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What is a credit rating?

A credit rating is an evaluation of the credit worthiness of a debtor: it is a representative expression of the ability to pay back the debt and the likelihood of default. The assessment is performed by a credit rating agency that uses publicly available data and private data obtained from the rated entity. The European regulator ESMA distinguishes the following classes of credit ratings:

  • A Sovereign and public finance ratings;
  • B Structured finance ratings;
  • C Corporate ratings.

European Rating House is not active in the domains A and B, only offers corporate ratings regarding commercial companies outside the financial sector. For more information we refer to: http://en.wikipedia.org/wiki/Credit_rating

What is a credit score?

A credit score is an evaluation of the credit worthiness of a debtor, created by credit agencies, banks or other commercial organizations. Their analytical models can use hundreds of parameters and values from the rated organization. For more information please refer to: https://en.wikipedia.org/wiki/Credit_score 

What is a business failure?

We define business failure as including a substantial decline of the stock price of the company, in combination with situations such as Default, Chapter 11, and Bankruptcy, or strong measures such as asset stripping, forced recapitalization, turnaround or forced take-over. These strong measures - usually enforced by shareholders, Supervisory Board and other stakeholders - are seen as the responsibility of the Executive Board. The substantial decline of the stock price that occurs during any business failure can cause serious damage to shareholders, bondholders and other stakeholders. In some cases fraud can be identified as the main cause of the business failure as many accounting scandals have shown.Timely warning is of utmost importance, and thus our OK-Score Model warns up to three years in advance for business failure.

- Chapter 11 https://en.wikipedia.org/wiki/Chapter_11

- Bankruptcy https://en.wikipedia.org/wiki/Bankruptcy

- Asset stripping https://en.wikipedia.org/wiki/Asset_stripping

- Recapitalization http://en.termwiki.com/DE:recapitalization_%E2%82%81

- Turnaround https://en.wikipedia.org/wiki/Turnaround_management

- Forced takeover https://en.wikipedia.org/wiki/Takeover

- Fraud/accounting scandals https://en.wikipedia.org/wiki/Accounting_scandals

What is ESMA?

The European Securities and Markets Authority (ESMA) is exclusively responsible for the registration and supervision of Credit Rating Agencies in the European Union. In addition, ESMA also carries out policy work to prepare future legislation, such as regulatory technical standards, and guidelines.  This work is undertaken through the CRA Technical Committee, which has representatives from all the national competent authorities.  For more information about ESMA, please refer to:

http://www.esma.europa.eu/page/Credit-Rating-Agencies

What is default? 

For a definition of default we refer to: https://en.wikipedia.org/wiki/Default_(finance)

What is OK-Score Institute?

OK-Score Institute is an independent provider of credit scores based on the OK-Score Model. European Rating House uses the OK-Score Model as a diagnostic tool in the rating process. For that purpose European Rating House has entered into an agreement with OK-Score Institute. For more information we refer to: www.ok-scoreinstitute.eu

What is the Gini-coefficient?

The Gini-coefficient is used to measure the accuracy of credit rating models, also called: ‘rating performance’. The Gini-coefficient is usually defined mathematically based on the Lorenz curve. For more details, please refer to: https://en.wikipedia.org/wiki/Gini_coefficient

What is a Type-1 error?

The Type-1 error corresponds to the situation in which the rating agency warns for business failure whereas no such failure follows. Also called: ‘false warning’, ‘false discovery error’, ‘false positive error’, or ‘α’. It is usually expressed as the number of false alerts divided by the total number of credit ratings issued. However in our opinion a more relevant definition is: the number of false alerts divided by the total number of alerts issued. The Type-1 error of European Rating House amounts to 2.2% of total alerts provided (population 2000-2013). For more information, please refer to http://en.wikipedia.org/wiki/Type_I_and_type_II_errors

What is a Type-2 error?

The Type-2 error corresponds to the situation in which a business failure occurs that the rating agency had not warned for default. Also called: ‘non-detection error, ‘false negative error’, or ‘β’. The Type-2 error of European Rating House is 2.25% of total business failures (population 2000-2013). For more information, please refer to: http://en.wikipedia.org/wiki/Type_I_and_type_II_errors

What is the Lorenz-curve?

The Lorenz-curve is a graph that shows the cumulative proportion of actual risk of business failure in the population (Y) as compared to the cumulative proportion of companies with the highest risk of business failure (X). For more information, please refer to: https://en.wikipedia.org/wiki/Lorenz_curve

 

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