Credit Score Rating scale –
Higher the rating better for you…oops…. What did my friend mean by this words… Mr Ram kept on wondering after meeting his friend on dinner and discussing on the topic Credit score rating scale.
Mr Ram not highly educated wanted to invest Rs 10000 in a financial instrument. He researched about different financial instruments like equity, commodity but found that bond is one safest instrument in comparison with equity and commodities. So has taken a decision to invest in a bond. Through newspapers, he found many top companies are issuing a bond. So he again got confused and couldn’t decide which companies to invest in but in all articles, he found something in common that is credit rating which he tried to discuss with his friend but couldn’t understand anything. Mr Ram takes a decision to go online and understand in brief about the credit score rating scale. To start up with, he first understands the meaning of credit rating scale.
What is the credit score rating scale?
A scale used by creditors to assess an individual’s creditworthiness i.e. a person’s likelihood of whether the company will be able to pay the debt obligation fully on time or no is known as credit score rating scale. Credit rating is provided by different credit rating agencies.
A rating is given to any issuer i.e. an individual, corporate, state, the sovereign government who seeks to borrow the money.
A rating 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.
A rating suggests both the present situation and the impact of the future events on credit risk.
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What does a credit score rating scale does not indicate?
Rating does not suggest whether:-
- A credit score rating scale does 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 the future or no
Credit rating agency VS Credit bureau:-
A credit rating agency provides an opinion which relates to the debt repayment by the borrower whereas a credit bureau provides information on past debt repayments by borrowers.
Credit score Rating scale:-
Every company has a different process to give credit rating and has different credit score rating scale
Source –Standard&Poor’s
Looking at this table we can see that the higher the rating higher is the creditworthiness of the issuer.
Bonds with different maturity period are rated differently. Long term ratings are assigned to bonds having the maturity period of more than 1 year. Short term credit ratings are assigned to bonds having the maturity period of less than 1 year. Generally, long-term and short-term credit ratings are interlinked to one another so if an issuer’s long-term rating is downgraded short-term rating gets downgraded automatically.
Investment Grade v/s Speculative-Grade Debt:-
Investment grade is referred to as securities which are rated as having higher credit quality whereas Speculative grade which is also 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:-
Some credit rating agencies also incorporate recovery ratings which suggest the opinion about the amount which may get recovered in the event of default. This is one of the important factors in evaluating the credit quality of a company mostly in the evaluation of non-investment grade debt.
| 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 |
Source- Standard & Poor’s
In the year 2003, Standard & Poor’s had started assigning recovery rating. They 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.
The recovery can be in any form
- Cash
- Debt
- Equity securities of a reorganized entity
- Combination of the three
Why Credit rating keeps on changing?
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.
Finally, Mr Ram got a clear picture of what is credit score rating scale and what did his friend mean by the word Higher the rating better for you
Credit Score Rating Scale Infographics
Learn the juice of this article in just a single minute, Credit Rating Scale Infographics
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