Objective:: S.S. College of Business Studies

S.S.
COLLEGE OF BUSINESS STUDIES
INTRODUCTION
Objective:
The objective of this study is to find out (a) the need of credit rating (b) how the credit rating agencies function (c) the limitations of credit rating. An analysis of credit rating is also included in the study.
CREDIT RATING-An Introduction

The role of financial markets in a market economy is that of an efficient intermediator, mediating between savers and investors, mobilizing capital on hand and efficiently allocating them between competing uses on the other. Such an allocative role hinges crucially on the availability of reliable information. The doctrine of efficient market allocation in fact has as its bedrock, what economists label perfect information. An investor in search of investment avenues has recourse to various sources of information- offer documents of the issuer(s), research reports of market intermediaries, media reports etc. In addition to these sources, Credit Rating Agencies have come to occupy a pivotal role as information providers, particularly for credit related opinions in respect of debt instruments; a role that has been strengthened by the perception that their opinions are independent, objective, well researched and credible. The impetus for the growth of Credit Rating came from the high levels of default in the US Capital markets after the Great Depression. Further impetus for growth came when regulatory agencies began to stipulate that institutions such as Government Pension Funds and Insurance Companies could not buy securities rated below a particular grade. Merchant bankers, underwriters and other intermediaries involved in the debt market also found rating useful for planning and pricing the placement of debt
S.S. COLLEGE OF BUSINESS STUDIES instruments. The other factors leading to the growing importance of the credit rating system in many parts of the world over the last two decades are 1. The increasing role of capital and money markets consequent to disintermediation;
2. Increasing securitization of borrowing and lending consequent to

disintermediation;
3. Globalisation of the credit market; The continuing growth of information

technology; 4. The growth of confidence in the efficiency of the market mechanism: and 5. The withdrawal of Government safety nets and the trend towards privatization. It was this growing demand on rating services that enabled credit rating agencies to charge issuers for their services. This was much in variance with the mode of financing used hitherto-with no fees charged to the issuers, a credit rating agency used to provide rating information through the sale of their publication and other materials.
Historical perspective: The Origins The origins of credit rating can be traced to the 1840s. Following the financial crisis of 1837, Louis Tappan established the first mercantile credit agency in New York in 1841. The agency rated the ability of merchants to pay their financial obligations. It was subsequently acquired by Robert Dun and its first rating guide was published in 1859. Another similar agency was set up by John Bradstreet in 1849, which published a ratings book in 1857. These two agencies were merged together to form Dun & Bradstreet in 1933, which became the owner of Moodys Investors Service in 1962. The history of Moodys Investors Service, and in 1909 published his Manual of Railroad Securities. This was followed by the rating of
S.S. COLLEGE OF BUSINESS STUDIES utility and industrial bonds in 1914, and the rating of bonds issued by U.S cities and other municipalities in the early 1920s. Further expansion of the credit rating industry took place in 1916, when the Poors Publishing Company published its first ratings, followed by the Standard Statistics Company in 1922, and Fitch Publishing Company in 1924. The Standard Statistics Company and the Poors Publishing company merged in 1941 to form Standard & Poors. Credit Rating: The Concept Ratings, usually expressed in alphabetical or alphanumeric symbols, are a simple and easily understood tool enabling the investor to differentiate between debt instruments on the basis of their underlying credit quality. The credit rating is thus a symbolic indicator of the current opinion of the relative capability of the issuer to service its debt obligation in a timely fashion, with specific reference to the instrument being rated. It is focused on communicating to the investors , the relative ranking of the default loss probability for a given fixed income investment, in comparison with other rated instruments. A rating is specific to a debt instrument and is intended as a grade, an analysis of the credit risk associated with the particular instrument. It is based upon the relative capability and willingness of the issuer of the instrument to service the debt obligations( both principal and interest) as per the terms of the contract. Thus a rating is neither a general purpose evaluation of the issuer, nor an overall assessment of the credit risk likely to be involved in all the debts contracted or to be contracted by such entity.
The primary objective of rating is to provide guidance to investors/ creditors in determining a credit risk associated with a debt instrument/credit obligation. It does not amount to a recommendation to buy, hold or sell an instrument as at does not take into consideration factors such as market prices, personal risk preferences and other considerations which may influence an investment decision. The rating
S.S. COLLEGE OF BUSINESS STUDIES process is itself based on certain givens. The agency, for instance, does not perform an audit . Instead It is required to rely on information provided by the issuer and collected by analysts from different sources, including interactions inperson with various entities. Consequently, the agency does not guarantee the completeness or accuracy of the information on which the rating is based.
The Use of Credit Rating

By Investors
For the investor, the rating is an information service , communicating the relative ranking of the default loss probability for a given fixed income investment in comparison with other rated instruments. In the absence of a credit rating system , the risk perception of a common investor vis--vis debt instruments largely depends on his/her familiarity with the names of the promoters or the collaborators. Such name recognition, often used to evaluate credit quality in the underdeveloped markets can not be an effective surrogate for systematic risk evaluation ; it suffers from a number of avoidable limitations it is not true that every venture promoted by a well known name will be successful and free from default risk. Nor is it true that every venture promoted by a relatively lesser known entity is disproportionately risk prone. While on one hand , name recognition restricts the options available to the investor, on the other it denies relatively lesser known entrepreneurs access to a wider investor base. What is therefore required for efficient allocation of resources is systematic risk evaluation. It is rarely, if ever, feasible for the corporate issuer of debt instrument to offer every prospective investor the opportunity to undertake a detailed risk evaluation. A professional credit rating agency is equipped with the required skills, the competence and the credibility, all of which eliminates, or at least minimizes, the role of name recognition and replaces it with well researched and scientifically analysed opinions as to the relative ranking of different debt instruments in terms of their credit quality. A rating provided by a professional credit rating agency is of significance not just for the individual/small investor but also for an organized
S.S. COLLEGE OF BUSINESS STUDIES institutional investor. Rating for them provides a low cost supplement to their own in-house appraisal system. Large investors may use credit rating spectrum of investment options. Such investors could use the information provided by rating changes, by carefully watching upgrades and downgrades and altering their portfolio mix by operating in the secondary market. Banks in some developed countries use the ratings of other banks and financial intermediaries for their decisions regarding inter-bank lending, swap agreements and other counter-party risks.
By Issuers
The benefit of credit rating for issuers stems from the faith placed by the market on the opinions of the rating provided and the widespread use of ratings as a guide for investment decisions. The issuers of rated securities are likely to have access to a much wider investor base as compared to unrated securities , as a large section of investors not having the required resources an skills to analyse each and every investment opportunity would prefer to rely on the opinion of a rating agency. The opinion of a rating agency enjoying investor confidence could enable the issuers of highly rated instruments to access the market even under adverse market conditions. Credit rating provides a compensated for basis for determining the additional return( over and above a risk free return) which investors must get in order to be the additional risk that they bear. They could be a useful benchmark for issue pricing. The differential in pricing would lead to significant cost savings for highly rated instruments.
By Intermediaries
Rating is a useful tool for merchant bankers and other capital market
intermediaries in the process of planning, pricing, underwriting and placement of issues. The intermediaries, like brokers and dealers in securities, could use rating as an input for their monitoring of risk exposures. Regulators in some countries specify capital adequacy rules linked to credit rating of securities in a portfolio.
S.S. COLLEGE OF BUSINESS STUDIES
By Regulators
Regulatory authorities worldwide have promoted the use of Credit Rating by issuing mandatory requirements for issuers. Specific rules, for instance restrict entry to the market of new issues rated below a particular grade, stipulate different margin requirements for mortgage of rated and unrated instrument and prohibit institutional investors from purchasing or holding of instruments rated below a particular level. In India , credit rating has been made mandatory for issuance of the following instruments: a) as per the requirements of SEBI, public issue of debentures and convertible/redeemable beyond a period of 18 months rating; b) as per the guidelines of RBI, one of the conditions for issuance of India is that the issue must have a rating not below the P2 CRISIL/A2 grade from ICRA/PR2 from CARE; CP in bonds
need credit
grade from
c) as per the guidelines of RBI , NBFCs having net owned funds of

