What is a shadow rating?
A shadow rating in an unofficial rating given to a bond or issuing party by a credit bureau, but without any public announcement of the rating. Shadow classification can serve two purposes. First, it can be useful for a company that is contemplating issuing rated debt on the market but is unsure how it would be received. Second, it can serve as a rough guide for issues or issuers that have not been formally rated by a credit bureau.
Investors who may be interested in purchasing debt (sovereign bonds, for example) that do not have an official credit rating can integrate the shadow rating into their investment decision process.
- A credit rating agency issues a shadow rating to an issuer, but unofficially and without public announcement.
- An issuer may obtain the shadow rating on an interim basis while waiting for its full credit rating to be written.
- An issuer can also use the shadow rating to test the waters before deciding to issue bonds without investors reacting. If the shadow rating is unfavorable, the company can simply forgo the bond issue.
Understanding Shadow Ratings
An issuer that has never been officially rated by a credit bureau can approach S&P, Moody’s, or another agency to obtain shadow ratings for itself and a debt issue to test the waters or get a rough indication of how it may be seen in the markets. public markets. The credit bureau would follow in your footsteps as it would in a formal rating process to assign a credit rating. This shadow rating would provide useful information to the prospective issuer on the price of the debt instrument (ie approximate interest expense) in the current market and the potential demand given known pools of debt investors.
If the shadow rating is favorable, the issuer can be encouraged to continue the offering and obtain an official rating from the credit bureau. If the shadow rating does not meet the issuer’s expectations, it can delay a formal rating and issue debt to the market. The value of a shadow rating option is clear, and after a credit bureau reviews the issuer or potential debt issue, the issuer will have a better understanding of what is necessary to achieve a certain desired rating, either in the way the company generates cash flows or how to structure a debt offering.
If investors are interested in traded debt issues that do not have credit ratings from an agency, they can look for parallel ratings in their assessment of the creditworthiness of the target investment. Investors can collaborate with a credit bureau to conduct an analysis, but they can also perform the exercise themselves using comparable analysis methods. An unrated sovereign, for example, possessing similar characteristics of a rated country could receive the same rating designation as this comp. The shadow rating, then, would help an investor determine whether a debt issue is an acceptable investment.