Credit rating

What it means

A credit rating is an assessment of the creditworthiness of a country, company or specific bond, assigned by rating agencies on a letter scale. The top grades mean minimal default risk, lower grades higher risk. The line between investment grade and speculative grade is crucial for investors.

A higher rating means lower risk and cheaper funding. A state or company with a better rating borrows at a lower risk premium, while a downgrade raises the cost of debt. Many institutional investors may only buy investment-grade bonds.

Besides the agencies' public ratings, banks produce internal ratings of their clients when lending. These draw on financial statements, repayment history, industry and management quality. The internal rating influences whether the bank lends, at what rate and with what security.

How it works in practice

Small and mid-sized companies usually have no public rating, but banks, credit insurers and suppliers still assess their creditworthiness. Good-quality financial statements filed on time, stable cash flow and a sound payment record are the best ways to improve the assessment.

A company planning a larger loan or a bond issue can prepare by knowing the ratios the bank looks at, such as leverage, interest coverage or net debt to EBITDA, and improving them in advance. Transparent communication with the bank helps too.

Sovereign ratings also affect businesses in the country: a downgrade can push up interest rates for banks and companies alike. In export deals with low-rated countries, the risk is managed through credit insurance or a letter of credit.

What to watch out for

A rating is the agency's opinion, not a guarantee. Agencies have historically reacted late, and highly rated companies or products have failed. Investors should supplement ratings with their own analysis rather than relying on them blindly.

A bank's internal rating is not public and the client often never sees it. If a bank declines a loan or offers worse terms, ask why and find out which ratios need improving; many issues can be resolved with better documentation.