than Rs. 2 crore must get their fixed deposit programmes March 1995 and the NBFCs having net owned 50 lacs(but less than 2 crore) must get their rated by 31st March 1996. The minimum to be eligible to raise fixed deposits from ICRA/BBB from CARE. Similar by National Housing Bank(NHB)
more
rated by 31st
funds of more than Rs fixed deposit programme
rating required by the NBFCs are FA(-) from CRISIL/ MA(-) regulations have been introduced
for housing finance companies also; programmes of
d) there is a proposal for making the rating of fixed deposit limited companies, other than NBFCs also the Companies Act,1956.
mandatory, by amendment of
Code of Conduct for Credit Rating Agencies SEBI (Credit Rating Agencies) REGULATIONS,1999)
1) A credit rating agency in the conduct of its business shall observe standards of integrity and fairness in all its dealings with its 2) A credit rating agency shall fulfill its obligations in an ethical clients. manner. high
3) A credit rating agency

independent professional
shall render at all times high standards of care and exercise wherever necessary, judgment. It shall
service, exercise due diligence, ensure proper
disclose to the clients, possible sources of conflict of duties and interests, while providing unbiased services. 4) A credit rating agency shall avoid any conflict of interest of any of its rating committee participating in the rating analysis. conflict of interest shall be disclosed to the client. 5) A credit rating agency shall not indulge in unfair competition nor they wean away client of any other rating agency on rating. 6) A credit rating agency shall not make any exaggerated statement, whether oral or written, to the client about its qualification or its capability to render certain services or its achievements in regard services rendered to other clients. 7) A credit rating agency shall always endeavour to ensure that all professional dealings ate effected in a prompt and efficient manner. any has to shall member
Any potential
assurance of higher
8) A credit rating agency shall not divulge to other clients, press or other party any confidential information about its clients, which of the rated company/client.
come to its knowledge, without making disclosure to the concerned person
S.S. COLLEGE OF BUSINESS STUDIES 9) A credit rating agency shall not make untrue statement furnished Board or to public or to stock exchange. to the
10) A credit rating agency shall not generally and particularly in issue of securities rated by it be party to (a) creation of false market;
respect of
(b) passing of price sensitive information to brokers, members stock exchanges, other players in the capital market other person or take any other action which is to the investors.
of the or to any
unethical or unfair
11) A credit rating agency shall maintain an arms length relationship between its credit rating activity and any other activity. 12) A credit rating agency shall abide by the provisions of the Act, regulations and circulars which may be applicable and relevant to activities carried on by the credit rating agency.
Source: Notification No. S.O .547(E), dated 7-7-1999,issued by SEBI
the
METHODOLOGY
Objective: The main objective of this study is to find out how the Credit Rating Agencies function, how they rate the instruments. The factors, which matter in the rating process is also included in this study. The secondary objective of this study is to find out the challenges being faced by the rating agencies and what is being done to face it. Research Design: Descriptive Research is used in this study. The nature of this study is such that it eradicates the necessary of doing primary research. Research has been done from secondary sources of information. Secondary sources of information: Credit Rating manuals from ICRA ICRA Information brochures Chartered Financial Analyst magazines ICFAI Reader magazine www.icraindia.com www.crisil.com www.businessstandard.com
CREDIT RATING AGENCIES IN INDIA

The rating coverage in India is not too old, beginning 1987 when the first rating agency, CRISIL was established. At present there are three main rating agencies CRISIL(Credit Rating and Information Services of India Ltd.),ICRA Ltd. (Investment Information and Credit Rating Agency of India Limited) and CARE(Credit Analysis and Research). The fourth rating agency is a JV between Duff & Phelps, US and Alliance Capital Limited , Calcutta.
CRISIL:
It was promoted by ICICI, nationalized and foreign banks and insurance companies in 1987. it went public in 1992 and is the only listed credit rating agency in India. In 1996 it entered into a strategic alliance with Standard & Poors to extend its credit rating services to borrowers from the overseas market. The services offered are broadly classified as Rating, Information services , Infrastructure services and consulting. Rating services cover rating of Debt instruments-long, medium and short term, securitised assets and builders. Information services offer corporate research reports and the CRISIL 500 index. The Infrastructure and consultancy division provide assistance on specific sectors such as power, telecom and infrastructure financing.
ICRA:
It was promoted by IFCI and 21 other shareholders comprising nationalized and foreign banks and insurance companies. Established in 1991 , it is the second rating agency in India. The services offered can be broadly classified as Rating services , Advisory services and Investment Information services. The rating services comprise rating of debt instruments and credit assessment. The Advisory services include strategic counseling, general assessment such as restructuring exercise and sector specific services such as for power, telecom, ports, municipal
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S.S. COLLEGE OF BUSINESS STUDIES ratings , etc. The information or the research desk provides research reports on specific industries, sectors and corporates. The Information services also include equity related services, viz, Equity Grading and Equity Assessment. In 1996, ICRA entered into a strategic alliance with Financial Proforma Inc. , a Moodys subsidiary to offer services on Risk Management Training and software: Moodys and ICRA has entered into memorandum, of understanding to support these efforts. a
CARE:
It was set up in 1992, promoted by IDBI jointly with other financial institutions, nationalized and private sector finance companies. The services offered cover rating of Debt instruments and sector specific industry reports from the research desk and equity research.
Market share
Marketshare of the different Credit Rating Agencies in India
2% 48% 39%
11%
CRISIL ICRA CARE Duff& Phelps
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ICRA - A Detailed Study

