What is credit rating?

Credit rating

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 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 Powerball on Tuesday, his credit score would remain 400 on Tuesday because his credit report does not take into account his improved future prospects.

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, know as the FICO credit score, was developed by Fair Isaac Corporation, however, the actual score is computed by credit bureaus.
• The term FICO is a registered trademark of Fair Isaac Corporation, which pioneered the credit rating concept in the late 1950s.

In Canada, individuals actually 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. Very few people maintain the R0 status for long, as there are similar mechanisms in place in Canada that would allow for monthly updates of one's credit rating.

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"

People living in Tasmania can also contact "Tasmanian Collection Service"

European Union

S&P's ratings of European countries (June 2011).

  AAA

  AA

  A

  BBB

  BB

  B

  CCC

  no rating

Corporate credit ratings

Main article: Bond credit rating

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.

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 table shows the ten least-risky countries for investment as of September 2010. Ratings are further broken down into components including political risk, economic risk. Euromoney's bi-annual country risk index "Country risk survey" 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" 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 insitutional 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. In Greater China, CTRISKS is the first CRA providing short-term ratings on sovereign risk, bank risk and corporations in the region.

Credit bureaus and credit rating agencies

Main articles: Credit bureau and Credit rating agency

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.^[5]

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.^[6]

In Canada, the main credit bureaus for individuals are Equifax, TransUnion and Northern Credit Bureaus/ Experian.^[7]

In India, commercial credit rating agencies include CRISIL, CARE, ICRA and Brickwork Ratings.^[8] 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.^[9] 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 and Poor's and Fitch Ratings.^{[citation needed]}

On 14.07.2010 Dagong International 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.^[10]

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.