A credit rating is an evaluation of the
credit risk of a prospective
debtor
A debtor or debitor is a legal entity (legal person) that owes a debt to another entity. The entity may be an individual, a firm, a government, a company or other legal person. The counterparty is called a creditor. When the counterpart of this ...
(an individual, a
business
Business is the practice of making one's living or making money by producing or Trade, buying and selling Product (business), products (such as goods and Service (economics), services). It is also "any activity or enterprise entered into for pr ...
,
company
A company, abbreviated as co., is a Legal personality, legal entity representing an association of people, whether Natural person, natural, Legal person, legal or a mixture of both, with a specific objective. Company members share a common p ...
or a government), predicting their ability to pay back the debt, and an implicit forecast of the likelihood of the debtor
defaulting.
The credit rating represents an evaluation of a
credit rating agency of the qualitative and quantitative information for the prospective debtor, including information provided by the prospective debtor and other non-public information obtained by the credit rating agency's analysts.
Credit reporting (or
credit score
A credit score is a numerical expression based on a level analysis of a person's credit files, to represent the creditworthiness of an individual. A credit score is primarily based on a credit report, information typically sourced from credit bu ...
) – is a subset of credit rating – it is a numeric evaluation of an ''individual's'' credit worthiness, which is done by a
credit bureau or
consumer credit reporting agency
A credit bureau is a data collection agency that gathers account information from various creditors and provides that information to a consumer reporting agency in the United States, a credit reference agency in the United Kingdom, a credit report ...
.
Sovereign credit ratings
A
sovereign credit rating
A credit rating is an evaluation of the credit risk of a prospective debtor (an individual, a business, company or a government), predicting their ability to pay back the debt, and an implicit forecast of the likelihood of the debtor defaulting.
...
is the credit rating of a
sovereign
''Sovereign'' is a title which can be applied to the highest leader in various categories. The word is borrowed from Old French , which is ultimately derived from the Latin , meaning 'above'.
The roles of a sovereign vary from monarch, ruler or ...
entity, such as a national government. The sovereign credit rating indicates the risk level of the investing environment of a country and is used by investors when looking to invest in particular jurisdictions, and also takes into account
political risk.
The "
country risk rankings" table shows the ten least-risky countries for investment . 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, with
Singapore emerging as the least risky country since 2017 – it is also the one of the only few countries in the world as well as the only in Asia to achieve a AAA sovereign credit rankings from all
major credit agencies.
Results focus foremost on economics, specifically
sovereign default risk or payment default risk for exporters (also known as a
trade credit risk).
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 and long-term ratings
A rating expresses the likelihood that the rated party will go into
default
Default may refer to:
Law
* Default (law), the failure to do something required by law
** Default (finance), failure to satisfy the terms of a loan obligation or failure to pay back a loan
** Default judgment, a binding judgment in favor of ei ...
within a given
time horizon. In general, a time horizon of one year or under is considered short term, and anything above that is considered long term. In the past institutional investors preferred to consider long-term ratings. Nowadays, short-term ratings are commonly used.
Corporate credit ratings
Credit ratings can address a corporation's
financial instrument
Financial instruments are monetary contracts between parties. They can be created, traded, modified and settled. They can be cash (currency), evidence of an ownership interest in an entity or a contractual right to receive or deliver in the form ...
s i.e.
debt security
Security is protection from, or resilience against, potential harm (or other unwanted coercive change) caused by others, by restraining the freedom of others to act. Beneficiaries (technically referents) of security may be of persons and social ...
such as a
bond, but also the corporations itself. Ratings are assigned by
credit rating agencies, the largest of which are
Standard & Poor's
S&P Global Ratings (previously Standard & Poor's and informally known as S&P) is an American credit rating agency (CRA) and a division of S&P Global that publishes financial research and analysis on stocks, bonds, and commodities. S&P is con ...
,
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 an AAA-rated and a BB-rated bond respectively).
However, some studies have estimated the average risk and reward of bonds by rating. One study by Moody's
[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][cited by authors Herwig Langohr and Patricia Langohr] claimed that over a "5-year time horizon" bonds it gave its highest rating (Aaa) to had a "cumulative default rate" of 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 period, 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. (See "Basis point spread" in table to right.) Looking at rated bonds for 1973–89, the authors found a AAA-rated bond paid 43 "
basis points" (or 43/100 of a percentage point) over a US 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 7% (724 basis points) more than a Treasury bond on average over that period.
[from Altman, Edward I "Measuring Corporate Bond Mortality and Performance" ''Journal of Finance'', (September 1989) pp. 909–22]
Different rating agencies may use variations of an alphabetical combination of lowercase and uppercase 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 uppercase letters and pluses and minuses.
The Moody's rating system uses numbers and lowercase letters as well as uppercase.
While Moody's, S&P and Fitch Ratings control 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 map 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 (ECB) for 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, which means that it takes the highest rating among the four agencies – 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 they affect 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.
Under the EU Credit Rating Agency Regulation (CRAR), the European Banking Authority has developed a series of mapping tables that map ratings to the "Credit Quality Steps" (CQS) as set out in regulatory capital rules and map the CQS to short run and long run benchmark default rates. These are provided in the table below:
See also
*
List of countries by government budget
*
List of countries by credit rating
*
List of countries by tax revenue to GDP ratio
*
List of countries by public debt
Individuals:
*
Credit history
*
Credit score
A credit score is a numerical expression based on a level analysis of a person's credit files, to represent the creditworthiness of an individual. A credit score is primarily based on a credit report, information typically sourced from credit bu ...
References
External links
*
{{Authority control
Credit
Rating