Ministry of Finance, Department of Economic Affairs , vide its letter No. 1(120) SE/89, dated the 19th Sept. 1990 accorded approval for the establishment of a second Credit Rating and Information Agency in the country to meet the requirements of companies based in North. The approval was granted subject to the following conditions viz . (1) The Agency shall be self-supporting after a maximum period of 2 years and accordingly shall not require any subvention thereafter IFCI; (2) The agency should be managerially independent. The major shareholders are:- Moodys Investment Company India private Ltd., IFCI Ltd., SBI, LIC, UTI, PNB, GIC, Central Bank of India, Union Bank of India, Allahabad Bank, United Bank of India, Indian Bank, Canara Bank, Andhra Bank , Export-Import Bank of India, UCO Bank HDFC Ltd., Infrastructure Leasing and Financial Services Ltd., Vysya Bank. The main objective of ICRA like any other Credit Rating Agency is to assess the credit instrument and award it a grade consonant to the risk associated with such instrument. ICRAs main objectives include providing guidance to the investors/creditors in determining the credit risk associated with a particular debt instrument or credit obligation and reflecting independent, professional and impartial assessment of such instruments/obligations. The ratings done by ICRA are not recommendations to buy or sell securities but culminate symbolic indicator of the current opinion of the relative capability of timely servicing of the debts and obligations. from
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RANGE OF SERVICES
The services offered by Credit Rating Agencies are as follows:1.
Rating servicerating of bonds, debentures, Commercial Paper(CP), certificates of deposit(CD), claim paying ability of corporate governance, structured obligations. insurance companies,
2.
Information
serviceprovides
sector/industry
specific studies
studies/publications, corporate reports and mandate based customized research.

3.
Grading servicesincludes grading of Construction Entities, Real Developers & Projects and Mutual Fund schemes.
Estate
4.
Advisory servicesit offers wide ranging management advisory covering the areas of Strategy practice, Risk Regulatory practice and Transaction practice.
services
Management practice,
RATING SERVICE
Credit Rating
The ICRA rating is a symbolic indicator of the current and prospective opinion on the relative capability of the corporate entity concerned to timely service debts and obligations with reference to the instrument rated. The rating is based on an analysis of the information and clarifications obtained from the entity , as also other sources considered reliable by ICRA. The independence and professional approach of ICRA ensure reliable, consistent and unbiased ratings. Ratings facilitate investors to factor credit risk in their investment decisions. ICRA rates long-term, medium-term and short-term debt instruments. ICRA offers its rating services to a wide range of issuers including: Manufacturing companies
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S.S. COLLEGE OF BUSINESS STUDIES Banks and financial institutions Power companies Service companies Municipal and other local bodies Non-banking financial service companies.
Structured Finance Rating

Structured finance ratings (SFRs) are based on the estimation of the expected loss to the investor on the rated instrument, under various possible scenarios. The expected loss is defined as the product of probability of default and severity of loss, once the default has occurred. An SFR symbol indicates the relative level of expected loss for that instrument, with the risk of loss being similar as in the case of a corporate credit rating of the same level. However, an SFR may be different from the credit rating of the issuer as in many cases the transaction is structured as an off-balance sheet item. ICRAs four major SFR products are listed below. ICRA employs a specific methodology for each of its SFR products. The methodology is based on ICRAs understanding of that particular asset class and the structured and legal issues associated with the transaction involved.
Asset Backed Securitization(ABS) - ABS refers to the securitisation of a diversified pool of assets, which may include financial assets like automobile loans, commercial vehicle loans, consumer durable loans or any other nonfinancial class of assets that are identifiable and separable from the operations of the issuer and whose risk of loss is measurable. Mortgage Backed Securitisation (MBS) An MBS has diversified
housing loans as the underlying asset for the transaction.
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S.S. COLLEGE OF BUSINESS STUDIES Collateralised Debt Obligation (CDO) A CDO transaction has a
pool of corporate loans, bonds or any other debt security, including structured debt, as the underlying asset. Future Flow Transaction (FFT) FFTs involve devising a structure
where specified sources of future cash flows are identified are earmarked for servicing investors. Some examples of such sources are property tax revenues of municipal corporations, power receivables of bulk consumers and property lease rentals. FFTs are not completed de-linked from the credit risk of the issuer, but the structure, through preferential tapping of cash flows of the issuer can achieve a rating that is higher than the issuers credit rating.
The Benefits
An issuer can derive multiple advantages from structured finance products like lowering the cost of funds, accessing new markets and investors on the strength of a higher rating vis--vis a stand-alone corporate credit rating, improving capital adequacy, reducing asset-liability mismatches and increasing specialization.
Claims Paying Ability Rating (for Insurance companies)

ICRAs claims paying ability ratings (CPRs) for insurance companies are an opinion on the ability of the insurers concerned to honour policy-holder claims and obligations on time. In other words a CPR is ICRAs opinion on the financial strength of the insurer, from a policy-holders perspective. Following deregulation, a paradigm shift is expected in the domestic insurance sector as newer players and products enter the market. Given this scenario, ICRA expects its CPRs to be an important input influencing the customers choice of insurance companies and products. ICRAs rating process involves analysis of an insurers business fundamentals and its competitive position and focuses primarily on the insurers franchise value, its management, organizational structure/ownership and underwriting and investment strategies. Besides, the analysis includes an
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S.S. COLLEGE OF BUSINESS STUDIES assessment of an insurance companys profitability, liquidity, operational and financial leverage, capital adequacy and asset / liability management method.
Corporate Governance Rating

