What is credit rating?

According to the Institute for Development and Econometric Analysis, Inc. (IDEA) credit analysis, in comparison with credit scoring usually yields credit rating. These are usually (alphabet) symbols that represent the probability of default. The credit rating system provides the capital markets with a common language for credit risk evaluation and is a means to compare several instruments or investments. Through its symbols, ratings give the public relative assessments of the credit quality of issues and institutions. On the other hand, counterparties that are credit rated aim to be given an investment grade (implying medium to high credit quality) for their securities, at the very least. Favorable ratings allow companies to attract investors.

Per IDEA’s latest Economic Digest, credit ratings in the Philippines gained substantial popularity in the latter half of 2004, when the government recognized the severity of its fiscal deficit. The ratings given by Standard & Poor’s, Moody’s and Fitch’s – the three top rating agencies in the world – were taken significantly, more than ever, as to how investors from the rest of the world regarded the overall investment climate in the Philippines in the midst of the burgeoning budget problem. Ratings, which measure the stability of the investment climate, and thus provide foreign investors an initial measure of a country’s potential as an investment site, are called sovereign credit ratings. Since the height of the fiscal crisis in late-2004, the success of the government’s fiscal program, which included the 12% Value-Added Tax, saw an improvement in the country’s sovereign ratings, as international rating agencies have raised the outlooks of the country’s ratings from negative to stable.

A more particular type of credit rating, the corporate credit rating, evaluates the credit risk associated with a corporation’s ability to pay specific debts that it issued or its over-all creditworthiness.

In the Philippines, the Securities and Exchange Commission (SEC) and the Bangko Sentral ng Pilipinas (BSP) require a company to obtain a rating from an accredited rating agency prior to issuance of debt securities. At present, there is only one domestic agency in the country, the Philippine Rating Services Corporation (PhilRatings), which has been rating firms in various industries since 1985. Another agency, Fitch Singapore PTE, Ltd., a subsidiary of Fitch Ratings, was recognized by the BSP in 2005. The small size of a rating industry in the Philippines may be reflective of the current status of the Philippine capital markets which, although growing, is still heavily dominated by publicly issued securities. Furthermore, the local capital market is currently being dwarfed by the banking sector and the equities market as a source of corporate financing.

Although credit ratings provide a useful and informative tool as a measure of credit risk of counterparty, the usual practice of investors is to consider them together with their own credit analysis. Traditional financial measures such as capitalization ratios and interest-coverage ratios of companies are most useful, especially for those who get exposed to credit risk through participation in the fixed-income securities market. There has also been the emergence of credit risk modeling, which covers any algorithm-based methods of assessing credit risk, according to IDEA.

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