Ratings: what does it mean for SMEs?

Yann Gindre
Posted by Yann Gindre
Posted on July 19, 2018 Leave a comment

What is a “bank rating for SMEs”?

By and large, this is your in-house risk manager assessing your counterparty risk. Rating agencies will assign ‘credit ratings’, which represents a bank’s ability to pay back debt by making timely payments and assess potential default - therefore including, among others, SME’s deposits.

 What is counterparty risk?

Any money deposited with any bank is potentially at risk. Of course, there are different level of risks but it is a risk as any banks can go down or default, making it difficult to reimburse client deposits.

 Who are the rating agencies?

Historically, ratings started in the US around 1900 and have developed rapidly to be used by regulators to decide how much capital would be required by Financial institutions holding different types of assets. It also affected pension funds and money market funds which could only purchase securities above a certain rating.

There are three main credit rating agencies controlling about 95% of the market. S&P, Moody’s and Fitch. The latter built its reputation through Financial Institutions.

How reliable are the rating agencies?

Agency reputation suffered during the 2008 financial crisis, mostly on structure products with inaccurate ratings which accelerated the financial crisis. As a result, the 2010 Dodd Franck reform and consumer protection act were created to impose improvements and addressed issues relating to the accuracy of credit ratings.

What do you need to know?

We have short and long-term ratings which express the likelihood that a party could go into default within a time horizon:

  1. Short-term credit ratings, for maturities up to 12 months
  2. Long-term Credit ratings, for maturities longer than 12 months,

Rating agencies use letter designations such as A, B, C or D with higher grades representing a lower probability of default.

For long term ratings, the most important factor is the difference between investment grade and Non-investment grade.

  1. Investment grade will start at AAA all the way to BBB or Baa3 for Moody’s. It represents a strong to adequate ability and capacity for a bank to meet its financial commitments
  2. Non-investment grade will start at Ba1 (Moody’s) and BB+, (S&P and Fitch). It represents a probability that the bank's ability to repay its debt is deemed from speculative to highly speculative.

The Long-Term ratings

S&P

Moody’s

Fitch

  • AAA: The obligor's capacity to meet its financial commitment on the obligation is extremely strong.
  • A-1 he obligor's capacity to meet its financial commitment on these obligations is extremely strong.
  • Aaa: Obligations rated Aaa are judged to be of the highest quality
  • P-1 Best ability to repay short term debt
  • AAA: Highest credit quality.
  • F1+ Indicates the strongest capacity for timely payment
  • AA: The obligor's capacity to meet its financial commitment on the obligation is very strong.
  • A-1 to A-2 The obligor's capacity to meet its financial commitment on these obligations is extremely strong to satisfactory
  • Aa: Obligations rated Aa are judged to be of high quality and are subject to very low credit risk
  • P-1 Best ability to repay short term debt

 

  • AA: Very high credit quality.
  • F1+ Indicates the strongest capacity for timely payment
  • A:  The obligor's capacity to meet its financial commitment on the obligation is still strong.
  • A-2 the obligor's capacity to meet its financial commitment on the obligation is satisfactory.
  • A: Obligations rated A are judged to be upper-medium grade and are subject to low credit risk.
  • P-1 or P-2 Best ability or high ability to repay short term debt
  • A: High credit quality
  • F1  Indicates the strongest capacity for timely payment
  • BBB: Adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation
  • A-3 Adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation.
  • Baa: Obligations rated Baa are judged to be medium-grade and subject to moderate credit risk.
  • P-2 High ability to repay short term debt
  • P-3 Acceptable ability to repay short term debt
  • BBB: Good credit quality.
  • F3 or F2 Strong or adequate capacity for timely payment

              

           Investment Grade                                            

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                                              Non - Investment grade                

As you look down this table, the ratings are lowering. Those above this point, i.e. the higher ratings, have a good enough rating to be considered 'Investment Grade'. However, we are now reaching ratings which no longer qualify for this title and are considered to be 'Non-Investment Grade'.
  • BB: An obligation rated 'BB' is less vulnerable to non-payment than other speculative issues.
  • Ba: Obligations are judged to be speculative and are subject to high credit risk
  • Not prime
  • BB: Speculative.
  • B: Uncertain capacity for timely payments
  • B: An obligation rated 'B' is more vulnerable to non-payment than obligations rated 'BB',
  • B:   Obligations rated B are considered speculative and are subject to high credit risk.
  • Not prime
  • B: Highly speculative.
  • B: Uncertain capacity for timely payments

 

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