Asset Quality Rating

Asset Quality Rating

An asset quality rating refers to the assessment of credit risk associated with a particular asset, such as a bond or stock portfolio. Other items which can impact asset quality are other real estate, other assets, off-balance sheet items, and to a lesser extent, cash and due from accounts, real estate holdings, and fixed assets The asset quality rating of a bank reflects its existing and potential credit risk associated with its loan and investment portfolios, other real estate owned, and other assets, as well as off-balance sheet transactions. An asset quality rating refers to the assessment of credit risk associated with a particular asset, such as a bond or stock portfolio. The definitions of each rating are as follows: A rating of 1 indicates strong asset quality and credit administration practices. For banks, the primary factor affecting overall asset quality is the quality of their loan portfolio and their credit administration program.

Asset quality rating assesses the relative riskiness of assets held in a portfolio.

What Is an Asset Quality Rating?

An asset quality rating refers to the assessment of credit risk associated with a particular asset, such as a bond or stock portfolio. The level of efficiency in which an investment manager controls and monitors credit risk heavily influences the rating bestowed.

Because asset quality is an important determinant of risk that profoundly impacts liquidity and costs, analysts go to great lengths to make sure they issue the most accurate evaluations possible. Indeed, their pronouncements can greatly affect the overall condition of a business, bank, or portfolio for years to come.

Asset quality rating assesses the relative riskiness of assets held in a portfolio.
The highest-quality assets are Treasuries and other highly-rated bonds.
Banks evaluate the asset quality (given a score of 1 to 5) of their loan and securities portfolio to determine their financial stability.

Understanding Asset Quality Ratings

Analysts consider a multitude of factors when issuing asset quality ratings, including portfolio diversification, operational efficiency, and how existing regulatory frameworks may or may not limit credit risk.

A rating of “one” may signal that an asset possesses high quality with little credit risk. Such a rating would likely be assigned to ultra-secure U.S. government Treasury bills (T-Bills). At the other end of the spectrum, a rating of “five” would likely be given to assets with significant credit deficits, such as high-risk corporate-issued junk bonds.

Asset Quality and Bank Financial Stability

Asset quality is also an important determinant of the overall financial condition of a bank. For banks, the primary factor affecting overall asset quality is the quality of their loan portfolio and their credit administration program.

Loans typically comprise a majority of a bank's assets and carry the greatest amount of risk to their capital. Securities may also comprise a large portion of the assets and also contain significant risks. Other items which can impact asset quality are other real estate, other assets, off-balance sheet items, and to a lesser extent, cash and due from accounts, real estate holdings, and fixed assets

The asset quality rating of a bank reflects its existing and potential credit risk associated with its loan and investment portfolios, other real estate owned, and other assets, as well as off-balance sheet transactions.

Asset Quality Ratings Definitions

The FDIC has established asset quality rating definitions that are applied to banks following a thorough evaluation of existing and potential risks and the mitigation of those risks. The definitions of each rating are as follows:

Related terms:

Accounting

Accounting is the process of recording, summarizing, analyzing, and reporting financial transactions of a business to oversight agencies, regulators, and the IRS. read more

Bank Rating

Learn more about bank ratings, a grade provided to the public by the FDIC and/or other private companies on the safety and soundness of banks and thrift institutions. read more

Bond Market

The bond market is the collective name given to all trades and issues of debt securities. Learn more about corporate, government, and municipal bonds. read more

CAMELS Rating System

The CAMELS rating system is an international bank-rating method in which bank supervisory authorities rate institutions according to six factors.  read more

Capital Adequacy Ratio – CAR

The capital adequacy ratio (CAR) is defined as a measurement of a bank's available capital expressed as a percentage of a bank's risk-weighted credit exposures. read more

Credit Analyst

A credit analyst is a financial professional who assesses the creditworthiness of individuals, companies, or securities.  read more

Credit Risk

Credit risk is the possibility of loss due to a borrower's defaulting on a loan or not meeting contractual obligations. read more

Rating

A rating is an assessment tool assigned by an analyst or rating agency to a stock or bond indicating its potential for opportunity or safety. read more

Securities-Based Lending

Securities-based lending is the practice of providing loans to individuals using securities as collateral. read more

Treasury Bills (T-Bills)

A Treasury Bill (T-Bill) is a short-term debt obligation issued by the U.S. Treasury and backed by the U.S. government with a maturity of less than one year. read more