Credit rating

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World countries by Standard & Poor's Foreign Rating:[1][2]
Dark Green - AAA Light Green - AA Celery - A
Yellow - BBB Orange - BB Red - B
Dark Red - CCC Grey - not rated

A credit rating is an evaluation of the credit worthiness of a debtor, especially a business (company) or a government, but not individual consumers. The evaluation is made by a credit rating agency of the debtor's ability to pay back the debt and the likelihood of default.[3] Evaluations of individuals' credit worthiness are known as credit reporting and done by credit bureaus, or consumer credit reporting agencies, which issue credit scores.

Credit ratings are determined by credit ratings agencies. The credit rating represents the credit rating agency's evaluation of qualitative and quantitative information for a company or government; including non-public information obtained by the credit rating agencies' analysts.

Credit ratings are not based on mathematical formulas.[citation needed] Instead, credit rating agencies use their judgment and experience in determining what public and private information should be considered in giving a rating to a particular company or government.[citation needed] The credit rating is used by individuals and entities that purchase the bonds issued by companies and governments to determine the likelihood that the government will pay its bond obligations.

A poor credit rating indicates a credit rating agency's opinion that the company or government has a high risk of defaulting, based on the agency's analysis of the entity's history and analysis of long term economic prospects.

Sovereign credit ratings[edit]

A sovereign credit rating is the credit rating of a sovereign entity, i.e., a national government. The sovereign credit rating indicates the risk level of the investing environment of a country and is used by investors looking to invest abroad. It takes political risk into account.

Country risk rankings (January 2013)[4][5] Least risky countries, Score out of 100 Source: Euromoney country risk
Rank Previous Country Overall score
1 1 Norway 89.87
2 3 Luxembourg 87.29
3 4 Singapore 86.81
4 5 Sweden 86.81
5 2 Switzerland 86.78
6 6 Finland 84.54
7 7 Denmark 82.64
8 9 Hong Kong 82.43
9 8 Netherlands 81.82
10 8 Canada 81.82

The "Country risk rankings" table shows the ten least-risky countries for investment as of January 2013. Ratings are further broken down into components including political risk, economic risk. Euromoney's bi-annual country risk index[6] monitors the political and economic stability of 185 sovereign countries. Results focus foremost on economics, specifically sovereign default risk and/or payment default risk for exporters (a.k.a. "trade credit" risk).

A. M. Best defines "country risk"[7] as the risk that country-specific factors could adversely affect an insurer's ability to meet its financial obligations.

Short-term rating[edit]

A short-term rating is a probability factor of an individual going into default within a year. This is in contrast to long-term rating which is evaluated over a long timeframe. In the past institutional investors preferred to consider long-term ratings. Nowadays, short-term ratings are commonly used.[citation needed]

First, the Basel II agreement requires banks to report their one-year rose if they applied internal-ratings-based approach for capital requirements. Second, many institutional investors can easily manage their credit/bond portfolios with derivatives on monthly or quarterly basis. Therefore, some rating agencies simply report short-term ratings.

Corporate credit ratings[edit]

Main article: Bond credit rating

Credit ratings that concern corporations are usually of a corporation's financial instruments i.e. debt security such as a bond, but corporations themselves are also sometimes rated. Ratings are assigned by credit rating agencies, the largest of which are Standard & Poor's, Moody's and Fitch Ratings. They use letter designations such as A, B, C. Higher grades are intended to represent a lower probability of default.

Agencies do not attach a hard number of probability of default to each grade, preferring descriptive definitions such as: "the obligor's capacity to meet its financial commitment on the obligation is extremely strong," or "less vulnerable to non-payment than other speculative issues ..." (Standard and Poors' definition of a AAA rated and a BB rated bond respectively).[8] However, some studies have estimated the average risk and reward of bonds by rating. One study by a rating service (Moody's)[9][10] claimed that over a "5-year time horizon" bonds it gave its highest rating (Aaa) to had a "cumulative default rate" of just 0.18%, the next highest (Aa2) 0.28%, the next (Baa2) 2.11%, 8.82% for the next (Ba2), and 31.24% for the lowest it studied (B2). (See "Default rate" in "Estimated spreads and default rates by rating grade" table to right.) Over a longer time horizon it stated "the order is by and large, but not exactly, preserved".[11]

Estimated spreads and
default rates by rating grade
Rating Basis
Point
spread
[12][13][14]
Default
rate[9][10]
AAA/Aaa 43 0.18%
AA/Aa2 73 0.28%
A 99 n/a
BBB/Baa2 166 2.11%
BB/Ba2 299 8.82%
B/B2 404 31.24%
CCC 724 n/a
Sources: Basis spread from
Federal Reserve Bank of
New York Quarterly Review
,
Summer-Fall 1994";
Default rate from study
by Moody's investment service

