Published on March 21, 2014
Credit Rating Scale
What is credit rating scale ? • A scale used by creditors to assess an individual’s credit worthiness i.e . a person’s likelihood of whether the company will be able to pay the debt obligation fully on time or no • A rating is :- Provided by different credit rating agencies Given to any issuer i.e. an individual, corporate, state, sovereign government who seeks to borrow the money. Does not say whether an investor should really buy that bond but it is just one of the most important parameter an investor should consider before investing in any bond. Suggests both the present situation and the impact of the future events on credit risk.
Credit rating scale do not indicate Do not measure performance sectors like price fluctuations or market value. A rated security is suitable for an investor or a group of investors and whether they should really buy, sell or hold the rated securities A rated security is appropriate as per an investors risk tolerance or the price of a security is perfect for its rating The market value of the security will change in future or no
Credit rating agency Credit rating bureau Provides an opinion which relates to the debt repayment by the borrower Provides information on past debt repayments by borrowers.
Rating Description AAA Extremely strong capacity to meet financial commitments AA Very strong capacity to meet financial commitments A Strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances BBB Adequate capacity to meet financial commitments, but more subject to adverse economic conditions BBB- Considered lowest investment grade by market participants BB+ Considered highest speculative grade by market participants BB Less vulnerable in the near term but faces major ongoing uncertainties to adverse business , financial and economics conditions B More vulnerable in the near term but faces major ongoing uncertainties to adverse business, financial and economic conditions CCC Currently vulnerable and dependent on favorable business, financial and economic conditions to meet financial statements CC Currently highly vulnerable C A bankruptcy petition has been filed or similar action taken, but payments of financial commitments are continued D Payment default on financial commitments Investment Grade Speculative Grade Credit Rating Scale Source –Standard & Poor’s
Credit Rating Scale Short term ratings are assigned to bonds having the maturity period of less than 1 year Long term ratings are assigned to bonds having the maturity period of more than 1 year Generally long term and short term ratings are interlinked to one another so if an issuers long term rating is downgraded short term rating gets downgraded automatically
Investment Grade Speculative Grade Debt Referred to as securities which are rated as having higher credit quality Referred to as non-investment grade is referred to as debt securities where the issuer currently has the ability to repay but uncertainties like adverse business or financial circumstances and might have the ability to default
Recovery Rating Scale Suggest the opinion about the amount which may get recovered in the event of default One of the important factors in the evaluation of credit quality of non-investment grade debt In the year 2003 Standard & Poor’s had started assigning recovery rating.
The recovery can be in any form Cash Debt Equity securities of a reorganized entity Combination of the three Recovery Rating Rating Description Recovery Expectations(%) Issuer rating relative to issuer credit rating 1+ High expectation, full recovery 100 +3 1 Very high recovery 90-100 +2 2 Substantial Recovery 70-90 +1 3 Meaningful Recovery 50-70 0 4 Average Recovery 30-50 0 5 Modest Recovery 10-30 -1 6 Negligible Recovery 0-10 -2 Recovery Rating Scale • S&P use a rating scale instead of letters to express an opinion about the percentage of principal and unpaid accrued interest which investors can expect to receive in the case of default. • This Recovery opinion is based on different factors like:- The rights that investors and/or creditors may have to specific assets The potential liquidation value of the entity’s assets, and The result of formal bankruptcy proceedings or informal out-of- court restructuring
Why credit rating change ? • Credit ratings are not constant. • They keep on changing from time to time as the credit quality of an issue or issuer alters in ways that were not expected at the time a rating was assigned. • For example, Consider a new technology coming in which was not expected and so it was not considered while assigning a rating to a company This new technology might lead to a negative impact on the financials of the company This may impact on the downgrading of the current rating.AAAAA
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