What is Credit Rating ?

What is Credit rating?

It is an estimate of the ability of a person or organization to fulfil their financial commitments, based on previous dealings.

A credit rating is an evaluation of the credit worthiness of a debtor, be it an individual, a business (company) or a government. The evaluation is made by a credit rating agency of the debtor's ability to pay back the debt and the likelihood of default.

How old were you when you got your first credit card? Store card? Heck, mobile phone? Chances are you were young and that you've been merrily adding to your collection of credit accessories ever since. Have you ever considered that it could all come to a screaming halt one day? That you might be, gasp, refused credit. Well, if you don't keep a close eye on your credit file, your days of flying high on someone else's dollar could be over.

What's a credit file?

It's basically a dossier on every person or business who's been 'credit-active' during the past seven years. It records details of the type, purpose of, and amount of credit you've applied for during that time, as well as outlining overdue accounts, bankruptcy details and other personal information. Your file can be accessed by credit providers when you make an application for credit, or providers of goods and services when the payment is deferred by a minimum of seven days. No-one can access your file unless you give them permission. Baycorp Advantage and Veda are Australia's leading provider of credit reporting information. "We are custodians of the credit history files of over 14 million Australians," says Erica Hughes, general manager Information Services and Solutions.

A common definition of a credit file is: 'a record of your credit history'. You're likely to have a credit file if you have applied for any of the following:

credit cards
loans, such as a personal or business loan
a mortgage
a mobile phone or internet plan
interest-free store loans
store cards
utility accounts with payment terms of at least seven days.

Banks, mortgage insurers and mobile phone companies are just a few examples of credit providers and lenders who may check your credit file. They will typically do this when you apply for credit, and their decision whether to accept your application depends on the lender's individual guidelines and criteria.

What Is a Corporate Credit Rating?

Before you decide whether to invest into a debt security from a company or foreign country, you must determine whether the prospective entity will be able to meet its obligations. A ratings company can help you do this. Providing independent objective assessments of the credit worthiness of companies and countries, a credit ratings company helps investors decide how risky it is to invest money in a certain country and/or security.

Credit in the Investment World

As investment opportunities become more global and diverse, it is difficult to decide not only which companies but also which countries are good investment opportunities. There are advantages to investing in foreign markets, but the risks associated with sending money abroad are considerably higher than those associated with investing in your own domestic market. (If you are interested in finding out more about investing in entities outside your domestic market, see our article "Is Offshore Investing for You?") It is important to gain insight into different investment environments but also to understand the risks and advantages these environments pose. Measuring the ability and willingness of an entity--which could be a person, a corporation, a security, or a country--to keep its financial commitments or its debt, credit ratings are essential tools for helping you make some investment decisions.

The Raters

There are three top agencies that deal in credit ratings for the investment world. These are: Moody's, Standard and Poor's (S&P's), and Fitch IBCA. Each of these agencies aim to provide a rating system to help investors determine the risk associated with investing in a specific company, investing instrument, or market.

Ratings can be assigned to short-term and long-term debt obligations as well as securities, loans, preferred stock, and insurance companies. Long-term credit ratings tend to be more indicative of a country's investment surroundings and/or a company's ability to honor its debt responsibilities.

For a government or company it is sometimes easier to pay back local-currency obligations than it is to pay foreign-currency obligations. The ratings therefore assess an entity's ability to pay debts in both foreign and local currencies. A lack of foreign reserves, for example, may warrant a lower rating for those obligations a country made in foreign currency.
It is important to note that ratings are not equal to or the same as buy, sell, or hold recommendations. Ratings are rather a measure of an entity's ability and willingness to repay debt.

The Ratings Are In
The ratings lie on a spectrum ranging between highest credit quality on one end and default or "junk" on the other. Longterm credit ratings are denoted with a letter: a triple A (AAA) is the highest credit quality, and C or D (depending on the agency issuing the rating) is the lowest or junk quality. Within this spectrum there are different degrees of each rating, which are, depending on the agency, sometimes denoted by a plus or negative sign or a number.

Thus, for Fitch IBCA, a "AAA" rating signifies the highest investment grade and means that there is very low credit risk. "AA" represents very high credit quality; "A" means high credit quality, and "BBB" is good credit quality. These ratings are considered to be investment grade, which means that the security or the entity being rated carries a level of quality that many institutions require when considering overseas investments.

Ratings that fall under "BBB" are considered to be speculative or junk. Thus for Moody's a Ba2 would be a speculative grade rating while for S&P's, a "D" denotes default of junk bond status.

Here is a chart that gives an overview of the different ratings symbols that Moody's and Standard and Poor's issue:

Bond Rating Grade  Risk  Moody's Standard & Poor's 
Aaa  AAA  Investment Lowest Risk
Aa   AA  Investment Low Risk
A  A  Investment Low Risk
Baa  BBB  Investment Medium Risk
Ba, B  BB, B  Junk  High Risk
Caa/Ca/C CCC/CC/C Junk  Highest Risk
C  D  Junk  In Default

Sovereign Credit Ratings
As previously mentioned, a rating can refer to an entity's specific financial obligation or to its general creditworthiness. A sovereign credit rating provides the latter as it signifies a country's overall ability to provide a secure investment environment. This rating reflects factors such as a country's economic status, transparency in the capital market, levels of public and private investment flows, foreign direct investment, foreign currency reserves, political stability, or the ability for a country's economy to remain stable despite political change.
Because it is the doorway into a country's investment atmosphere, the sovereign rating is the first thing most institutional investors will look at when making a decision to invest money abroad. This rating gives the investor an immediate understanding of the level of risk associated with investing in the country. A country with a sovereign rating will therefore get more attention than one without. So to attract foreign money, most countries will strive to obtain a sovereign rating and they will strive even more so to reach investment grade. In most circumstances, a sovereign credit rating is the highest rating a specific debt obligation can achieve.

A credit rating is not only a useful tool for the investor, but also for the entities looking for investors. An investment grade rating can put a security, company, or a country on the global radar, attracting foreign money and boosting a nation's economy. Indeed for emerging market economies, the credit rating is key to showing their worthiness of money from foreign investors. And because the credit rating acts to facilitate investments, many countries and companies will strive to maintain and improve their ratings, hence ensuring a stable political environment and a more transparent capital market.

What to do if your Private credit report is not accurate?

If your credit report contains errors, you can contact either the agency, the creditor or both to dispute its accuracy and request a correction. If the agency will not agree to amend your report, you may contact the relevant industry ombudsman service or the Privacy Commission and ask them to assist to have the report corrected.

If you have paid a debt after it has been listed on your credit report, you are entitled to have the report updated and the default marked 'paid'. The default will not be deleted from your report.

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