A credit rating is an evaluation of the credit worthiness of a debtor (a business (company) or a government) predicting the debtor's ability to pay back the debt; it thus forecasts implicitly the likelihood of the debtor's default. The credit rating represents the evaluation of the credit rating agency of qualitative and quantitative information for the debtor; including non-public information obtained by the credit rating agencies' analysts.
A credit reporting (or credit score) - in distinction to a rating - is an evaluation of an individuals' credit worthiness which is done by a credit bureau, or consumer credit reporting agency.
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 "country risk rankings" table shows the ten least-risky countries for investment as of January 2013. 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. 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.
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Short-and long-term-ratings
A rating expresses the likelihood that the rated party will go into default within a a given time-horizon: 1 year (short-term) or above (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 instruments i.e. debt security such as a bond, but also the corporations itself. Ratings are assigned by credit rating agencies, the largest of which are Standard & Poor's, 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 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 4% (404 basis points) more than a Treasury bond on average over that period.
Different rating agencies may use variations of an alphabetical combination of lower-case and upper-case 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 upper-case letters and pluses and minuses. The Moody's rating system uses numbers and lower-case letters as well as upper case.
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.
Credit rating agencies
In addition to "the Big Three" of Moody's, Standard & Poor's, and Fitch Ratings, other agencies and rating companies include (in alphabetical order):
Agusto & Co. (Nigeria), A. M. Best (U.S.), China Chengxin Credit Rating Group (China), Shanghai Brilliance Credit Rating & Investors Service Co.,Ltd (China), Credit Rating Agency Ltd (Zambia), Credit Rating Information and Services Limited (Bangladesh), CTRISKS (Hong Kong), Dagong Europe Credit Rating (Italy), DBRS (Canada), Dun & Bradstreet (U.S.), Egan-Jones Rating Company (U.S.), Global Credit Ratings Co. (South Africa), HR Ratings (Mexico), The Pakistan Credit Rating Agency Limited (PACRA) (Pakistan), ICRA Limited (India), Japan Credit Rating Agency (Japan),JCR VIS Credit Rating Company Ltd (Pakistan), Levin and Goldstein (Zambia), Morningstar, Inc. (U.S.), Muros Ratings (Russia, alternative rating company), Public Sector Credit Solutions (U.S., not-for profit rating provider), Rapid Ratings International (U.S.), RusRating (Russia), Universal Credit Rating Group (Hong Kong), Veda (Australia, previously known as Baycorp Advantage), Wikirating (Switzerland, alternative rating organization), Humphreys Ltd (Chile, previously known as Moody´s Partner in Chile), Credit Research Initiative (Singapore, non-profit rating provider).
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