The credit rating is a score given by the rating agencies to the credits or debts of different companies, governments or individuals, according to their credit quality (which measures the probability that these credits will be unpaid).
The credit rating is made based on the credit history of a natural or legal person and especially the ability to repay the financing. This capacity is based on the analysis of all assets and liabilities.
Also called rating, this operation consists of assessing, either for internal information or as a method of analysis of committed third-party credits, the quality of the debt taken on by a borrower, based on the ability to generate financial flows, profits, volume of debt and growth in the medium or long term in the case of a country.
Therefore, it is a concept closely related to debt issues, which can be rated by indicating the security of payments on that issue, or the issuer of the debt can also be a rating target as an institution. For issuers, it is also a factor that influences the possibility of placing the issues and the cost or service of the debt.
Main functions of the credit rating
The credit rating or debt rating arises from the need to establish scales and indices that inform the extent to which a debtor will be able to repay the debt according to its situation and financial structure. When financial institutions try to debate whether or not to grant a loan to other institutions or companies, they positively value these studies that take all types of registration and form variables to determine the repayment capacity and study the minimum interest that must be requested to lend the loan. money. Therefore, its most important functions are:
- Facilitate, from the investor’s point of view, the perception of the degree of solvency of a certain issuer.
- Report, from the regulatory point of view, on the level of risk assumed by the issuing entities to the competent supervisory bodies.
- Guide, from the market point of view, the different economic agents that intervene in the market (Collective Investment Institutions, SICAV, etc.) on the credit capacity of the different issuers with a view to their investment decisions.
Credit rating agencies
Rating agencies such as Fitch, Moody’s or Standard & Poor’s have gained visibility and importance in recent years. Their qualifications are usually distinguished by letter acronyms or letters and numbers, where each grade reflects a scenario and situation of the institution. Starting from the highest rating (AAA), which has a lower probability of default than if it had a BBB rating, to the most basic, which indicates a high probability of default (CCC). These are the debt ratings of the most important agencies:
The official ratings differ according to whether they are for short-term debts (liquidity is really determined) or long-term (soundness and solvency are evaluated), considering as short-term, normally, operations with a maturity of up to one year, and long-term that exceed the year.
Investors prefer a lower risk of default (lower probability) for a given yield, while the lower rating notes (higher probability) are those that offer higher returns to the investor, as a way to offset the higher risk assumed.
The rating of institutions is related to financial strength, while the rating of a given bond issue is related to the amount of collateral contributed or the priority structure of payments in the event of bankruptcy (see types of debt).
How are credit ratings done?
For a rating agency to study your creditworthiness, you have to pay a fee for rating rights. Any debt issuer or company can be a client of the agencies. Sometimes it can cause controversy, since it could be thought that it is paid to obtain a better grade. However, this rarely happens, because otherwise it would end the business of these agencies, which is based on issuing the more accurate ratings the better.
The rating is especially influenced by:
- The volume of the broadcast.
- In securitisations, the order of priority.
- The debt ratio of the issuer: comparison with the sector.
- Structure of own and other resources.
- Volatility of your income.
- Use of productive capacity.
- Distance to neutral.
- Economic and financial leverage.
- Debt coverage.
The usual process by which agencies give their opinion on credit quality begins with gathering a large amount of information about the issuer. On the one hand, purely economic-financial information is analyzed (balance sheets, profit and loss accounts, payment history, etc.) and, on the other, market information (price history, situation of the sector in which it operates, etc.).
This information is usually complemented by conducting interviews and meetings with the management staff of the issuing entity. Once all the data has been collected and interpreted, the analysts issue a specific rating in the form of an alphanumeric code which meets different criteria depending on the rating agency in question. In other words, there is no standard credit rating code that is shared by each and every one of the agencies, but rather each one uses its own nomenclature.
The rating is not static
Given market conditions, the rating may vary depending on the financial markets, the evolution of the business and the factors mentioned above.
Rating agencies usually issue a perspective (rating outlook) that can be in three ways:
- Positive (upgrade): It is issued when the current rating can improve for the better.
- Stable: The rating attributed to the company is not foreseeable that it will vary.
- Negative (downgrade): Issued when the current rating may deteriorate.