The general concept of a credit rating is that it is an estimate of the credit worthiness of the company or entity (such as a government) that has issued the debt. It is an evaluation made by a credit rating agency of a borrower's ability to repay its debt and may provide an investor with an indicator as to the relative risk of investing in an interest rate security. A poor credit rating typically indicates a higher risk of an entity defaulting on its borrowings and thus typically should attract a higher interest rate to compensate for this risk.
When considering the credit rating on an Interest Rate Security, you need to consider:
- the organisation’s credit rating; and also
- that of the security.
An organization’s credit rating is an opinion on the overall financial capacity of an organisation to pay its financial obligations (its creditworthiness). The rating considers the organisation's capacity and willingness to meet financial commitments as they fall due.
A product credit rating is an opinion about the creditworthiness of a specific debt security. It takes into account the terms and conditions of the issue, the creditworthiness of the organisation and any guarantees or other forms of credit enhancement on the obligation.
Credit ratings can be either long term or short term. Short-term ratings relate to obligations with an original maturity of 365 days or less—including commercial paper. Long term ratings – relate to financial obligations with a term of more than one year. The long-term rating generally addresses the period out to three to five years.
Exchange-traded Australian Government Bonds ("AGBs") are considered to have the lowest possible credit risk and therefore may be suitable for investors seeking stable and highly secure cashflows.
If a company is unrated, it does not necessarily mean that its bonds are high risk, but it does mean that investors will have to turn to other means to evaluate its financial strength. An investment adviser or broker may be able to assist with company research data.