A credit rating can help indicate a company’s “probability of default”
Reduce your risk
Credit ratings
A credit rating gives an independent opinion of a company’s ability to meet its financial commitments in full and on time. Only a handful of finance companies have a credit rating.
Look for a rating that is “investment grade” and from an internationally recognised agency. "Investment grade" ratings are at least BBB- (Standard & Poor’s), Baa3 (Moody's), BBB- (Fitch).
Any ratings below this are regarded as "speculative" or "sub-investment grade" and so they're higher risk than investment-grade finance companies - sometimes substantially so.
Rating agencies use different scales, so they can be hard to decipher and compare. The table below shows the investment-grade ratings used by three international agencies: Standard & Poor's, Moody's, and Fitch.
Tip
Some finance companies advertise a credit rating that may not be from an internationally recognised agency, and may not even indicate an “investment grade” rating. A rating of ‘B’ does not indicate a good credit rating grade.
Probability of default
A credit rating can help indicate a company’s “probability of default” – that is, failing to repay investors in full or on time. Knowing an investment’s estimated probability of default can help you assess how risky it is.
A company with a high credit rating – such as a Standard & Poor’s AAA rating – has a low probability of default. A company with a much lower C rating is highly vulnerable and has a higher chance of defaulting.
The probability of default increases sharply, the lower the credit rating. For example, a Standard & Poor’s BBB rating indicates a company has an average 0.3 percent (three-in-one-thousand) probability of not repaying a one-year investment in full and on time.
But a company with a Standard & Poor’s B rating has an average 3 to11 percent chance of not repaying a one-year investment in full and on time. So the probability of default is now somewhere between three-in-one hundred and just over one-in-ten.
See our diagram below for how this works.
Source: Standard & Poor’s
Important
Like you, we can't predict the future - which means we can't guarantee the performance of any company or investment. Consumer NZ does not endorse any specific company, scheme or investment. ConsumerSaver is a good starting point - but, before you commit, we strongly suggest you seek independent financial advice. See our full disclaimer.
