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A Primer on Corporate Bonds – I (Credit Ratings)

This is a column by regular contributor Clark.

The earlier parts of the bond series dealt with the basic types of bonds and their risks and suitability. This part will begin a sub-series on corporate bonds.

As mentioned in the first part of the series, corporate bonds are issued by companies to gather funds for their business. With thousands of companies issuing bonds, where does one start to make the list smaller?

Credit Rating Agencies

Similar to credit reporting bureaus that keep track of a consumer’s credit history, there are Nationally (US) Recognized Statistical Rating Organizations such as DBRS (short for Dominion Bond Rating Service), Moody’s, Standard and Poor’s(the S&P Indices fame) and Fitch Ratings that issue credit ratings for companies. These agencies offer a rating system to aid investors in determining the risks associated with investing in any company. Debt could be secured or unsecured and there are specific ratings for short-term debt, long-term debt, preferred stock, etc. A glance at the long-term credit ratings of a company (that also considers assets or collateral needed in case of default) would show the company’s ability to fulfill its debt obligations and credit worthiness. It must be noted that credit ratings are not meant as alerts to buy, hold or sell; they are just a tool to assess a company’s capacity to pay back debt.

Foreign Currency Debt

Companies may borrow from lenders inside and/or outside the country (for example, Canadian companies may make use of US banks and vice versa). As would be obvious, borrowing from foreign lenders comes with currency rate fluctuations. Repaying a local (as in country) lender is straightforward – if the company has the money and willing to repay, then the debt is paid. But, in the case of foreign currency debt, companies would have to consider currency rates and decide if it is lucrative to repay debt at that existing currency rate or watch market forecasts and calculate if they would be in better health by holding off until when they think the exchange rate will be stronger (they may also invest overseas at such a time). Foreign currency debt throws another variable into the mix but thankfully, agencies evaluate an organization’s ability to repay debts in local and foreign currencies. If the organization has foreign currency debt but does not have sufficient foreign currency reserves, then their rating may be lower.

Corporate Credit Rating

Corporate credit ratings range from the highest quality (best) to junk level (worst). Agencies use different designations but in general, long-term ratings are denoted by the letters AAA (triple A), which is the best credit rating (meaning low credit risk) and C or D (based on the agency) is the worst (default level as in failing to meet obligations). There are subsets to the basic category, which might involve a “+” or “-” sign to indicate subclasses (again, varies based on the agency). For example, the Fitch Ratings use AAA, AA, AA, BBB for investment grade and BB, B, CCC, CC, C, D and NR (not rated) for non-investment grade bonds. A good credit rating helps a corporation attract new partners or retail investors, apply for an increase to their line of credit, or sell their business.

Sovereign Credit Rating

A sovereign credit rating provides information about a country’s ability to provide a stable and secure investment market. This rating is contingent on a country’s economic status, market transparency, foreign investments, currency (local and foreign) reserves, and political stability to name a few. Potential investors can analyze the country-level risk associated with the company they are looking at and arrive at their decision. A sovereign rating is critical, since it will boost the country’s prospects in terms of pulling in foreign investments and assisting in the growth of the economy.

In the next part, we’ll look at some metrics worth knowing about when purchasing corporate bonds.

About the Author: Clark is a twenty-something Saskatchewan resident employed in the manufacturing sector. He repaid around $20,000 in student loans and has been working to build his investment portfolio as a DIY investor (not trader) while nurturing plans to retire early. He loves reading (and using the lessons learned) about personal finance, technology and minimalism.







8 Comments, Comment or Ping

  1. 1. Rachelle

    Thanks Clark

    I sure know more than I did a few minutes ago about corporate bonds

  2. Clark, have you ever invested in individual issues before? The only experience I have is through ETFs.

  3. 3. Clark

    @Rachelle: You are welcome! There’s more in the coming parts.

    @FrugalTrader: No, I’ve not bought individual issues and hold some bonds through the TD e-Series fund. At this point, buying individual stocks seem like an easier task.

  4. 4. Joseph

    GREETINGS,
    I am looking for a safe investment in cooperate bonds. Is there any such thing. I heard that ATnT is safe and pays somewhere around 7%. I have $100,000 to invest. I am also looking into the possiblity for Gold and Silver, Is there amyone who can guide me properly. Thank you

  5. Joseph, if you are looking for safe, you may want to consider government or investment grade corporate bonds. ETFs are probably the best bet, check out XBB, XCB, XSB, CLF and CBO.

  6. 6. Clark

    @Joseph: As FrugalTrader said, ETFs would be the way to go. You could buy individual corporate bonds, if you have the time and interest to pore over the annual reports of at least a few companies. Else, ETFs will offer the diversification needed to negate the impact of defaults, if any, on your portfolio. With respect to gold, I would suggest that ETFs like Claymore’s CGL or iShares’ XGD might be worth looking into.

  7. 7. Joseph

    How do I go about purchasing them and where.

    What are the fees and firms that I should avoid

    Any other advise would be appreciated

    Thank you for the reply and advice

  8. 8. Gerry

    Individual corporate bonds are sold directly through brokerages. They can be expensive, typically sold in lots of around $5,000. Also, there is no open exchange for bonds; you pay what your broker wants to charge and you’ll only get what your broker is willing to pay. That said, buying is usually quite easy. I’ve bought individual issues through TD Waterhouse and it’s pretty much the same as buying a stock, but it’s done through their “Fixed Income Centre”. Selling can be a bit of a headache if you buy bonds that aren’t “simple”. Some of the bonds I bought are more complex with callable provisions and conversion clauses. Because of that, Waterhouse doesn’t let you sell them through their web page, you have to call in and discuss the sale with an agent. It’s not exactly a free and fair process so I have moved on to holding the ETFs that both Clark and FT have pointed out.

    Don’t forget CHB, Claymores Advantaged High Yield Bond fund. It invests in liquid, below-investment grade US bonds. I wouldn’t touch these bonds as individual issues because I could never get enough diversity to feel safe. Through a large ETF that problem is solved. The fund currently returns 7.5% which is quite good in it’s own. However, it is structured to pay most income as captial gains and return of capital, lowering the tax burden on the income when compared to simple interest income. There’s a bit more accounting to do but it saves taxes. I’ve found that my broker (Waterhouse) takes care the adjusted cost base for me automatically so it’s really no extra work.

    On the side of gold, it’s worth pointing out that the iShares Global Gold ETF (XGD) is actually an ETF of gold miners, not gold bullion. The relationship between the price of the miners and the price of the metal is complicated. CGL is a 100% gold bullion fund. If you’re looking for precious metals exposure, take a look at Central Fund of Canada (CEF), a mixed fund of physical gold, silver, and some cash.

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