Credit Rating is an evaluation of the credit risk of an individual; a business; a state; a provincial authority; a sovereign government or a country in order to predict their ability to repay a debt, i.e. fulfill their financial commitments. It is a measure of solvency of an entity.
These ratings are based on detailed analysis of the entity's historical financial-performance of borrowing, lending and operating activities and are published by well-known and established credit rating agencies like Standard & Poor's, Moody's Investors Service, Fitch, DBRS and Dun & Bradstreet.
Credit ratings are also used by sovereign wealth funds, pension funds, traders and other investors to gauge the credit worthiness or Country Risk of countries around the world.
Credit Rating expresses the likelihood that the rated entity may go into default within 1 year (short-term) or above one year (long-term).
Different credit agencies have their own evaluation methods to assign ratings as shown below for Standard & Poor’s (S&P), Moody’s, Fitch and DBRS (originally known as Dominion Bond Rating Service) :
The Rating Scale:
As is the case with all DBRS rating scales, long-term debt ratings are meant to give an indication of the risk that the borrower will not fulfill its full obligations in a timely manner, with respect to both interest and principal commitments. DBRS ratings do not take factors such as pricing or market risk into consideration and are expected to be used by purchasers as one part of their investment process. Every DBRS rating is based on quantitative and qualitative considerations, which are relevant for the borrowing entity.
Highest Credit Quality
Superior Credit Quality
Satisfactory Credit Quality
Adequate Credit Quality
Very Highly Speculative
In default of principal, interest, or both
"High" and "low" grades are used to indicate the relative standing of a credit within a particular rating category. The lack of one of these designations indicates a rating, which is essentially in the middle of the category. Note that "high" and "low" grades are not used for the AAA or D categories.
Bonds rated AAA are of the highest credit quality, with exceptionally strong protection for the timely repayment of principal and interest. Earnings are considered stable, the structure of the industry in which the entity operates is strong, and the outlook for future profitability is favourable. There are few qualifying factors present which would detract from the performance of the entity, the strength of liquidity and coverage ratios is unquestioned and the entity has established a creditable track record of superior performance. Given the extremely tough definition, which DBRS has established for this category, few entities are able to achieve a AAA rating.
Bonds rated AA are of superior credit quality, and protection of interest and principal is considered high. In many cases, they differ from bonds rated AAA only to a small degree. Given the extremely tough definition, which DBRS has for the AAA category (which few companies are able to achieve), entities rated AA are also considered to be strong credits which typically exhibit above average strength in key areas of consideration and are unlikely to be significantly affected by reasonably foreseeable events.
Bonds rated A are of satisfactory credit quality. Protection of interest and principal is still substantial, but the degree of strength is less than with AA rated entities. While a respectable rating, entities in the A category are considered to be more susceptible to adverse economic conditions and have greater cyclical tendencies than higher rated companies.
Bonds rated BBB are of adequate credit quality. Protection of interest and principal is considered adequate, but the entity is more susceptible to adverse changes in financial and economic conditions, or there may be other adversities present which reduce the strength of the entity and its rated securities.
Bonds rated BB are defined to be speculative, where the degree of protection afforded interest and principal is uncertain, particularly during periods of economic recession. Entities in the BB area typically have limited access to capital markets and additional liquidity support, and in many cases, small size or lack of competitive strength may be additional negative considerations.
Bonds rated B are highly speculative and there is a reasonably high level of uncertainty as to the ability of the entity to pay interest and principal on a continuing basis in the future, especially in periods of economic recession or industry adversity.
Bonds rated CCC are very highly speculative. The degree of adverse elements present is more severe than bonds rated B. Bonds rated CCC often have characteristics which, if not remedied, may lead to default.
Bonds rated CC are extremely speculative. These bonds are in danger of default of interest and/or principal. Bonds rated CC have characteristics, which, if not remedied, will lead to default.
Bonds rated C are extremely speculative and are in immediate danger of default. This is the lowest rating category provided to long term instruments that are not in default.
Bonds rated D are currently in default of interest, principal, or both.