Facebook pixel

Credit Classification Definitions for Financial Institution Risk

Qualitative Descriptions of Financial Institution Risk for Medium and Long-Term Transactions

SOV+: Better than Sovereign

This is an exceptional classification. The entity achieving such a classification is one with an exceptionally strong credit profile which could be expected to fulfill its payment obligations during a period of sovereign debt distress or even default. International Credit Rating Agencies issue regular reports listing Corporate and Counterparty Ratings that exceed the Sovereign's Foreign Currency Rating. Except when the risk sovereign has been identified through the Sovereign Risk Assessment Methodology as being significantly higher than country risk, Participants proposing that an entity be classified as better than sovereign shall reference such better than sovereign ratings in support of their recommendation. In order to be classified as better than its host sovereign, an entity would be expected to display several or normally a majority of the following characteristics or equivalents:

  • A strong credit profile;
  • substantial foreign exchange earnings relative to its currency debt burden;
  • production facilities and cash generation ability from subsidiaries or operations offshore, especially those domiciled in highly rated sovereigns, i.e. multinational enterprises;
  • a foreign owner or a strategic partner which could be relied on as a source of financial support in the absence of a formal guarantee;
  • a history of preferential treatment of the entity by the sovereign, including exemption from transfer and convertibility constraints and surrender requirements for export proceeds, and favorable tax treatment;
  • committed credit lines from highly rated international banks, especially credit lines without a material adverse change (MAC) clause which enable banks to withdraw committed facilities in the event of a sovereign crisis or other risk events; and
  • assets held offshore, especially liquid assets, often as a result of rules allowing exporters to trap and maintain cash balances offshore that are available for debt service.

Normally the SOV+ buyer risk category is not applicable to:

  • Publicly owned entities and utilities, sub-sovereigns as line ministries, regional governments, etc;
  • financial institutions domiciled in the sovereign's jurisdiction; and
  • entities primarily operating in the domestic market in local currency.

SOV: Sovereign

Sovereign obligors/guarantors are entities that are explicitly legally mandated to enter into a debt payment obligation on the behalf of the Sovereign State, typically Ministry of Finance or Central bank . A risk designated as sovereign is one where:

  • the obligor/guarantor is legally mandated to enter into a debt payment obligation on behalf of the Sovereign and thereby commits the full faith and credit of the sovereign; and
  • in the event of rescheduling of sovereign risk, the debt in question would be included in the rescheduling and payment obligations acquired by the sovereign by virtue of the rescheduling.

CC0: Exceptionally Good Credit Quality (Equivalent to the Sovereign)

The "equivalent to sovereign" category embraces two basic types of obligors/guarantors:

  • Public entities where due diligence reveals that either the buyer has the implicit full faith and credit/support of the sovereign or that the likelihood of sovereign liquidity and solvency support is very high, both in relation to recovery prospects as well as default risk. Non-sovereign public entities equivalent to the sovereign would also include companies owned by the government with a monopoly or near monopoly on operations in a sector (e.g. power, oil, gas).
  • Financial Institutions with an exceptionally strong credit profile, displaying features in terms of both default and recovery prospects which indicate that the risk could be seen as being equivalent to sovereign. Candidates include financial institution for which the likelihood of sovereign liquidity and solvency support is exceptionally high.

Exceptionally good credit quality implies that the risk of payment interruption is expected to be negligible and that the entity has an exceptionally strong capacity for repayment and this capacity is not likely to be affected by foreseeable events. The credit quality is typically manifested in a combination of some, if not all, of the following characteristics of the entity's business and financial profile:

  • exceptionally good to very good earnings strength
  • exceptionally good to very good asset quality
  • exceptionally good to very low liquidity
  • exceptionally good to very good capital adequacy
  • exceptionally strong to very strong business profile
  • High quality of financial and ownership disclosure

Depending on the classification of the country in which the obligor/guarantor is domiciled, it is likely that an obligor/guarantor classified in buyer risk category CC0 would be rated between AAA (Country Category 1) and B (Country Category 7) by accredited CRAs.

