When an individual purchases a bond, one of the factors they consider is the current bond rating. Standard & Poor’s (S&P) is one of the major independent rating agencies that helps to determine bond ratings. It looks at the issuer of a bond to see if they have the financial strength to pay back the bond and the interest as noted in the bond indenture.
If the bond rating is good, this means the company is strong enough to pay its obligations, which include expenses, payments on debts, and dividends. The highest rating issued by S&P is AAA. The grades AAA, AA, A, BBB+, BBB to BBB- are considered “investment grade” or of high quality. Grades BB+ to D are considered to be of greater risk. The risk increases with the lower of the grade.
While the rating is a top consideration at the purchase of a bond, many individuals never give it a second thought once the purchase is made. However, just because the bond is of good quality at purchase does not mean it will stay that way. Case in point is the current state of many bonds in the Energy Sector. While many of them were highly rated in the past, several have fallen to junk status and no longer have value. Bond downgrades usually happen gradually in steps but that is not always the case now. We have seen dramatic downgrades with a corresponding drop in the bond price recently. So then, the question of what to do with that bond becomes paramount. Do you sell it off immediately and take the hit on the price or do you hold the bond taking the risk that the bond may fall further and not get paid the full maturity price of the bond? The answer to that depends on many variables and you must take the time to understand the causes of the downgrades, the seriousness of the financial situation of the company, and the economic outlook of the industry it is in.
Most people don’t have the time to devote to this process or the knowledge to make the best choice so it is important to team up with someone who knows the market, can monitor the changes in the bond market and take the time to truly understand the situation. If a bond’s rating starts to fall, they can help you adjust your investment mix so that you do not end up holding a bond that is valueless. For more information in monitoring bond statuses, contact the team at Financial Fiduciaries.