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When is a Bond Dropped?

Original post by Michael Wolfe of Demand Media

When a bond is issued, a credit rating agency will generally choose to assign it a rating that reflects how likely it is that the company will pay it back. When a bond is dropped, this refers to it's credit rating being lowered. This can happen if the bond suddenly looks in danger of being defaulted on. There are a number of situations in which a rating agency may choose to downgrade a particular bond issue's rating.

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Issuer Problems

In many cases, a bond will have its rating dropped when the party that issued or that guaranteed the bond has financial problems that affect its creditworthiness. In such a case, the risk that the bond will be defaulted on increases if the company looks like they may not be able to pay back the debts they've taken out. As a result, the bond rating is lowered.

Tranche-Specific Issues

In some cases, a bonds payment may be linked to revenues generated from a particular source, with the bond guarantee by this particular income stream rather than from the entire stream of revenues that were provided to its issuer. Therefore, if this revenue stream has a wrench thrown in its works, jeopardizing its cash flow, then the credit rating agency may hit the bond tranche with a downgrade.

Economic Instability

In some cases, the bond issuer may be doing fine and the revenue stream for the tranche may not have run into any problems. However, if the rest of the economy is in turmoil, the bond issuer may become worried that the issuer will run into financial problems in the future. In such a case, the bond issue may be downgraded as a precautionary measure.

New Methodology

In rare instances, a credit rating agency will actually publicly change the methodology that it uses to bestow ratings on bonds. When this happens, it means that bonds it previously gave a specific rating may be provided with another rating that reflects changes in how the company calculates risk. However, that also means that in some cases, a change in methodology can boost a bond's rating.


                   

References

  • "Investing for Dummies"; Eric Tyson; 2008

About the Author

Michael Wolfe has been writing and editing since 2005, with a background including both business and creative writing. He has worked as a reporter for a community newspaper in New York City and a federal policy newsletter in Washington, D.C. Wolfe holds a B.A. in art history and is a resident of Brooklyn, N.Y.


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