Another study in Journal of Finance calculated the additional interest rate or "spread" corporate bonds pay over that of "riskless" US Treasury bonds, according to the bonds rating. (See "Basis point spread" in table to right.) Looking at rated bonds from 1973–89, the authors found a AAA rated bond paid only 43 "basis points" (or 43/100th of a percentage point) over a Treasury bond (so that it would yield 3.43% if the Treasury yielded 3.00%). A CCC-rated "junk" (or speculative) bond on the other hand, paid over 4% (404 basis points) more than a Treasury on average over that period.[12][13]

Different rating agencies may use variations of an alphabetical combination of lower and upper case letters, with either plus or minus signs or numbers added to further fine tune the rating (see colored chart). The Standard & Poor's rating scale uses upper case letters and pluses and minuses.[15] The Moody's rating system uses numbers and lower case letters as well as upper case.

While Moody's, S&P and Fitch Ratings controlling approximately 95% of the credit ratings business,[16] they are not the only rating agencies. DBRS's long-term ratings scale is somewhat similar to Standard & Poor's and Fitch Ratings with the words high and low replacing the + and -. It goes as follows, from excellent to poor: AAA, AA(high), AA, AA(low), A(high), A, A(low), BBB(high), BBB, BBB(low), BB(high), BB, BB(low), B(high), B, B(low), CCC(high), CCC, CCC(low), CC(high), CC, CC(low), C(high), C, C(low) and D. The short-term ratings often maps to long-term ratings though there is room for exceptions at the high or low side of each equivalent.[17]

S&P, Moody's, Fitch and DBRS are the only four ratings agencies that are recognized by the European Central Bank for the purposes of determining collateral requirements for banks to borrow from the central bank. The ECB uses a first, best rule among the four agencies that have the designated ECAI status.[18] That means that it takes the highest rating among the four - S&P, Moody's, Fitch and DBRS - to determine haircuts and collateral requirements for borrowing. Ratings in Europe have been under close scrutiny, particularly the highest ratings given to countries like Spain, Ireland and Italy because it affects how much banks can borrow against sovereign debt they hold.[19]

A. M. Best rates from excellent to poor in the following manner: A++, A+, A, A-, B++, B+, B, B-, C++, C+, C, C-, D, E, F, and S. The CTRISKS rating system is as follows: CT3A, CT2A, CT1A, CT3B, CT2B, CT1B, CT3C, CT2C and CT1C. All these CTRISKS grades are mapped to one-year probability of default.

Moody's S&P Fitch rating description
Long-term Short-term Long-term Short-term Long-term Short-term
Aaa P-1 AAA A-1+ AAA F1+ Prime
Aa1 AA+ AA+ High grade
Aa2 AA AA
Aa3 AA- AA-
A1 A+ A-1 A+ F1 Upper medium grade
A2 A A
A3 P-2 A- A-2 A- F2
Baa1 BBB+ BBB+ Lower medium grade
Baa2 P-3 BBB A-3 BBB F3
Baa3 BBB- BBB-
Ba1 Not prime BB+ B BB+ B Non-investment grade
speculative
Ba2 BB BB
Ba3 BB- BB-
B1 B+ B+ Highly speculative
B2 B B
B3 B- B-
Caa1 CCC+ C CCC C Substantial risks
Caa2 CCC Extremely speculative
Caa3 CCC- Default imminent with little
prospect for recovery
Ca CC
C
C D / DDD / In default
/ DD
/ D

Credit rating agencies[edit]

Main article: Credit rating agency

In addition to "the Big Three" of Moody's, Standard & Poor's, and Fitch Ratings, other agencies and rating companies include (in alphabetical order):

Agusto & Co. (Nigeria), A. M. Best (U.S.), China Chengxin Credit Rating Group (China), Credit Rating Information and Services Limited[20][21] (Bangladesh), CTRISKS (Hong Kong),[22] Dagong Europe Credit Rating (Italy), DBRS (Canada), Dun & Bradstreet (U.S.), Egan-Jones Rating Company (U.S.), Global Credit Ratings Co. (South Africa), HR Ratings (Mexico), ICRA Limited (India), Japan Credit Rating Agency[23] (Japan), Levin and Goldstein (Zambia), Morningstar, Inc. (U.S.), Muros Ratings[24] (Russia, alternative rating company), Public Sector Credit Solutions[25] (U.S., not-for profit rating provider), Rapid Ratings International[26] (U.S.), Veda (Australia, previously known as Baycorp Advantage), Wikirating (Switzerland, alternative rating organization), Humphreys Ltd (Chile, previously known as Moody´s Partner in Chile).

