A credit rating can be an investment risk indicator for bonds or other fixed interest investments. They help you understand how likely it is that interest will be paid on time and you’ll get your money back when your investment reaches the end of its term.
The rating applies to the organisation offering the investment or their holding company, and is the rating agency’s assessment of the likelihood that the organisation may default.
In New Zealand, most banks, finance companies, building societies, credit unions and other non-bank organisations taking deposits from the public have a credit rating. The main credit rating agencies approved by the Reserve Bank of New Zealand are Standard and Poor’s, Moody’s, Fitch and Corporate Scorecard (CSC).
5 things to look out for
1. Ratings agencies have different credit rating systems
A credit rating is useful as an initial assessment of risk but it’s only one factor you need to take into account. See understanding risk.
2. A good credit rating doesn’t mean the investment is risk-free
It’s simply the agency’s opinion of the organisation’s ability to meet its financial obligations.
3. Be careful of any investment that’s been rated less than an ‘A’
In most tests, a grade ‘B’ is considered good. This isn’t the case for credit ratings. As shown in RBNZ’s standardised rating scale, an ‘AAA’ rated company has a much lower risk of default (1 in 600 over five years) compared with a ‘B’ rated company (1 in 5 over five years).
4. Ratings issued by financial advisers should be treated with caution
They’re a useful guide but they’re not from approved agencies.
5. Sometimes an organisation might have no credit rating
This doesn’t necessarily mean you should avoid the investment, but you should take extra care to assess the risk. You could ask a financial adviser why there’s no credit rating.
The RBNZ’s standardised rating scale
The RBNZ has published a table that maps the rating scales of the three main credit rating agencies.
