Credit rating & Rating agencies

Credit rating – an evaluation of the credit worthiness of a debtor, especially a state, business (company) or a government. Or in other words, an estimate of the ability of a person or organization to fulfill their financial commitments, based on previous dealings. The evaluation is made by a credit rating agency of the debtor's ability to pay back the debt and the likelihood of default.

The real role of credit ratings in the financial system is to improve the functioning of markets by reducing information asymmetry between issuers and borrowers who need funding and the investors and lenders who can provide it. Credit ratings thus can help make markets more efficient by putting all lenders and investors on more equal footing, thereby minimizing variations in return that can arise from differences in the ability to make sound credit judgments. Credit rating agencies assess the relative credit risk of specific debt securities or structured finance instruments and borrowing entities (issuers of debt), and in some cases the creditworthiness of governments and their securities. By serving as information intermediaries, CRAs (Community Reinvestment Act) theoretically reduce information costs, increase the pool of potential borrowers, and promote liquid markets. These functions may increase the supply of available risk capital in the market and promote economic growth.

A credit rating can be assigned to any entity that seeks to borrow money – a corporation, state or provincial authority, or sovereign government. Credit assessment and evaluation for companies and governments is generally done by a credit rating agency. These rating agencies are paid by the entity that is seeking a credit rating for itself or for one of its debt issues.

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 for borrowers are based on substantial due diligence conducted by the rating agencies. While a borrower will strive to have the highest possible credit rating since it has a major impact on interest rates charged by lenders, the rating agencies must take a balanced and objective view of the borrower’s financial situation and capacity to service/repay the debt.

The credit rating has an inverse relationship with the possibility of debt default. In the opinion of the rating agency, a high credit rating indicates that the borrower has a low probability of defaulting on the debt; conversely, a low credit rating suggests a high probability of default.

Credit ratings are issued by independent rating agencies, such as the internationally recognized Standard & Poor’s, Fitch Ratings and Moody’s Investors Services. 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. They formulate and disseminate ratings opinions that are used by investors and other market participants who may consider credit risk in making their investment and business decisions. In part because rating agencies are not directly involved in capital market transactions, they have come to be viewed by both investors and issuers as impartial, independent providers of opinions on credit risk.

The rating is usually calculated as the likelihood of a failure occurring over a given period and is expressed as an alphabetical rating, with the higher rating e.g. ‘AAA’, being superior (having a lower chance of default) to a lower rating e.g. ‘C’ (a higher risk of default). Each agency applies its own methodology in measuring creditworthiness and uses a specific rating scale to publish its ratings opinions.

In this table you can see methodology of the three most popular rating agencies.

And on this picture you can see World countries by Standard & Poor's Foreign Rating

Credit rating changes can have a significant impact on financial markets. A prime example of this effect is the adverse market reaction to the credit rating downgrade of the U.S. federal government by Standard & Poor’s on August 5, 2011. Global equity markets plunged for weeks following the downgrade.

A high credit score indicates a stronger credit profile and will generally result in lower interest rates charged by lenders.

Credit Worthiness - an assessment of the likelihood / risk that a borrower will default on any type of debt by failing to make required payments. The risk is primarily that of the lender and includes lost principal and interest, disruption to cash flows, and increased collection costs. It is based upon factors, such as their history of repayment and their credit score. Lending institutions also consider the availability of assets and extent of liabilities to determine the probability of default.

The loss may be complete or partial and can arise in a number of circumstances. For example:

· A consumer may fail to make a payment due on a mortgage loan, credit card, line of credit, or other loan

· A company is unable to repay asset-secured fixed or floating charge debt

· A business does not pay an employee's earned wages

· A business or government bond issuer does not make a payment on a coupon or principal payment

· An insolvent insurance company does not pay a policy obligation

· An insolvent bank won't return funds to a depositor

· A government grants bankruptcy protection to an insolvent consumer or business

In general, the higher the risk, the higher will be the interest rate that the debtor will be asked to pay on the debt.

Дата добавления: 2015-10-23