Credit rating: what you need to know

Credit rating is a technical term referring to an opinion of a ratings service provider (or a credit rating agency – CRA) on the ability of an entity, be it a business or an individual, to fulfill its financial obligations on time What is credit rating? Credit rating is a technical term referring to an opinion of a ratings service provider (or a credit rating agency – CRA) on the ability of an entity, be it a business or an individual, to fulfill its financial obligations on time. Credit rating also indicates the possibility of default of a debtor. Basically, it is an indication of the credit risk by a debt instrument - whether it is a loan or a bond issue.

However, credit rating is not a guarantee of financial viability by a debt instrument. The opinions given by a credit rating agency are not interchangeable with those of a financial consultant or portfolio manager, and they should only be used as a reference tool when making decisions.

Difference between Credit Rating and Credit Score Credit rating is used to determine the creditworthiness of an entity which can be an individual, a business, a company or a sovereign nation. In the case of a loan, the rating is used to decide whether the loan should be made in the first place. If the process goes further, it will help determine the loan's term such as repayment date, interest rate, etc.

In the case of a bond issue, the credit rating shows the worthiness of a company or country for its ability to repay bond payments on time. It helps investors assess whether or not to invest in bonds. Credit score, however, is personal only, reflecting one’s own credit health. It shows the ability to comply with the terms and conditions of the loan, including the interest rate and repayment date. Credit scores for individuals are used by banks, credit card issuers and other lenders serving individuals.

Who assesses Credit Ratings?

A CRA assesses the credit rating of a company by analyzing its qualitative and quantitative attributes. Information may be obtained from within the entity, such as its audited financial statements, annual reports, as well as external information including analytical reports, public news, industry reports A CRA is not involved in the business activity or transaction of the entity, and of course does not benefit from that business. Therefore, the provided information on credit risk of the entity is completely independent and objective.

Currently, Moody’s Investor Services, Standard and Poor’s (S&P), and Fitch Group are three giants that control 85% of the ratings market. Each has their own method of rating, however, in general, there are similarities in the way credit rating is shown.

Despite holding 85% of the market and operating around the world, they are not the only credit rating agencies. In Vietnam, when it comes to a ratings service provider, we cannot ignore VietnamCredit, a credit rating agency that has been in the field for 23 years. VietnamCredit's rating scale is quite similar to that of Standard & Poor's and Fitch. From excellent to poor, it goes as follows:

What are Credit Ratings for? Credit rating is an indispensable reference source for investors and intermediaries such as investment banks, debt issuers, and businesses and corporations.

Intermediaries use credit ratings to assess credit risk and continue valuing debt issues.

Debt issuers including corporations, governments, municipalities, etc. utilize credit ratings as an independent evaluation of their creditworthiness and credit risk associated with their debt issuance. The ratings can, to some extent, provide prospective investors with an idea of the quality of the instrument and what kind of interest rate they should be expecting from it.

Businesses and corporations that are seeking to assess the risks associated with a deal with a certain partner also consider credit ratings as a useful reference. It can help entities seeking to enter into partnerships or joint ventures with other businesses to evaluate and especially, have better negotiation position.

Investors, whether they are individual or institutional, use credit ratings for the purpose of assessing investment-related risks in the context of their entire portfolio.