Credit Rating
A credit rating is an independent agency's assessment of how likely a borrower or a debt instrument is to default — on a scale from AAA through BBB (the lowest investment grade) to CCC and D — that sets what the borrower pays to borrow and which investors may lend to it. Moody's, S&P and Fitch assign most; a fintech meets them when it issues bonds or securitises its loans.
- Also known as
- Credit score (for companies), Bond rating, Issuer rating
- Used at
- bond issues, securitisations (each tranche is rated separately), bank and insurer counterparty limits, regulatory capital (risk weights depend on ratings), and loan pricing grids that step with the rating
- Binding
- no — an opinion; but investment mandates, regulations and loan agreements make the grade a term with consequences (a downgrade below investment grade triggers forced selling and covenant changes)
- Typical scale
- AAA, AA, A, BBB (investment grade); BB, B, CCC (speculative or "high yield"); D (default); with + and − modifiers; agencies are paid by the issuer, which is the conflict the 2008 crisis exposed
- Typical fintech ratings
- the largest payment processors are investment grade (BBB to A); most fintechs have no rating at all and borrow from banks and private credit on the lender's own analysis; their securitisations carry ratings on the senior tranches
- Parties
- the agencies, the issuers who pay them, the investors who rely on them, and the regulators who wrote them into the rules and have been trying to write them out since 2008
How a credit rating works in practice
A company planning a €300m bond engages an agency. Analysts review its business, cash flows, leverage, liquidity and management, compare it with rated peers, and assign a grade — BB+, say — with a report explaining why and what would change it. The bond prices off the grade: a BB+ issuer pays perhaps 250–350 basis points over government bonds, an A issuer 60–100. Investors whose mandates allow only investment grade cannot buy it; high-yield funds can. The rating is monitored and can be upgraded or downgraded; a fall from BBB− to BB+ crosses the line into speculative grade and forces some holders to sell, which is why companies manage their balance sheets to the boundary.
Securitisations are rated by tranche. A pool of consumer loans is sliced into a senior tranche (AAA or AA — losses would have to exceed 15% of the pool to touch it), a mezzanine (BBB) and an unrated equity piece; the agency models the pool's expected losses and stresses them to decide how thick each tranche must be for its grade. The 2008 lesson — AAA tranches of subprime pools that defaulted — was about the models' assumptions and the issuer-pays incentive, and the rules since require more disclosure and less reliance on ratings in regulation.
For most fintechs the rating is indirect: the securitisation of their loan book is rated, their own debt is not, and a bank counterparty's rating decides whether a treasurer may hold client money there.
Example
A consumer lender securitises €500m of loans. The agency's model: expected lifetime losses of 4%, stressed to 12% for AAA; a senior tranche of €400m (80%) survives losses up to 20% and is rated AAA; a mezzanine of €60m (12%) rated BBB; an equity piece of €40m unrated and retained. The senior tranche prices at 90 basis points over the benchmark, the mezzanine at 350; the lender's blended funding cost is about 1.6% over the benchmark against the 4.5% its warehouse bank charged. Two years later losses run at 5.5%; the agency affirms the ratings, since the equity absorbs it. Had losses reached 12%, the equity would be gone, the mezzanine impaired and downgraded, and the lender's next securitisation priced by investors who remember.
Common mistakes
- Treating a rating as a probability rather than as an opinion with a methodology and a payer. - Managing a balance sheet to the letter of a grade and not to the risk. - Investors relying on the rating of a tranche without reading the assumptions in the pre-sale report. - Fintechs assuming their own creditworthiness follows from their securitisation's senior rating; it does not. - Forgetting that a downgrade across the investment-grade line is a forced-selling event, not a change of opinion.