CC1: Very Good Credit Quality

The risk of payment interruption is expected to be low to very low. The obligor has a very strong capacity for repayment and this capacity is not likely to be affected by foreseeable events. The obligor has a limited or very limited susceptibility to adverse effects of changes in circumstances and economic conditions.

The credit quality is typically manifested in a combination of some, if not all, of the following characteristics of the financial institution:

  • Very good to good earnings strength
  • Very good to good asset quality
  • Very good to good liquidity
  • Very good to good capital adequacy
  • Very strong to strong business profile
  • High quality of financial and ownership disclosure unless there is a very high likelihood of support from a parent (or sovereign) with a buyer risk classification equal or stronger than what corresponds to this buyer risk category

CC2: Good to Moderately Good Credit Quality

The risk of payment interruption is expected to be low. The obligor has a good to moderately good capacity for repayment and this capacity is not likely to be affected by foreseeable events. The obligor has a limited susceptibility to adverse effects of changes in circumstances and economic conditions.

The credit quality is typically manifested in a combination of some, if not all, of the following characteristics of the financial institution:

  • Good to moderately good earnings strength
  • Good to moderately good asset quality
  • Good to moderately good liquidity
  • Good to moderately good capital adequacy
  • Good to moderately good business profile
  • High quality of financial and ownership disclosure unless there is a very high likelihood of support from a parent (or sovereign) with a buyer risk classification equal or stronger than what corresponds to this buyer risk category

CC3: Moderate Credit Quality

The risk of payment interruption is expected to be moderate to moderately low. The obligor has a moderate or moderately good capacity for repayment. There is a possibility of credit risk as the obligor faces major ongoing uncertainties or exposure to adverse business, financial or economic conditions which could lead to inadequate capacity to meet timely payments. However, business or financial alternatives may be available to allow financial commitments to be met.

The credit quality is typically manifested in a combination of some, if not all, of the following characteristics of the financial institution:

  • Moderately good to moderate earnings strength
  • Moderately good to moderate asset quality
  • Moderately good to moderate liquidity
  • Moderately good to moderate capital adequacy
  • Moderately good to moderate business profile
  • Adequate quality of financial and ownership disclosure unless there is a very high likelihood of support from a parent (or sovereign) with a buyer risk classification equal or stronger than what corresponds to this buyer risk category

CC4: Moderately Weak Credit Quality

The risk of payment interruption is expected to be moderately high. The obligor has a moderately weak capacity for repayment. There is a possibility of credit risk as the obligor faces major ongoing uncertainties or exposure to adverse business, financial or economic conditions which could lead to inadequate capacity to meet timely payments. However, business or financial alternatives may be available to allow financial commitments to be met.

The credit quality is typically manifested in a combination of some, if not all, of the following characteristics of the financial institution:

  • Moderate to moderately weak earnings strength
  • Moderate to moderately weak asset quality
  • Moderate to moderately weak liquidity
  • Moderate to moderately weak capital adequacy
  • Moderate to moderately weak business profile
  • Adequate quality of financial and ownership disclosure unless there is a very high likelihood of support from a parent (or sovereign) with a buyer risk classification equal or stronger than what corresponds to this buyer risk category

CC5: Moderate Credit Quality

The risk of payment interruption is expected to be high to very high. The obligor has a moderately weak to weak capacity for repayment. The obligor currently has the capacity to meet repayments but a limited margin of safety remains. However, there is a likelihood of developing payment problems as the capacity for continued payment is contingent upon a sustained, favorable business and economic environment. Adverse business, financial or economic conditions will likely impair capacity or willingness to repay.

The credit quality is typically manifested in a combination of some, if not all, of the following characteristics of the financial institution:

  • Moderately weak to weak earnings strength
  • Moderately weak to weak asset quality
  • Moderately weak to weak liquidity
  • Moderately weak to weak capital adequacy
  • Moderately weak to weak business profile
  • Poor quality of financial and ownership disclosure unless there is a very high likelihood of support from a parent (or sovereign) with a buyer risk classification equal or stronger than what corresponds to this buyer risk category

Most typically this would be a risk on the central bank or Ministry of Finance. For central government entities other than the finance ministry, due diligence shall be undertaken to affirm that the entity commits the full faith and credit of the sovereign.