ICRAs Corporate Governance Rating(CGR) provides a current opinion on the level to which an organization accepts and agrees to codes and guidelines of corporate governance practices that serve the interests of stakeholders such as shareholders, customers, creditors, bankers, employees, government and society at large. The aspects examined during a CGR exercise include: ownership structure; financial stakeholder relation; financial transparency & information disclosure; and Board structure & process. A CGR , carrying the ICRA stamp, helps the corporate entity concerned in raising funds; listing on stock exchanges; dealings with third parties like creditors; providing comfort to regulators; improving image/credibility; improving its valuation; and bettering its corporate governance practices through benchmarking.
GRADING SERVICES
The grading services of ICRA include ---Grading of Construction Entities ---Grading of Mutual Fund Schemes
Grading of Construction Entities

The unique grading methodology developed by ICRA, along with the Construction Development Industry Council(CIDC) encompasses all the entities in a construction project, the contractor, the consultant, the project owner and the project itself. The service of grading, by providing an independent opinion on the quality of the entity graded , is designed to enhance the lenders confidence in financing construction sector participants.
Grading of Mutual Fund Schemes
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S.S. COLLEGE OF BUSINESS STUDIES ICRAs grading of Mutual Funds seeks to address the perceived need among investors and intermediaries for an informed, reliable and independent opinion on the performance and risks associated with investing in individual Mutual Fund Schemes. Specifically the gradings are opinions on the relative past-performance of Mutual-Fund schemes and the various factors that can influence their future performance. ICRA Mutual Fund Grading services include: Performance Grading Credit Risk Grading Market Risk Grading
ADVISORY SERVICES
RISK MANAGEMENT PRACTICE
The Risk Management Practice advises clients on efficient management of credit risks, market risks, and operational risks. ICRAs clients include commercial banks, financial institutions, multi-lateral agencies, non-banking finance companies, project financiers, equity investors, venture capital firms, insurance firms and manufacturing firms. For manufacturing and service companies, ICRA Advisory offers consultancy in risk management, planning and control. Counterparty risk assessment: ICRA Advisory has developed Counterparty Risk Assessment(CPRA) to assess risks that counterparties are exposed to in the course of buying and selling of goods and services in all kinds of marketplaces. CPRA is a relative measure of counterpartys ability to honour the terms of trade. ICRA Advisory offers CPRA as an on-line plug and play model for emarketplaces/Virtual Private networks, and as an off-line facility for organizations desiring to assess counter party risks of buyers/dealers and suppliers. Credit Risk Regulatory compliance
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S.S. COLLEGE OF BUSINESS STUDIES Processes/systems for credit risk management Internal risk rating systems Credit monitoring systems(including MIS) Moodys software for credit risk management Organization design for risk management Portfolio management Industry and corporate reports Credit risk culture assessment
Market risk Regulatory compliance Asset-liability management Interest rate/liquidity/currency risks Hedging strategies Transfer pricing Software for ALM Integrating ALM with overall planning
Training for Risk management Analyzing financial statements-basic/advanced Credit risk management-middle/senior executives Understanding ALM Customized training for bankers
Operating Risk Diagnostic analysis of risk for a company
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S.S. COLLEGE OF BUSINESS STUDIES Systems for risk measurement Risk mitigation strategies Internal control and corporate governance
REGULATORY PRACTICE
ICRA advisory Services focuses on issues concerned with economic aspects of regulation. Instances of the regulatory practice would be assisting in policy formulation with regard to pricing of public goods, competition, efficient market making mechanisms, consumer protection and fair trade practices , subsidies and public-private partnership structures. Clients of regulatory practice are Governments, regulatory authorities and municipalities who formulate economic and financial policies. ICRA also work with corporate entities in formulating their strategies in dealing with regulatory issues. ICRA advisory Services has worked on several consulting projects concerning regulatory issues in the areas of power, water, public sector, banking and urban infrastructure. Functional Areas Tariff setting for public goods and services Economic development Development of regulations Fiscal management policies Privatization policies Institutional strengthening Determining of subsidies Evaluation of contracts & agreements
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RATING PROCESS
Rating is an interactive process with a prospective approach. It involves series of steps. The main points are described below:
(a)
Rating request: Ratings in India are initiated by a formal request
(or mandate) from the prospective issuer. This mandate spells out the terms of the rating assignment. Important issues that are covered include: binding the credit rating agency to maintain confidentiality, the right to the issuer to accept or not to accept the rating and binds the issuer to provide information required by the credit rating agency for rating and subsequent surveillance.
(b)
Rating team: The team usually comprises two members. The
composition of the team is based on the expertise and skills required for evaluating the business of the issuer. (c )Information requirements: Issuers are provided a list of information requirements and the broad framework for discussions. The requirements are derived from the experience of the issuers business and broadly conform to all the aspects which have a bearing on the rating. (d)Secondary information: The credit rating agency also draws on the secondary sources of information including its own research division. The credit rating agency also has a panel of industry experts who provide data and trends including policies about the industry. (e)Management meetings and plant visits: Rating involves assessment of provide
guidance on specific issues to the rating team. The secondary sources generally
number of qualitative factors with a view to estimate the future earnings of the issuer. This requires intensive interactions with issuers management specifically relating to plans, future outlook, competitive position and funding policies.
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S.S. COLLEGE OF BUSINESS STUDIES Plant visits facilitate understanding of the production process, assess the state of equipment and main facilitates, evaluate the quality of technical personnel and form and opinion on the key variables that influence level, quality and cost of production. These visits also help in assessing the progress of projects under implementations. (f)Preview meeting: After completing the analysis, the findings are discussed at length in the internal committee, comprising senior analysts of the credit rating agency. All the issues having a bearing on the rating are identified. At this stage, an opinion on the rating is also formed. (g)Rating committee meeting: This is the final authority for assigning ratings. A brief presentation about the issuers business and the management is made by the rating team. All the issues identified during discussions in the internal committee are discussed. The rating committee also considers the recommendations of the internal committee for the rating. Finally a rating is assigned and all the issues, which influence the rating, are clearly spelt out. (h)Rating communication: The assigned rating along with the key issues is communicated to the issuers top management for acceptance. The ratings which are not accepted are either rejected or reviewed. The rejected ratings are not disclosed and complete confidentiality is maintained. (i)Rating reviews: If the rating is not accepted to the issuer , he has a right to appeal for a review of the rating. These reviews are usually taken up only if the issuer provides fresh inputs on the issues that were considered for assigning the rating. Issuers response is presented to the Rating Committee. If the inputs are convincing, the Committee can revise the initial rating decision. (j)Surveillance: It is obligatory on the part of the credit rating agency to monitor the accepted ratings over the tenure of the rated instrument. As has been mentioned earlier, the issuer is bound by the mandate letter to provide information to the credit rating agency. The ratings are generally reviewed every year, unless the circumstances of the case warrant an early review. In a
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S.S. COLLEGE OF BUSINESS STUDIES surveillance review the initial rating could be retained or revised(upgrade or downgrade) . The various factors that are evaluated in assigning the ratings have been explained under rating framework.
ICRAs Rating Process

