Credit rating


Credit rating
Credit rating of governments around the world by Standard & Poor's:
  AAA
  AA
  A
  BBB
  BB
  B
  not rated

A credit rating evaluates the credit worthiness of an issuer of specific types of debt, specifically, debt issued by a business enterprise such as a corporation or a government. It is an evaluation made by a credit rating agency of the debt issuers likelihood of default.[1] 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.

Credit ratings are often confused with credit scores. Credit scores are the output of mathematical algorithms that assign numerical values to information in an individual's credit report. The credit report contains information regarding the financial history and current assets and liabilities of an individual. A bank or credit card company will use the credit score to estimate the probability that the individual will pay back loan or will pay back charges on a credit card. However, in recent years, credit scores have also been used to adjust insurance premiums, determine employment eligibility, as a factor considered in obtaining security clearances and establish the amount of a utility or leasing deposit.

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. A poor credit score indicates that in the past, other individuals with similar credit reports defaulted on loans at a high rate. The credit score does not take into account future prospects or changed circumstances. For example, if an individual received a credit score of 400 on Monday because he had a history of defaults, and then won the lottery on Tuesday, his credit score would remain 400 on Tuesday because his credit report does not take into account his improved future prospects.

Contents

Credit scores

An individual's credit score, along with his credit report, affects his or her ability to borrow money through financial institutions such as banks.

The factors that may influence a person's credit score are:[2]

  • ability to pay a loan
  • interest
  • amount of credit used
  • saving patterns[not in citation given]
  • spending patterns
  • debt

In different parts of the world different personal credit score systems exist.

North America

In the United States, an individual's credit history is compiled and maintained by companies called credit bureaus. Credit worthiness is usually determined through a statistical analysis of the available credit data.

  • A common form of this analysis is a 3-digit credit score. The most common form of credit score, known as the FICO credit score, however, the actual score is computed by credit bureaus. The term FICO is a registered trademark of Fair Isaac Corporation, which developed FICO and pioneered the credit rating concept in the late 1950s.

In Canada, individuals receive credit ratings such as the North American Standard Account Ratings, also known as the "R" ratings, which have a range between R0 and R9. R0 refers to a new account; R1 refers to on-time payments; R9 refers to bad debt.

Australasia (Australia and NZ)

In Australia, The Australian Government Office of the Privacy Commissioner provides information on how to obtain a copy of your credit report. Personal credit reports in Australia are generally required to be given free of charge.

There are two main credit reporting agencies, Veda Advantage and Dun & Bradstreet.

European Union

Corporate credit ratings

The credit rating of a corporation is a financial indicator to potential investors of debt securities such as bonds. Credit rating is usually of a financial instrument such as a bond, rather than the whole corporation. These are assigned by credit rating agencies such as A. M. Best, Dun & Bradstreet, Standard & Poor's, Moody's or Fitch Ratings and have letter designations such as A, B, C. The Standard & Poor's rating scale is as follows, from excellent to poor: AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-, BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, CC, C, D. Anything lower than a BBB- rating is considered a speculative or junk bond.[3] The Moody's rating system is similar in concept but the naming is a little different. It is as follows, from excellent to poor: Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, C.

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  
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- In default with little
prospect for recovery
Ca CC
C
C D / DDD / In default
/ DD
/ D

Sovereign credit ratings

S&P's ratings of European countries (June 2011).
  AAA
  AA
  A
  BBB
  BB
  B
  CCC
  no rating

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.[4]

Country risk rankings (June 2011)[5][6] Least risky countries, Score out of 100 Source: Euromoney Country risk June 2011
Rank Previous Country Overall score
1 1 Norway 92.44
2 6 Luxembourg 90.86
3 2 Switzerland 90.20
4 4 Denmark 89.07
5 3 Sweden 88.72
6 12 Singapore 87.65
7 5 Finland 87.31
8 7 Canada 87.24
9 6 Netherlands 86.97
10 13 Germany 85.73

The table shows the ten least-risky countries for investment as of June 2011. Ratings are further broken down into components including political risk, economic risk. Euromoney's bi-annual country risk index[7] 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"[8] 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 probability 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.

Credit bureaus and credit rating agencies

Credit scores for individuals are assigned by credit bureaus (US; UK: credit reference agencies). Credit ratings for corporations and sovereign debt are assigned by credit rating agencies.

