What Is Credit Quality?

Credit quality is a measure ✃of the financial solvency of an individ🅷ual or an entity such as a company or a government. Specifically, it is an evaluation of the ability of that person or entity to repay their debts.

A principal criterion for judging the investment quality of a bond or a bond mutual fund is 💫the credit quality of the company or governme𝓰nt issuing the bond or bonds.

Credit Quality and Individuals

The creditworthiness of an individual is determined most commonly through the person's credit score.

The creditworthiness of American consumers is most often determined by a 澳洲幸运5官方开奖结果体彩网:FICO score. This is a credit score compiled using a methodology developed by the Fair Isaac Corporation (FICO) a🧸nd based on factors including the individual's current amount of debt, number of active credit lines, and length of credit history.🌠

The facts that are fed into individual FICO scores are compiled and tracked by several c🎉redit reporting agencies including Equifax, TransUnion, and Experia🍰n.

FICO is the oldest and most widely used credit score, but it has newer competitors such as 澳洲幸运5官方开奖结果体彩网:VantageScore.

Lenders use credit scores, along with other details in individual 澳洲幸运5官方开奖结果体彩网:credit reports, as a way of assessing applicant credit risks and, ultimately, making a ☂decision about whether or not to extend credit. Credit scores also are checked by insurance companies, employers, landlords, and others as a means of determining a per🌳son's credit quality.

The Math of Credit Scoring

In essence, a credit score is a mathematical summary of the information in a person's credit reports, ranked on a scale ranging from 300 to 850.

Credit scoring formulas assign weights to various aspects of a person's credit history. FICO scores give the highest weight to payment history (whether the person has consistently paid their credit bills on time), which accounts for 35% of their score. Amounts owed, including their 澳洲幸运5官方开奖结果体彩网:credit utilization ratio) counts for 30%. Length of credit history (older accounts are better) counts for 15%. New accounts (too many of them is a negative) and credit mix (having a variety of credit types, such as a credit card and a mortgage, is a plus) count for 10% each.

The higher a person's credit score, the more creditworthy that person is considered to be. Having a high credit score also helps borrowers get more favorable interest rates. Scores above 670 are generally considered good or better.

An individual may have multiple credit scores 🅠from any or all of the credit rating agencies. In addition, there are sli🐓ghtly different scoring models for use by mortgage companies, auto lenders, and credit card issuers.

An individual's various credit scores should be close if not identical. An extreme difference may indicate an error in one of the reports.

Credit Quality and Compa𓆉nies or Other Bond Issuers

澳洲幸运5官方开奖结果体彩网:Credit ratings are to corporations and other bond issuers what credit scores are to individuals, a form of shorthand for describing their credit quality. A credit rating can be a𝄹ssigned to an entire company or to a particular issue of its bonds.

Also referred to as bond ratings, credit ratings are assigned by independent bond rating agencies including 澳洲幸运5官方开奖结果体彩网:Fitch Ratings, 澳洲幸运5官方开奖结果体彩网:Moody's Investors Service, and 澳洲幸运5官方开奖结果体彩网:S&P Global. Another major company, AM Best, specializes in ratings of insurance companies.

Each rating agency has its own alphabetical designations, although they are relatively similar. M🌌ost range from high (AAA to AA), to medi🌠um (A to BBB), and low (BB, B, CCC, CC, C, and D).

Rating agencies are ty⛄pic⛦ally paid by the companies they rate.

In the credit markets, high credit ratings are also referred to as 澳洲幸运5官方开奖结果体彩网:investment-grade ratingsꦓ. Investment-grade bonds typically have ratings of AAA, AA, A, or BBB.

About Junk Bonds

Non-investment-grade bonds, also called 澳洲幸运5官方开奖结果体彩网:high-yield or junk bonds, are judged to have lower credit quality and, therefore, present a h𝔍igher risk to investor🌃s.

Non-investment-grade bonds typically have ratings of BB and lower. These ratings indicate that there's a greater chance that the bond issuer will default on its payment.

In fact, D, the lowest grade, is reserved for bonds that are already in defaul𒐪t.

Non-investment-grade bonds typi🃏cally offer higher rates of return to compensate for the greater potential risk.

There are bꦯond mutual funds and ETFs that speci♓alize in bonds of different grades.

How Companies Are Rated

Corporate credit ratings are based on a firm's financial statements, including its capital structure, credit payment history, revenue, and ea꧑rnings. Corporate credit ratings are meant to help assess the firm's ability to pay its debts.

Credit rܫating agencies also assign ratings to insurance companies to indicate their financial strength and likely ability to pay future claims.

Governments and government agencies that issue debt are rated individually. As with any entity that borrows money, the credit rating reflects the government or agency's ability to repay its debts.

The credit rating agencies stress that their ratings are basically well-informed judgment calls. S&P Global, for example, refers to its ratings as "forward-looking opinions about the ability and willingness of debt issuers, like corporations or governments, to meet their financial obligations on time and in full" and as just "one of many inputs" for investors to consider.

The Bottom Line

Credit scores and cre♕dit ratings are informed judgments of the credit quality of individ💛uals and entities, respectively. Both are useful to lenders, investors, and others.

It's worth remembering that their number or letter grades are simply estimates and shouldn't be considered perfectly predictive.