An Overview
Mandate
Initial Stage
Assign Rating Team
Receive initial information Conduct basic research
Fact findings and analysis

Meetings and visits Analysis and Preparation of Report
Purview Meeting
Rating Finalisation
Rating Meeting
Fresh inputs/Clarifications
Assign Rating
Communicate the rating and rationale
Request for Review
Acceptance
Non Acceptance
Surveillance
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RATING FRAMEWORK
The basic objective of rating is to provide an opinion on the relative credit risk (or default risk) associated with the instrument being rated. This in a nutshell includes, estimating the cash generation capacity of the issuer through operations (primary cash flows) vis--vis its requirements for servicing obligations over the tenure of the instrument. Additionally , an assessment is also made of the available marketable securities(secondary cash flows) which can be liquidated if require d, to supplement the primary cash flow may be noted that secondary cash flows have a greater bearing in the short term ratings , while the long term ratings are generally entirely based on the adequacy of primary cash flows. All the factors whish have a bearing on future cash generation and claims that require servicing are considered to assign ratings. These factors can be conceptually classified into business risk and financial risk drivers. Business risk drivers Industry characteristic Market position Operational efficiency New projects Management quality
Financial risk drivers Funding policies Financial flexibility
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S.S. COLLEGE OF BUSINESS STUDIES Industry characteristics: This is the most important factor in credit risk assessment. It is a key determinant of the level and volatility in earnings of any business. Other factors remaining the same , industry risk determines the cap for ratings. Some of the factors that are analyzed include: Demand factors Drivers & potential Nature of product Nature of demand-seasonal, cyclical Bargaining position of customers
State of competition Existing & expected capacities Intensity of competition Entry barriers for new entrants Exit barriers Threat of substitutes
Environmental factors Role of the industry in the economy Extent of government regulation Government policies-current and future direction
Bargaining position of suppliers Availability of raw material
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S.S. COLLEGE OF BUSINESS STUDIES Dependence on a particular supplier Threat of forward integration Switching costs
For credit risk evaluation , stable businesses(low industry risk) with lower level of cash generation are viewed more favorably compared to business with higher cash generation potential but relatively higher degree of volatility. It needs to be mentioned that with the opening up of the Indian economy, it is also critical to establish international competitiveness both at the industry and unit level. Market position : All the factors influencing the relative competitive position of the issuer are examined in detail. Some of these factors include positioning of the products , perceived quality of products or brand equity, proximity to the markets, distribution network and relationship with the customers. In markets where competiveness is largely determined by costs, the market position is determined by the units operational efficiency. The result of these factors is reflected in the ability of the issuer to maintain/ improve its market share and command differential in pricing. It may be mentioned that the issuers whose market share is declining, generally do not get favourable long term ratings. Operational efficiency : In a competitive market , it is critical for any business unit to control its costs at all levels. This assumes greater importance in commodity or me too businesses, where low cost producers almost always have an edge. Cost of production to a large extent is influenced by: Location of the production units Access to raw materials Scale of operations Quality of technology Level of integration
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S.S. COLLEGE OF BUSINESS STUDIES Experience Ability of the unit to efficiently use of its resources
A comparison with the peers is done to determine the relative efficiency of the unit. Some of the indicators for measuring production efficiency are:- resource productivity, material usage and energy consumption. Collection efficiency and inventory levels are important indicators of both the market position and operational efficiency. New project risks : The scale and nature of new projects can significantly
influence the risk profile of any issuer. Unrelated diversifications into new products are invariably assessed in greater detail. The main risks from new projects are:-Time and cost overruns, even non-
completion in an extreme case, during construction phase; financing tie-up; operational risks; and market risk. Besides clearly establishing the rationale of new projects, the protective factors that are assessed include: track record of the management in project implementation, experience and quality of the project implementation team, experience and track record of technology supplier, implementation schedule, status of the project, project cost comparisons, financing arrangements, tie-up of raw material sources , composition of operations team and market outlook and plans. Management quality : The importance of this factor can not be overemphasized. When the business conditions are adverse , it is the strength of management that provides resilience. A detailed discussion is held with the management to understand its objectives, plans & strategies, competitive position and views about the past performance and future outlook of the business. These discussions provide insights into the quality of the management. It also helps in establishing managements priorities. A review of the organization
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S.S. COLLEGE OF BUSINESS STUDIES structure and information system is done to assess whether it aligns with the managements plans and priorities. The interactions with key operating personnel help in determining the quality of the management. Issues like dependence on a particular individual and succession planning are also addressed. Funding policies :This determines the level of financial risk. Managements views on its funding policies are discussed in detail. These discussions are generally focused on the following issues: Future funding requirements Level of leveraging Views on retaining shareholding control Target returns for shareholders Views on interest rates Currency exposures including policies to control the currency risk Asset-liability tenure matching
Financial flexibility : While the primary source for servicing obligations is the cash generated from operations, an assessment is also made of the ability of the issuer to draw on other sources, both internal(secondary cash flows) and external, during periods of stress. These sources include: availability of liquid investments, unutilized lines of credit, financial strength of group companies, market reputation, relationship funds from different sources. Past financial performance : The impact of the various drivers is reflected in the actual performance of the issuer. Thus , while the focus of rating exercise is to determine the future cash flow adequacy for servicing debt obligations, a detailed review of the past financial statements is critical for better understanding of the influence of all the business and financial risk factors. with financial institutions and banks, investors perceptions and experience of tapping
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S.S. COLLEGE OF BUSINESS STUDIES Evaluation of the existing financial position is also important for determining the sources of secondary cash flows and claims that may have to be serviced in future. Accounting quality : Consistent and fair accounting policies are a pre-requisite for financial evaluation and peer group comparisons. It may be mentioned that accounting quality is also an important indicator of the management quality. Rating analysts review the accounting policies, notes to accounts and auditors comments in detail. Wherever necessary, rating analysts adjust the financial statements to reflect the correct position. Over a period of time the focus of financial analysis at the credit rating agency has shifted towards evaluation of cash flow statements as cash flows to a large extent offset the impact of financial engineering. Indicators of financial performance: Financial indicators over the last few years are analyzed and performance of the issuer is compared with its peers. Comparison with peers is important for better understanding of the industry trends and determining the relative position of the issuer. Some of the important indicators that are analyzed are presented below: Profitability : A traditional indicator of success or failure of any business endeavor has been its ability to add to its wealth or generate profits. A few important indicators are trends in: Return on capital employed Return on net worth Gross operating margins
Higher profitability implies greater cushion to debt holders. Profitability also determines the market perception which has a bearing on the support of share holders and other lenders. This support can be an important factor during stress. Gearing or level of leveraging : This is an important determinant of the financial risk. Some important indicators are:
Total debt as a % of net worth
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Long term debt as a % of net worth Total outside liabilities as a% of total assets
It needs to be emphasized that business risk is a prime driver, while gearing has a secondary role in determining the overall rating. Coverage ratios : Considered to be of primary importance to the debt holders. The important ratios are: Interest coverage ratio(OPBIT/Interest) Debt service coverage ratio Net cash accruals as a % of total debt
The level of these ratios reflects the result of business risk drivers and the funding policies. Generally speaking, higher the level of coverage, higher is the rating. However as mentioned earlier , business with lower level of coverage can get higher ratings if the earnings are steady. Liquidity position : The indicators of liquidity positions are , the levels of: Inventory Receivables Payables
The state of competition , issuers market position & policies , relationship with customers and suppliers arte the important factors that impact the above levels. Comparison with peers on these indicators helps to determine the relative position of the issuer in the industry. The funding profile with respect to matching of asset liability tenures also has an important bearing on the liquidity position. Cash flow analysis : Cash is required to service obligations. Thus, any financial evaluation would be incomplete if cash flow analysis is not carried out. Cash flows reflect the sources from which cash is generated and it is deployed.
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S.S. COLLEGE OF BUSINESS STUDIES Cash flows offset the impact of diverse accounting policies and hence facilitate peer comparison. Future cash flow adequacy : The ultimate objective of the rating is to determine the adequacy of cash generation to service obligations. Number of assumptions based on the future outlook of the business is made to draw projections of financial statements. Invariably, the financial projections are carried out for a number of scenarios incorporating a range of possibilities in the set of assumptions for the key cash flow drivers. A few important drivers are expectations of growth , selling prices, input costs, working capital requirements, value of currencies.
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Rating Scale by ICRA Long-Term including Debentures LAAA : Highest safety. Indicates fundamentally strong
position. Risk factors are negligible. There may be circumstances adversely affecting the degree of safety but such circumstances, as may be visualized are not likely to affect the timely payment of principal and interest as per terms. LAA+ LAA LAA LA+ LA LAHigh safety. Risk factors are modest and may vary slightly. the protective factors are strong and the prospect of timely Payment of principal and interest as per terms under adverse circumstances, as may be visualized, differs from LAAA only marginally. Adequate safety. Risk factors are more variable and greater in periods of economic stress. The protective factors are average and any adverse change in circumstances, as may be visualized, may alter the fundamental strength and affect the timely payment of principal and interest as per terms LBBB+ LBBB LBBBLBB+ LBB : Moderate safety. Considerable variability in risk factors. The protective factors are below average. Adverse changes in business /economic circumstances are likely to affect the timely payment of principal and interest as per terms Inadequate safety. The timely payment of interest and principal is more likely to be affected by present or prospective changes in business/economic
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S.S. COLLEGE OF BUSINESS STUDIES LBBcircumstances. The protective factors fluctuate in case of changes in economy/business conditions. LB+ LB LBLC+ LC LCLD : : : Risk-prone. Risk factors indicate that obligations may not be met when due. The protective Factors are narrow. Adverse changes in business/ economic conditions could result in inability/unwillingness to service debts on time as per terms. Substantial risk. There are inherent elements of risk and timely servicing of debts/obligations could be possible only in case of continued existence of favourable Circumstances. Default. Extremely speculative. Either already in default in Payment of interest and/or principal as per terms or expected to default. Recovery is likely only on liquidation or re-organisation.
Medium-Term including Fixed Deposit Programmes MAAA : Highest Safety. The prospect of timely servicing of the Interest and principal as per terms is the best. MAA+ MAA MAAMA+ MA MAMB+ : : Adequate safety. The prospect of timely servicing of the interest and principal as per terms is adequate. However, debt servicing may be affected by adverse changes in the business/economic conditions. Inadequate safety. The timely payment of interest : High safety. The prospect of timely servicing of the interest and principal as per terms is high, but not as high as in MAAA rating.
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S.S. COLLEGE OF BUSINESS STUDIES MB MBMC+ MC MCMD : : and principal is more likely to be affected by future uncertainties. Risk prone. Susceptibility to default is high. Adverse changes in business/economic conditions could result in inability/unwillingness to service debts on time and as per terms. Default. Either already in default or expected to default.
Short-Term Commercial Paper A1+ A1 A2+ A2 A3+ A3 : : : Highest safety. The prospect of timely payment of debt/ obligation is the best. High safety. The relative safety is marginally lower than in A1 rating. Adequate safety. The prospect of timely payment of interest and installment is adequate, but any adverse change in business/economic conditions may affect the fundamental strength. A4+ A4 A5 : : Risk prone. The degree of safety is low . likely to default in case of adverse changes in business/economic conditions. Default. Either already in default or expected to default.
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RATING OF STRUCTURED OBLIGATION

