KEY POINTS:
Q. What is an organisation's credit rating and why is it so important?
A. It is an independent assessment of the creditworthiness of an organisation, and a key indicator of its financial security and ability to meet its financial commitments. Having a rating from a respected international ratings agency is an indication of how secure your investment is with a bank or finance company.
Q. Who pays for these ratings and can they be trusted?
A. The ratings agencies charge for their services so the bank or finance company that is rated pays. They can be most definitely trusted. The larger reputable agencies, such as Standard and Poor's or Moody's, are internationally respected for their service.
Q. Are the ratings agencies just reliant on the information you choose to show them?
A. Not at all. They use information from both the organisations they are rating, and other sources they consider reliable and appropriate. Ratings agencies often have access to privileged information ordinary investors would otherwise not have access to.
Q. What is the proper meaning of "investment grade"?
A. This relates to the quality of a company's credit - its ability to meet its financial commitments. To be considered for this grade, the company must rate BBB or higher.
Q. What is a useful rating below which I should not invest?
A. This is a decision for investors. It comes down to how much risk they are willing to take, and if the return compensates for that. Are they receiving in interest enough to compensate that they may not get their money back? As a guide, anything rated BB or lower is known as junk grade, which means the ability of the bank or finance company to repay its issued debt is considered to be speculative.
Q. Don't the higher rated banks or companies just pay less interest?
A. The higher the credit rating, the less risky an investment is deemed to be, and the less interest the organisation should have to pay to an investor. Essentially a lower risk can mean a lower return. However there are exceptions. For example RaboPlus.co.nz has a triple A rating, but also offers among the highest interest rates available. It pays to shop around.
Q. How can I know the return offered is reasonable given the rating or the risk?
A. That comes down to an individual decision for the investor and/or their adviser, and reflects just how much risk an individual is prepared to accept. It also pays to shop around. Recently investors have been shying away from organisations such as finance companies, as some of those investments have proved to be risky.
Q. Do organisations with higher ratings use my savings in a different way to the lower rated ones?
A. The organisations with higher rating have a less-risky and more prudent philosophy when considering how they will invest their customers' hard-earned savings.
Q. Why do some banks or finance companies have ratings and others don't?
A. Some may have chosen not to have them because it would spell out how risky their businesses are. The proposed legislation from the Government, to have finance companies acquire and publish a credit rating from a reputable ratings agency, is a step in the right direction for investors, who will be better informed about risks.
* RaboPlus.co.nz is a division of Rabobank New Zealand Ltd, the only bank in NZ with an AAA rating from Standard and Poor's.
