DEFINITION of 'Ratings Service'

Ratings range from AAA or Aaa (the highest) to C or D, which represents a company that has already defaulted.

BREAKING DOWN 'Ratings Service'

While fixed income and bonds investments can inject a measure of diversification in a common stock portfolio, these vehicles can be complicated, with variant risk profiles. A standardized ratings methodology that compares and contrasts their an investment's risk characteristics with other offerings of the same ilk, can go a long way in prudent decision making.

In determining bond ratings, a host of factors are considered, such as:

Economic sensitivity: the sensitivity levels of a company’s financial position, relative to a shifting economy--whether that economy is strengthening or weakening.

Interest coverage ratio: whether or not a company, a government or a municipality is continually able to cover the interest payments on its bond offerings, given various stress test outcomes. Interest coverage ratios are arguably the most critical measures, because they signal precisely how risky a bond is, if the revenue of a company or government declines or dries up completely.

Recoverability: a measure indicating how easily a company, government, or other bond-issuing entity would be able to cover any outstanding debt—solely with the extra cash it has overseas, should entity go into default.

Seniority: As some bondholders are paid before others, if the issuing entity runs out of cash, seniority measures the whether a given bond is likely default, depending on its ranking on the pecking order.

The S&P Global Ratings Designations and What they Indicate Specifically:

AAA: The highest possible rating, signaling an issuer’s extremely a high likelihood of meeting its financial commitments.

AA: A moderately lower rating than ‘AAA’, this rating signals that an issuer’s likelihood of meeting its financial commitments is still very strong.

A: An obligation rated 'A' is indicates that an issuer is somewhat susceptible to the adverse effects of changes in circumstances and economic conditions, than obligations in other higher-rated categories.

BBB: An obligation rated 'BBB' shows adequate protection measures, but adverse economic conditions are more likely to weaken the obligor's capacity to meet its financial commitments, than higher rated issues.

BB, B, CCC, CC, and C: These ratings indicate that a bond has significant speculative characteristics, where ‘BB' indicates the least speculative, and ‘C' the most.

D: Debt obligation with a 'D' are in default or in breach of an imputed promise. This designation is used when payments on an obligation are not made by a given due date.

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