Structured Obligation (SO) or Structured Finance is a term that is applied to a wider variety of debt instruments wherein the repayment of principal and interest is backed by: Cash flows from sense Credit enhancement from a third party.
financial assets and/or
The process of converting financial assets (loans, receivables, etc.) into tradable securities is generally referred to as securitization and the securities thus created are referred to as asset backed securities(AIS). A cash flow structure is the one in which some or all of the cash flows generated by the identified assets are dedicated for the payment of principal and interest. The cash flows to the investors are secured primarily by cash flows from the specific pool of assets. Credit Enhancement is a form of protection against collateral losses. Examples include-letter of credit, guarantee, cash reserve account, over collateralization, etc. A structured obligation can be considered as variation of conventional secured debt instrument wherein the credit quality of debt obligation is backed by a lien on identified assets or credit support from third party. In conventional debt instruments the income/profits made by the company remain the primary source of debt servicing. However, in the case of structured obligations, a repayment mechanism is devised in such a way that the debt servicing is taken over by a specific pool of assets or by a third party which acts as a credit support provider. Advantages of securitisation The main advantages of securitisation for companies holding financial assets are listed below: (a) Increased Liquidity: relatively illiquid assets are converted into tradable securities.
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S.S. COLLEGE OF BUSINESS STUDIES (b) Risk Diversification: securitisation allows the issuer to manage its credit exposure to a particular borrower/sectors and thus helps in risk diversification of asset portfolios.
(c)
Higher Credit Quality: the structure of the instrument can be tailored in such a manner that a desired credit rating, which is higher than company holding the assets is achieved. the rating of
(d) Asset Liability Management: securitisation offers an efficient way of tenure matching of assets and liabilities. (e) Funding Sources: securitisation allows the issuer to find alternate sources of funding and also raise funds at low costs with improved credit rating.
CASH FLOW STRUCTURE
Borrower of assets
loan repayments Transfer of assets
Company holding financial assets LENDER

