What do credit ratings mean?


Credit is important since individuals and corporations with poor credit will have difficulty finding financing, and will most likely have to pay more due to the risk of default

Credit rating is done for debt instruments such as debentures, fixed deposits, commercial papers, bonds, etc. Credit rating is an assessment of the credit worthiness of individuals and corporations. It is based upon the history of borrowing and repayment, as well as the availability of assets and extent of liabilities. 

The company which issues debt instruments is called “an issuer” or “issuing company”. The issuer, issues instruments to collect finance from investors. Among other factors, an investor should also look at the credit rating of the debt instrument and the issuer before investing.

Typically, ratings are expressed as letter grades that range, for example, from ‘AAA’ to ‘D’ to communicate the credit rating agency’s opinion of relative level of credit risk. Credit is important since individuals and corporations with poor credit will have difficulty finding financing, and will most likely have to pay more due to the risk of default.

Ratings are provided by organisations such as Standard & Poor’s, CRISIL, ICRA, Fitch and Moody’s, commonly called credit rating agencies, which specialise in evaluating credit risk. Each agency applies its own methodology in measuring creditworthiness and uses a specific rating scale to publish its ratings opinions. 

Credit rating is only an opinion. It is not a recommendation. It does not ask an investor to buy, hold or sell an instrument. Credit rating is not permanent, and it is reviewed periodically.

General meaning of credit ratings

Rating of long-term debt instruments

Significance

AAA (Highest safety)

These companies offer the highest degree of safety to pay interest / repay capital to the investors in a timely manner. Even if these companies experience financial difficulties, their ability to service the debt is not likely to be affected.

AA (High safety)

These companies too offer a high level of safety and are only marginally different from AAA companies.

A (Adequate safety)

These companies have adequate safety to service the debt. But their ability to meet their monetary obligations could be affected if there are any serious financial problems going forward.

BBB (Moderate safety)

Such companies offer a moderate safety for debt servicing, which is quite likely to be impaired if there are any adverse developments in the future.

BB (Inadequate safety)

Here the safety is not adequate. While they are not likely to default in the near future, their debt servicing capability is quite vulnerable.

B (High risk)

The risk in these instruments is high. Therefore, they may not be in a position to meet their commitment even with minor setbacks.

C (Substantial risk)

These are at risk to default and will make timely payments only if the favourable conditions continue.

D (Default)

These are already in default or are expected to default on the scheduled dates.



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