A credit rating is an evaluation of the credit worthiness of a debtor, especially a business
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. 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. 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. 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
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. 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 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. M. Best defines "country risk" as the risk
that country-specific factors could adversely affect an insurer's ability to meet its financial
obligations. Short-term rating
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. 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
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 ...". However, some studies have estimated
the average risk and reward of bonds by rating. One study by a rating service claimed that
over a "5-year time horizon" bonds it gave its highest rating to had a "cumulative default
rate" of just 0.18%, the next highest 0.28%, the next 2.11%, 8.82% for the next, and 31.24%
for the lowest it studied. Over a longer time horizon it stated "the order is by and large,
but not exactly, preserved". 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. Looking at rated bonds from 1973–89, the authors
found a AAA rated bond paid only 43 "basis points" over a Treasury bond. A CCC-rated
"junk" bond on the other hand, paid over 4% more than a Treasury on average over that
period. 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. The Standard & Poor's rating scale
uses upper case letters and pluses and minuses. 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, 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.
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. 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. 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.
Credit rating agencies
In addition to "the Big Three" of Moody's, Standard & Poor's, and Fitch Ratings, other
agencies and rating companies include: Agusto & Co., A. M. Best, China Chengxin Credit
Rating Group, Credit Rating Information and Services Limited, CTRISKS, Dagong Europe Credit
Rating, DBRS, Dun & Bradstreet, Egan-Jones Rating Company, Global Credit Ratings Co.,
ICRA Limited, Japan Credit Rating Agency, Levin and Goldstein, Morningstar, Inc., Muros
Ratings, Public Sector Credit Solutions, Rapid Ratings International, Veda, Wikirating, Humphreys
Ltd. See also
Government budget by country List of countries by credit rating
List of countries by tax revenue as percentage of GDP
List of sovereign states by public debt Individuals:
Credit history Credit score