Credit Quality

Reviewed by Sujaini | Updated on Aug 27, 2020

What Is Credit Quality?

Credit quality is one of the key criteria used to judge the investment quality of a mutual fund or bond fund. As the term implies, credit quality tells investors about the creditworthiness or default risk of a bond or bond portfolio. The credit quality of a company or security might also be known as its "bond rating."

Understanding Credit Quality

Credit quality is a key aspect of credit markets. The credit quality of an individual bond or bond mutual fund is calculated by private credit rating agencies, such as Moody's, Standard & Poor's, or Fitch. Each credit rating agency has its own credit quality designations that typically range from high ('AAA' to'AA') to medium ('A' to' BBB') to low ('BB', 'B','CCC' and 'C').

Credit rating agencies issue credit quality ratings on the credit market to all types of issuers. Factors influencing a corporate rating include the capital structure of the company, the history of credit payments, revenue, and earnings.

In the credit market, bonds having investment-grade ratings are considered to be of high quality. On the other hand, non-investment-grade bonds, also called high-yield/junk bonds, have lower credit quality and higher risk. Investment-grade bonds come with lower yields, while non-investment grade bonds require higher yields to offset the greater risk.

Investors who are interested in the quality of their bond investments should stick to investment-grade bonds ('AAA, 'AA', 'A' and 'BBB'), while investors who are willing and able to accept a higher level of risk may prefer lower credit-grade bonds with higher yields. They can go for the latter if they believe that those low-credit borrowers are likely to pay back.

Factors that influence a corporate credit rating include the company's capital structure, credit payment history, revenue, and earnings.