How does a rating agency issue its credit ratings?On March 29, 2020 by Cameron Floyd
When a state or a company issues bonds, he / she must reimburse the amount borrowed from the buyers of these bonds before the maturity date arrives, but also the interest which is added to this amount. In order to assess the capacity of such a debtor to repay the capital and interest on time, credit rating agencies publish credit ratings. How does such an agency work? Find out here.
The ABCs of Credit Ratings
The most famous rating agencies are BZ Rate’s, Moira’s and Mitch. These agencies publish for each debtor or issuer of a security a credit rating composed of letters or numbers. The AAA rating, for example, is excellent. It indicates that the risk of non-reimbursement (default rate in English) for this or that title is negligible. These securities are then qualified as investable or investment-grade securities. The more you go down in the rating scale and approach the speculative rate category (Ba1 rating and lower), the higher the risk of non-repayment. The B ratings and following are also called high risk bonds, or high yield bonds. The last category of the scale is category C, grouping the so-called “rotten” bonds or junk bonds.
A simple risk assessment
Please note that credit ratings do not represent buying or selling advice and do not guarantee that the issuer of the security will honor its debt. They only assess its theoretical repayment capacity on the basis of fundamental analyzes and probability calculations.
How does the grading process take place? Agencies start by gathering all kinds of data to assess the risk associated with a bond and create a committee made up of management and analysts. Specialists in a specific company, sector, region or activity class, they are chosen according to the obligation to be noted and its type. The committee then decides on the credit rating to be assigned and ensures that the rating chosen always corresponds to the reality on the ground.
The sources of a credit rating
The analysts of a rating agency rely on all the information they can gather in order to issue their credit rating. It can therefore be:
- public information such as annual reports and prospectuses
- market-related data such as stock prices and bond spreads
- data from international consultancies and groups such as the World Bank
- of data from public institutions and regulators
- academic, financial or journalistic reports
- of discussions held within academic, industrial and government circles
- of data collected during personal interviews with the issuer of the security
Rating outlook in watchlist
In addition to credit ratings, rating agencies also publish outlooks and rating reviews. A rating perspective indicates how a rating will evolve in the long and medium term and is expressed using the terms “positive”, “stable”, “negative” or “evolving” (when a particular event occurs). In the event of a review of a credit rating, an agency this time places a rating on a list under control, or watchlist, in anticipation of an increase or low in its value.