Credit Rating: How is a credit rating assigned and why a company should have ratings from several agencies, says Alexander Proklov, Senior Managing Director of the NKR Rating Agency
An investor who wants to assess the credit quality of a company, bank or government body, to understand how reliable they are as borrowers, cannot do without credit ratings. They are also used by government agencies – for example, when placing budget funds in banks or when developing rules for investing pension funds. At the same time, it is useful not only to distinguish between rating levels, but also to have some idea of how they are assigned and how rating agencies work.
Credit Rating: Counterparty valuation
The need for ratings appeared at the dawn of the modern financial market – an independent assessment of the creditworthiness of issuers was needed valuable papers … Over time, the demand for credit ratings only grew, since not everyone can carry out an independently qualified assessment of the creditworthiness of a borrower or counterparty, especially in the context of constantly complicating market relations.
The rating can be assigned on an international or national scale. The international scale makes it possible to compare the ratings of companies from different countries, however, the rating of a company, as a rule, cannot be higher than the rating of the country where it operates. There is no such barrier on the national scale.
In Russia, there are four Russian rating agencies and three foreign ones (the so-called “big three”). But in the regulatory documents within the country, only the ratings of Russian agencies are used. Companies that need access to foreign funding also use ratings from the Big Three agencies.
At its core, a credit rating is an estimate of the probability of default borrower in accordance with a special rating scale. The rating itself usually consists of several parts. In its meaning, first, there are symbols (letters, numbers, plus or minus signs) that show the rating level, then after the dot, it is indicated on which scale the rating is assigned. A forecast is given in a separate word – the agency’s opinion on the likelihood of a rating change in one direction or another.
A more accurate understanding of the rating of a particular company, bank or issue of debt securities will be helped by the agency’s press release, which necessarily accompanies the assignment of the rating. It sets out the factors that justify the level of the rating, including, as a rule, the main “pain points” of the rated person are indicated. For example, it is worth looking at where the company is located in terms of assessing its own creditworthiness (OSK), that is, without taking into account possible support from the state and owners.
Determination of the rating
Sufficient accuracy of credit ratings is ensured by the fact that the agency gets access not only to public documents and published financial statements but also to data that is usually hidden from a wide audience. In addition, the ratings are assigned based on the agencies’ own methodologies, the quality of which is ensured by an effective multilevel control system. Specialized rating analysts are involved in the development of methodologies, and they are checked by an independent validation service before being approved. Methodologies are approved by a methodological committee of at least three people. After approval, the methodology is sent to the Central Bank for verification for compliance with legal requirements. The correctness of its application is strictly monitored both by the members of the rating committee, and methodologists and employees of the internal control service. Identified deviations from the methodology are recorded and publicly disclosed.
The complex procedure for assigning a rating includes the analysis of primary financial documents, meetings of rating analysts with representatives of the rated company or bank, and the construction of financial models. If we are talking about a non-financial company, then a number of additional factors, sometimes not obvious, are assessed. For example, the ability to quickly replace a supplier, the geography of sales, and the forecast for the development of the market in which the company operates.
The rating agency closely monitors its reputation, because it is the main asset that ensures success in the market. The agency’s work is based on a strict delineation of rating assignment processes and business processes, while rating analysts are physically separated from other departments that are not directly related to the rating process.
The rating revision takes place, as a rule, once a year – this is a planned procedure. If this happens more often, then the investor should take a closer look at the company, assess its prospects and, possibly, reconsider his strategy.
All Russian rating agencies must be included in the register of credit rating agencies of the Bank of Russia and supervised by the Central Bank. However, there are differences between them. One of the main ones is the degree of readiness to disclose the content of their actions and explain in nuances why this or that decision was made and how this or that indicator influenced the rating level. But at the same time, taking into account the similarity of the scales, the ratings can be compared with each other, which allows the investor to make an informed decision about the willingness to take risks.
Often, companies and banks have ratings from several agencies at once. Due to the difference in methodologies, this allows them to obtain a more complete independent assessment. For an investor, a company has several ratings – a serious confirmation of its openness and stability.