Payment for assets
Servicer repayments
loan
Issuer Spl Purpose Vehicle

Principal & Interest payments Payment for Securities
Credit Support
Issues Securities
Investors
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S.S. COLLEGE OF BUSINESS STUDIES The Steps in Securitisation Transaction Step1: Origination-Lender (Banks, NBFCs, etc.) makes a loan to a borrower for purchase of an asset(car, property, etc.) Step2: Pooling-Large number of homogenous loans are aggregated or packaged into a pool. The maturities and interest rates of pooled loans generally the same. Step3: Sales/Transfer Sale (or transfer ) of assets from originator to an entity that is generically referred to as a Special Purpose Vehicle or SPV. An SPV may be a trust, a special purpose bankruptcy remote company or a public sector entity. Step4: Credit Enhancement-Protection against the failure of borrower to make interest and principal payments on the loans. Examples include letter of credit, financial guarantee from a third party, cash collateral or over-collateralisation. Step5: Issue of ABS SPV issues securities to investors and the proceeds from the issuance are used to pay the originator for the pool of loans. Some Conditions for Securitisation A structured obligation is highly beneficial for issuers who are in a position to structure appropriate levels of credit protection so that they achieve the desired credit rating. The conditions under which a securitisation transaction is highly suited for issuers are: the availability of clearly identifiable and homogenous pool of assets; relatively predictable stream of cash flows from the identified assets; a positive interest rate spread which is defined as the difference between interest earned on the assets and the interest plus servicing costs of security; the presence of full credit support in the structure. are
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Rating Methodology
Credit ratings plays a very important role in the issuance of structured debt instruments. The structure of the instruments is generally quite complex which makes the task of assigning the credit risk extremely difficult for lay investors. Credit ratings provide a simple and objective assessment of default risk in the form of a symbolic indicator which is easy to comprehend. The framework used for assessing the risk of default involves assessment of three types of risk-credit risk, structured risk and legal risk.
a)
Credit Risk: It is the risk of default by the borrower. It refers to the uncertainty regarding the extent to which the borrowers of underlying assets backing the security will pay as per terms of contract. The factors considered in assessment of credit risk are: credit risk characteristics of the underlying pool of assets; key factors that influence the incentive and ability of borrowing to pay off their loans; pool selection process; future performance of the selected pool;
b)
Structured Risk: It refers to the manner in which the transaction is structured to direct the payment stream from the collateral or support provides to the investors. Assessment of structural risk includes the following factors:
analysis of credit support provider; evaluation of the size of enhancement and the change in size over time, trigger events;
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S.S. COLLEGE OF BUSINESS STUDIES analysis of liquidity facilitates in structures wherein cash inflows do not match the payments to the investors;
third party risk which is the risk of non-performance of the various parties such as receiving and paying agent, trustees, etc who are involved in the transaction;
c)
Legal Risk: It refers to the risk of potential insolvency of the issuer or other parties involved in securitisation transaction. Assessment of legal risk includes: Evaluation of the manner in which the rights of the assets are transferred to investors. Legal enforceability of cash flows structure under various Scenarios Compliance with various laws and regulations
Thus credit rating of a structured obligation is a forward-looking measure of relative safety level of the structural transaction against credit loss that may occur over the life of the instrument.
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RATING INADEQUACIES
Rating agencies by making information widely available at a low cost have increased market efficiency radically over the last few decades. However, in the credit rating business, unlike any other business, the issuers of information do not pay for it. It is so because though investors, financial intermediaries and other end users use the results of the rating agencies, they actually do not pay for it. The issuer of the financial instruments whose information is disclosed by the rating agency actually pays it . this is the basic source of revenue of the rating agencies. This aspect makes the rating business a different animal. The potential for conflict of interest facing rating agencies is thus inherent. Diversification: Traditionally, the agencies used to gather and analyse all sorts of pertinent financial and non-financial information. Then they used to utilize it to provide a rating of the intrinsic value or quality of a security. This was considered as a convenient way for investors to judge quality and make investment decisions. However, they were not the only source of information. Market based ratings provided by market analysts outside the purview of the rating agencies, also performed about as well as the agency ratings. This eventually posed challenges to the rating agencies and emerged as a potential threat. Rating agencies sell information and survive, based on their ability to accumulate and retain reputation capital. However , once regulation is passed that makes it mandatory for a company to incorporate ratings, rating agencies begin to sell not only information but also valuable property rights associated with compliance of regulation. This again accentuates the possibility of the rating agencies to exploit the regulation. Though the rating agencies will never force any company to buy their information, the companies will always try to oblige the rating agencies by buying them. As the sale of these products generates revenues the rating agencies will not be willing to lose them. There lies the potential conflict of interest. If the companies buy the services of the
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S.S. COLLEGE OF BUSINESS STUDIES rating agencies , irrespective of the quality aspect, then the reward they expect is definitely a better rating. Both CRISIL, ICRA have diversified into the consultancy business, after perceiving the potential threat and partly foreseeing the saturation of the market for new rating business. Presently both the rating giants provide a well diversified portfolio of risk-consultancy services. Over the past two decades. The risk consultancy services of Moodys has become a leading provider to investors, financial analysts and other end-users in managing the risk in portfolios of credit exposures to both private and public companies. It allows credit risk professionals to employ Moodys ratings and credit history experience to better measure and manage credit risk, to price credit risk, to identify industry and geographic concentrations , and to measure the impact of the prospective purchases or sale of debt within a portfolio context. The international practice is being replicated in India on an increasing basis by ICRA and CRISIL given the fact that Moodys and S&P hold stakes in each of them respectively. In the aftermath of the Enron debacle , allegations have been raised against the rating agencies for not being prompt in identifying the Enron debacle. It has been opined by various people that had the rating agencies been quick in envisaging the companys bankruptcy, many investors would have saved themselves from burning their hands. Holier than thou approach The rating agencies defending themselves, say that their job is to portray the true picture of the riskiness associated with a bond and its likelihood of default in the long run. The possibility of the rating agencies being jittery of revealing shoddy financial statements hiding actual transaction cannot be ruled out. With Enron , it is possible that they thought it better to think twice before having the courage to say that the emperor is not wearing any clothes. And that took time to downgrade the company.