See also[edit]

Individuals:

References[edit]

  1. ^ "S&P | Ratings Sovereigns Ratings List | Americas". Standard & Poor's. Retrieved August 7, 2011. 
  2. ^ Reference for the United States: "United States of America Long-Term Rating Lowered To 'AA+' On Political Risks And Rising Debt Burden; Outlook Negative". Standard & Poor's. Retrieved August 5, 2011. 
  3. ^ Kronwald, Christian (2009). Credit Rating and the Impact on Capital Structure. Norderstedt, Germany: Druck und Bingdung. p. 3. ISBN 978-3-640-57549-7. 
  4. ^ "Country risk survey - previous ranking from previous quarter, Euromoney Country risk". Euromoney.com. Retrieved 2013-06-18. 
  5. ^ "Country Risk Full Results": Originally a bi-annual survey which monitors the political and economic stability of 185 sovereign countries, according to ratings agencies and market experts. The information is compiled from Risk analysts; poll of economic projections; on GNI; World Bank’s Global Development Finance data; Moody’s Investors Service, Standard & Poor’s and Fitch IBCA; OECD consensus groups (source: ECGD); the US Exim Bank and Atradius UK; heads of debt syndicate and loan syndications; Atradius, London Forfaiting, Mezra Forfaiting and WestLB.
  6. ^ "Country risk survey". Euromoney.com. 
  7. ^ "Country Risk". ambest.com. Retrieved 2011-08-08. 
  8. ^ Sinclair, Timothy J. (2005). The New Masters of Capital: American Bond Rating Agencies and the Politics of Creditworthiness. Ithaca, New York: Cornell University Press. p. 36, Bond Rating Symbols and Definitions, Table 2,. ISBN 978-0801474910. Retrieved 21 September 2013. 
  9. ^ a b Cantor, R., Hamilton, D.T., Kim, F., and Ou, S., 2007 Corporate default and recovery rates. 1920-2006, Special Comment: Moody's investor Service, June Report 102071, 1-48 page 24
  10. ^ a b cited by authors Herwig Langohr and Patricia Langohr
  11. ^ Langohr, Herwig; Patricia Langohr (2010). The Rating Agencies and Their Credit Ratings: What They Are, How They Work. Wiley. p. 48. 
  12. ^ a b Cantor, Richard; Packer, Frank (Summer–Fall 1994). "The credit rating industry". Federal Reserve Bank of New York Quarterly Review (Federal Reserve Bank of New York). p. 10. ISSN 0147-6580. 
  13. ^ a b from Altman, Edward I "Measuring Corporate Bond Mortality and Performance" Journal of Finance, (September 1989) p.909-22
  14. ^ Note: Based on equally weighted averages of monthly spreads per rating category. Spreads for BB and B represent data from 1979-87 only, spreads for CCC, data for 1982-87 only.
  15. ^ de Servigny, Arnaud and Olivier Renault (2004). The Standard & Poor's Guide to Measuring and Managing Credit Risk. McGraw-Hill. ISBN 978-0-07-141755-6. 
  16. ^ Alessi, Christopher. "The Credit Rating Controversy. Campaign 2012". Council on Foreign Relations. Retrieved 29 May 2013. 
  17. ^ "DBRS: Short-Term and Long-Term Rating Relationships". DBRS. Retrieved 2013-06-28. 
  18. ^ "External credit assessment institution source (ECAIs)". European Central Bank. Retrieved 21 January 2014. 
  19. ^ Jones, Marc (19 December 2013). "First crunch date in Europe's ratings calendar is April 11". Reuters. Retrieved 21 January 2014. 
  20. ^ "List of Credit Rating Companies". Bangladesh Securities and Exchange Commission. 2 September 2008. Retrieved 2007-03-12. 
  21. ^ Crisl History
  22. ^ "SFC achieves smooth transition for credit rating agencies falling within new regulatory regime". Hong Kong Securities and Futures Commission. 2 June 2011. Retrieved 2014-07-29. 
  23. ^ "Credit Rating Agencies—NRSROs". U.S. Securities and Exchange Commission. 25 September 2008. Retrieved 2009-04-30. 
  24. ^ "Murosgroup.com". Murosgroup.com. Retrieved 2013-06-18. 
  25. ^ "Public Sector Credit Solutions". Public Sector Credit Solutions. Retrieved 2013-09-21. 
  26. ^ "rapidratings.com". rapidratings.com. Retrieved 2013-06-18.