What makes a good bond?
Bond ratings provide crucial insight into a company’s financial health
Canadian financial institutions don’t post huge profits each year by taking undue risks. This is clearly illustrated by their lending practices — before approving a loan, they’ll take every possible step to ensure we’ll pay the money back. They base their judgement on our credit rating — a measurement detailing our financial history and forecasting our ability to pay back the money. A poor rating means the banks aren’t confident we’ll pay back the loan and it’s unlikely they’ll take a chance.
Similarly, knowing a company’s credit rating helps investors reduce their chances of making a poor decision. These ratings provide crucial insight into a company’s financial history. In Canada, there are two such agencies that carry out this function: the Canadian Bond Rating Service and the Dominion Bond Rating Service. Each rates over 500 Canadian corporate and government issuers of commercial paper, long-term debt, and preferred shares. As well, they cover international companies that access the markets in North America.
Before asgning a rating, analysts look into a variety of factors and carry out extensive financial and economic research. These findings paint a comprehensive financial picture of the company — detailing both its earnings and its ability to pay back debt and interest. The resulting rating helps us decide whether the investor is buying into a high or low risk venture.
This is especially useful when choosing between two companies in the same industry. For example, Company A and Company B are both in the telecommunication industry. However, Company A has a higher bond rating — thus making it a more solid investment.
When the bond rating services have completed their analyses, they assign a rating in the form of a letter grade. The highest rated bond is an A++. Such a company would have a strong combination of earnings, assets and little debt. Moreover, it would be considered a good bet to pay off this debt. A lower rating means the company has not performed well — perhaps failing to make debt repayments — making it a more speculative investment. The lowest rating is D, which usually means the companies are no longer able to make their scheduled debt or interest payments.
Investment professionals follow the ratings closely and will act quickly when they change, especially downward. So, following a ratings downgrade, a company can expect to see its share prices drop.
Because bond rating agencies aren’t in the business of buying, trading or recommending securities, they can operate in a reliable and unbiased manner. The two bond rating agencies are available online: Dominion Bond Rating Service at http://www.dbrs.com and the Canadian Bond Rating Service at
http://www.cbrs.com. Both sites allow you to access up-to-date ratings as well as related information on companies across North America.