Credit Rating can be simply defined as an data backed up opinion of rating agency which reflects the ability and willingness of the manager of debt instruments to fulfill its debt obligation when required. In simple terms, credit ratings ranks the issuer and debt instruments on the basis of their ability to fulfill the debt obligation. Credit Ratings are usually expressed in alphabetic and alphanumeric symbols.
There are some distinctive characteristics of credit rating. Some of such distinctive features are:
Rating is based on information
Rating of financial instruments is solely based on the published information. This is the ground rule for any rating and also it is one of the limitations of rating systems. The quality of information available is reflected on the creditworthiness of the instrument. The assistance of the issuer regarding the insights about the instrument and performance of the company will help in precise valuation and rating of instruments. For such cooperation, rating agencies must not expose such confidential insights.
Rating by more than one agency
Rating has no standard form and parameter for credit rating and may vary from agency to agency. Same debt instruments can be rated differently by different credit rating agencies. The alphanumeric format for the same rating may also vary.
Many factors affecting rating
Credit rating doesn’t involve any particular mathematical formula. There is no standard format for calculating credit rating. Final rating considers various factors such as corporate strategy, expansion policies, operational consistency, quality of management, business environment, economic outlook etc. Along with it, some basic factors are financial and credit analysis.
Monitoring the already rates issues
Credit Rating is not a one time process. The parameter during the rating process may differ over the time. Credit rating agencies should regularly monitor the rated instruments and the factors associated with them. Agencies should regularly upgrade or downgrade the ratings as per new valuation. This will help investors to understand the potential of the instrument and make proper decisions.
Publication of Ratings
Rating process is different for different economies. In some economies, issuers request rating agencies to their instruments to encourage investment and in some economies, agencies independently rate various instruments with the corresponding available information. When rating is done as per request by the issue, the rating is published with the concern of the issue and if rating is conducted independently, agencies publish their work and make it available to investors.
Right of Appeal against assigned rating
If the issuer of the instrument is not happy with the rating then the issuer may request for review. In such a situation, the issuer will provide additional information evaluation which may result in an upgraded rate. The rating of the instrument is directly dependent on the information made available to the agencies or public. Unless the rating agency had overlooked critical information at the first stage chances of the rating being changed on appeal are rare.
Rating of rating agencies
Credit rating for the same instrument may vary from agency to agencies. The credibility of the ratings performed by the credit ratings depends on the creditworthiness of the rating agencies. The success of a rating agency is measured from the quality and consistency of past ratings, parameters and regularity in rating and eventually integrity of the agency.
Rating is for instrument and not for the issuer company
One of the most essential aspects of rating is that rating is for instruments not for the issuer company. Ratings on the two different instruments from the same company may be different. The rating doesn’t reflect on the issue company. Yes, one might associate the issuer company with the nature of instruments it issues. Similarly, the obligation of the issuer company with the instrument may change with the nature of instrument issued.
Rating not applicable to equity shares
The name credit rating suggests that it is the rating of the debt instruments. Equity instruments don’t have obligations like debt instruments and equity investment is more likely a venture capital fund therefore, rating in equity is not applicable.
Credit rating vs Financial Analysis
It is one of the biggest misconceptions among investors that Credit Rating and Financial Analysis are the same. Credit Rating involves financial analysis but credit rating doesn’t only mean financial analysis. Credit rating involves multiple other factors that measure the qualitative and quantitative aspect of the instrument and the issuing company before final rating. Financial analysis is done for the issuer company. Credit analysis involves financial analysis to undertake the financial ability of the issuer to handle the instruments.