In the United States, the main credit bureaus are Experian, Equifax, and TransUnion. A relatively new credit bureau in the US is Innovis.[9]

In the United Kingdom, the main credit reference agencies for individuals are Experian, Equifax, and Callcredit. There is no universal credit score as such, rather each individual lender credit scores based on its own wish-list of a perfect customer.[10]

In Canada, the main credit bureaus for individuals are Equifax and TransUnion.[11][12]

In India, commercial credit rating agencies include CRISIL, CARE, ICRA and Brickwork Ratings.[13] The credit bureaus for individuals in India are Credit Information Bureau (India) Limited (CIBIL) and Credit Registration Office (CRO).

In Hong Kong, the locally-based credit rating agency is CTRISKS.[14] The firm offers sovereign ratings on major economies, bank ratings on banks in China, Taiwan, Hong Kong and Macau, obligor ratings on 4000 listed companies in Greater China, bonds ratings on 1000+ bonds in China, Taiwan and Hong Kong and product risk ratings on 1000+ investment products.

The largest credit rating agencies (which tend to operate worldwide) are Dun & Bradstreet, Moody's, Standard & Poor's and Fitch Ratings.[citation needed]

On July 14, 2010, Dagong Global Credit Rating Co. from China released a credit rating that is a break with other western credit rating agencies in an attempt to compete with them.[15]

Information and Rating Agency Credo Line is the only Rating Agency in Ukraine which assigns short-term and long-term credit ratings to Ukrainian, CIS and Eastern-European importing companies in the course of their foreign economic activity and trade financing, in particular.

See also

References

  1. ^ Kronwald, Christian (2009). Credit Rating and the Impact on Capital Structure. Norderstedt, Germany: Druck und Bingdung. p. 3. ISBN 978-3-640-57549-7. http://books.google.com/books?id=CzjS5YV5nK8C&printsec=frontcover&dq=%22credit+rating%22&hl=en&ei=KPMxTuLRCMyBtgeTwImYDQ&sa=X&oi=book_result&ct=result&resnum=2&ved=0CEoQ6AEwAQ#v=onepage&q=%22credit%20rating%22&f=false. 
  2. ^ "Consumer information center FAQ". Equifax.com. http://www.equifax.com/EFX_Canada/consumer_information_centre/faqs_e.html#ques14. Retrieved 2011-08-08. 
  3. ^ de Servigny, Arnaud and Olivier Renault (2004). The Standard & Poor's Guide to Measuring and Managing Credit Risk. McGraw-Hill. ISBN 978-0071417556. 
  4. ^ "Credit rating companies and their impact on the economy". Forexpromos.com. http://www.forexpromos.com/what-are-credit-rating-companies-and-their-impact-on-the-economy. Retrieved 2011-08-08. 
  5. ^ "Country risk survey" previous ranking from Euromoney Country risk September 2010
  6. ^ "Country Risk Full Results": Originally 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.
  7. ^ "Country risk survey". Euromoney.com. http://www.euromoney.com/poll/10683/PollsAndAwards/Country-Risk.html. Retrieved 2011-08-08. 
  8. ^ "Country Risk". ambest.com. http://www3.ambest.com/ratings/cr/crisk.aspx?l=1&Menu=Country+Risk. Retrieved 2011-08-08. 
  9. ^ Holden Lewis (2002-14-14). "The credit report you don't know about". Bankrate.com. http://www.bankrate.com/brm/news/mortgages/20021114a.asp. Retrieved 2007-09-24. 
  10. ^ Martin Lewis. "Credit Ratings: How they work". MoneySavingExpert.com. http://www.moneysavingexpert.com/banking/credit-rating-credit-score. Retrieved 2008. 
  11. ^ "Student workbook", CIBC p. 14
  12. ^ Vanessa Chris (2009-03-31). "Canada Loses a Credit Bureau". Spendonlife.ca. http://www.spendonlife.ca/blog/canada-loses-credit-bureau. Retrieved 2011-08-08. 
  13. ^ "Credit Rating Agency in India". Brickwork Ratings. http://www.brickworkratings.com. Retrieved 2011-08-08. 
  14. ^ "Ctrisks". Ctrisks. http://www.ctrisks.com. Retrieved 2011-08-08. 
  15. ^ Eschenbacher, Stefanie (2010-11-15). "Chinese downgrade for American treasuries". Fundstrategy.co.uk. http://www.fundstrategy.co.uk/markets/chinese-downgrade-for-american-treasuries/1021876.article. Retrieved 2011-08-08. 

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