Rating Agency Credit Risk

The credit risk of a company rated by a traditional rating agency can vary significantly from a company that is not

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Introduction

Banks develop their own internal rating processes and methodologies independently of traditional rating agencies.

An independent view aims to avoid the systematic risk that can occur from following a small number of viewpoints.

Credit officers might use ratings from External Credit Assessment Institutions (ECAIs) as a benchmark, but they form their own opinion. Banks can have information about the companies they lend to that is more closely related to their lending practices than rating agencies.

The behaviour of entities rated and unrated by rating agencies can vary due to several factors. Monitoring risk separately for these two segments can improve risk management.

Only approximately 10% of entities in the Credit Benchmark dataset have a rating from a public rating agency. We can perform a free coverage check on your portfolio. This will highlight where we provide a rating beyond the main rating agencies.

Monitoring Differences in Credit Risk Between Publicly Rated and Unrated Entities

Differences in credit risk between a company rated by a traditional credit rating agency and an unrated one can stem from a variety of reasons including the level of information available, transparency, and market perceptions.

Regulations

Sometimes regulators or industry standards might mandate a company to obtain a credit rating. Having to comply with these regulations could impact the credit quality of a company.
Unrated entities may not be subject to the same regulations and may face challenges in demonstrating their creditworthiness. This is one example where consensus credit ratings can help.
The graph shows how publicly rated Semiconductor companies slightly improved in credit risk over 12 months up to March 2024. Meanwhile, unrated companies experienced a sharp decline.

Financing Terms

Investors and creditors often rely on ratings from rating agencies.
A rated company may benefit from a positive market perception, leading to lower financing costs and greater access to capital. Conversely, an unrated entity may be subject to higher financing costs and limited access to certain types of financing.
A credit rating distribution plot is helpful to understand how different the credit composition of entities within UK Electricity is. Rated companies are mostly rated ‘a’ while unrated entities are riskier with the bulk of them lying in bbb and bb.

Financing Sources

Companies with credit ratings can issue bonds or other debt instruments to a broader investor base, which could potentially be at more favourable terms.
Unrated entities might face challenges accessing public debt markets and be limited to financing through private sources, that could have less favourable terms.
To compensate for the perceived lack of information and higher uncertainty, credit risk lenders to unrated entities may require higher interest rates or additional collateral.

Liquidity

Companies with credit ratings may experience higher market liquidity for their debt securities, as rated instruments are generally more attractive to a wider range of investors.
The absence of a rating may result in lower liquidity and reduced investor interest for debt securities.

If you are interested in seeing what Credit Consensus Ratings can offer, sign up here to access the Credit Risk IQ Reports for free.