government to provide analysis and opinions on the creditworthiness of debt issuers and financial institutions. Bonds are a form of debt reviewed by the rating agencies. The agencies used by the federal government are also widely used and followed by private investors and money managers for credit ratings on bonds.
Function
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The credit rating agencies review the financial condition of bond issuers and give the issuers grades on their ability to make the payments on their debt. The credit ratings are given to the issuer and then the issuer's bonds will carry the same rating. The agencies will regularly review bond issuers and can change their ratings of financial conditions change. Extraordinary events can also cause the agencies to review an issuer and change a rating.
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Considerations
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The rating agencies provide letter grades to the bond issuers that indicate their ability to pay the issuer's financial obligations. Bond ratings can be divided into two broad categories, investment grade and non-investment grade. The investment grade ratings are the letter grades of BBB through AAA. Ratings below BBB are considered to be non-investment grade bonds and issuers. Non-investment grade bonds are also known as high-yield and "junk" bonds.
Types
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Rating agencies can be recognized as NRSROs in five classes of credit ratings. Bond ratings come under the classes of corporate issuers, asset-backed security issuers and government debt issuers. The government issuers include municipal bond issuers and foreign governments. Other areas of credit ratings are for financial institutions and insurance companies.
Significance
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The U.S. Securities and Exchange Commission--SEC--recognizes 10 companies as Nationally Recognized Statistical Rating Organizations. The two best known and widely quoted rating agencies are Standard & Poors and Moody's Investors Service. Fitch Ratings Service, which has headquarters in New York and London, is well known as an international rating agency.
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