What is a credit rating?
A credit rating is a way of measuring the likelihood of a prospective debtor paying back a debt. In practice, it represents an evaluation of the creditworthiness of the debtor and the risk of defaulting.
Thus, credit ratings are opinions expressed on an alphanumeric scale on the relative ability and willingness of a debt issuer to meet their financial compromises. These debt ratings are typically generated by a credit agency.
What are credit ratings agencies?
There are three main global agencies that specialise in assigning these ratings:
- Standard and Poor’s (S&P)
- Moody’s
- Fitch
To award this rating, they consider several factors that could increase or decrease this risk including the credit quality of the issuer, their ability to cover interest payments from profits and any security – usually in the form of assets such as property – on offer.
These ratings aim to be objective, transparent, consistent and comparable across instruments, maturities, industries and countries. Some specific sectors, maturities and countries have their own rating scales.
How is the credit rating done?
Depending on their associated risks, the ratings may vary from AAA or “triple A” for the safest, low-risk securities, typically issued by high-quality institutions like the UK bond government and blue-chip companies, down to D for those which have failed to make a coupon payment on time and are therefore in default.
For S&P and Fitch, the long-term global rating scale contains nine grades: AAA, AA, A, BBB, BB, B, CCC, CC, and C; plus positive and negative modifiers, the scale encompasses up to 21 different grades (AAA+, AAA, AAA- …), going from the highest grade to the lowest grade in increasing order of riskiness.
Moody’s scale is quite similar, but uses different letters and numbers to obtain the same grades in increasing order of riskiness: Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C (applying modifiers such as Aa1, Ba2, etc).
These ratings have a strong impact on investments worldwide, as many fund managers are mandated by the regulator to hold “investment grade” bonds, meaning those with a credit rating of BBB and above.
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Category: Financial Glossary