Credit Ratings Defined
What is a credit rating? A credit rating is an assessment of an entity’s capability and willingness to pay obligations upon maturity. It is a credit opinion based on the evaluation of available information. In a market like the Philippines, the Securities and Exchange Commission, requires a credit rating for publicly-issued debt like commercial papers, bonds, and asset-backed securities. A credit rating serves as protection for investors who provide the funds to these debt issuers. The Bangko Sentral ng Pilipinas likewise requires a credit rating for banks who will be issuing Tier-2 capital.
A credit rating is not a recommendation to buy or sell nor is it a guarantee against loss. Credit ratings are typically done for debt rather than equity issues. I have yet to come across ratings for equities though it is typical that when people learn about us being in credit rating, they would ask what are the good stocks to invest in. They also think that we give out loans and say things like: “A, maraming may gusto ng credit dito.” (”There are plenty of people here who need to borrow.”)
Does it mean that when a debt issue is credit rated, you are sure not to lose money? Not the case also. Analysts can only do so much and they do not have a crystal ball. If we anticipated everything that could possibly go wrong, then we would be unbelieveably rich. Still, having a third party, objective, independent evaluation can help an investor assess the risks related to particular debt issue or transaction better. It is still up to each individual investor, though, to make his/her own assessment and then just supplement this with a rating agency’s own opinion as expressed in its credit rating.
A credit rating agency, however, realizes that it is, in its best interests, to call things properly. A highly-rated paper which eventually defaults does a lot of damage to a rating agency’s reputation and credibility. You can’t have too much of that. Otherwise, the ratings won’t be of much use to the market and the rating agency’s reputation would be in question.