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. And 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. After all, their pronouncements can greatly affect the overall condition of a business, bank, or portfolio for years to come.
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” signals 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.