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CONCLUSION
Credit Rating in India is a concept with not too long a history. Given its significance as an information provider and facilitator for the efficient allocation of resources by the financial market, credit rating services will continue to occupy a place of significance in our growing economy. The success of the system will ultimately hinge on the presentation of credibility and integrity by the concerned agencies. The rating agencies faces a lot of challenges specially after the Enron debacle. Allegations have already been raised against the rating agencies for not doing their job. As the credit rating agencies have to maintain their own reputation for their survival, it becomes imperative to them to remain extremely alert to the developments both in the market and within companies. Mr. Clifford Griep, Chief Credit Officer, S&P says Many changes are underway, including publishing commentary more frequently so that the markets hear from us after routine events such as earning calls and management changes. According to him , the forward looking commentary will enable the investor to identify credit cliff situations and the change in the credit worthiness of companies over a period of time. The fast changing economic scenario, increased global competition, high volatility among investment grade credits and securities price behavior has fueled the demand for a more complete and rigorous surveillance and commentary from rating agencies. However , the flipside of prompt down(or up) gradation by the rating agencies henceforth , will increase the volatility in the stock prices, to a grate extent. It may also lead to a loss of long-term focus of credit rating.
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S.S. COLLEGE OF BUSINESS STUDIES Another issue that asks for introspection is how the credit rating agencies account for off-balance sheet deals and the degree of financial disclosure of the company they rate. The rating agencies must put more focus on the information related to the offbalance sheet transactions. Clearly, lesser the transparency in financial disclosure, more is the possibility of surprises to investors. The rating agencies should more promptly identify companies trying to suppress financial information.
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BIBLIOGRAPHY
1. Verma J.C/ Credit Rating(Practice & Procedure), New Delhi, Bharat Publishing House. 2. SEBI Manual, Taxmann 3. Credit Rating, ICRA , 4. Risky Conflicts, Chartered Financial Analyst, 5. Rating-Knotty issues, Chartered Financial Analyst, 6. www. icraindia.com 7. www.crisil.com 8. www.businessstandard.com
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PREFACE
This study was undertaken to understand the functioning of credit rating agencies, their role and impact in the capital market in India. Credit Rating agencies , worldwide has evolved over the years. It was started by rating the ability of merchants to pay their financial obligations and that of Railroad Securities. Nowadays the items that are rated include debt, instruments issued by manufacturing companies, commercial banks, NBFCs, FIs, PSUs and municipalities; structured obligation; Corporate Governance; Claim paying ability of Insurance Companies; Construction Entities; Real Estate Developers & Projects; and Mutual Fund Schemes. Credit Rating is a boon for the common investors in terms of information which are not always accessible to them and also for the issuers as it helps them to build a credibility and helps them to raise funds from the market at a cheaper rate.
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CONTENTS
Introduction --Objective --Historical Origin --Concept of Credit Rating --Use --SEBI Regulations Methodology Credit Rating Agencies in India ICRA -Range of services Rating Process Rating Framework Rating of Structured obligations Rating Inadequacies Conclusion Annexure Bibliography
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ANNEXURE
Source: Internet Credit Ratings and Analysis A credit rating is an assessment by a third party of the creditworthiness of an issuer of financial securities. It tells investors the likelihood of default, or nonpayment, by the issuer of its financial obligations.
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What is credit rating??? How is it generally done? A credit rating assesses the credit worthiness of an individual, corporation, or even a country. Credit ratings are calculated from financial history and current assets and liabilities. Typically, a credit rating tells a lender or investor the probability of the subject being able to pay back a loan. However, in recent years, credit ratings have also been used to adjust insurance premiums, determine employment eligibility, and establish the amount of a utility or leasing deposit. A poor credit rating indicates a high risk of defaulting on a loan, and thus leads to high interest rates, or the refusal of a loan by the creditor. Personal credit ratings In countries such as the United States, an individual's credit history is compiled and maintained by companies called credit bureaus. In the United States, credit worthiness is usually determined through a statistical analysis of the available credit data. A common form of this analysis is a 3-digit credit score provided by independent financial service companies such as the FICO credit score. (The term, a registered trademark, comes from Fair Isaac Corporation, which pioneered the credit rating concept in the late 1950s.) An individual's credit score, along with his or her credit report, affects his or her ability to borrow money through financial institutions such as banks. In Canada, the most common ratings are the North American Standard Account Ratings, also known as the "R" ratings, which have a range between R0 and R9. R0 refers to a new account; R1 refers to on-time payments; R9 refers to bad debt. The factors which may influence a person's credit rating are: * ability to pay a loan * interest * amount of credit used * saving patterns Corporate credit rating or
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S.S. COLLEGE OF BUSINESS STUDIES Bond credit rating The credit rating of a corporation is a financial indicator to potential investors of debt securities such as bonds. These are assigned by credit rating agencies such as Standard & Poor's or Fitch Ratings and have letter designations such as AAA, B, CC. Credit rating is done by a credit rating agency..check out info about that also A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations. In most cases, these issuers are companies, cities, non-profit organizations, or national governments issuing debt-like securities that can be traded on a secondary market. A credit rating measures credit worthiness, the ability to pay back a loan, and affects the interest rate applied to loans. (A company that issues credit scores for individual credit-worthiness is generally called a credit bureau or consumer credit reporting agency.) Interest rates are not the same for everyone, but instead are based on risk-based pricing, a form of price discrimination based on the different expected costs of different borrowers, as set out in their credit rating. There exist more than 100 rating agencies worldwide. Credit rating agencies for corporations * A. M. Best (U.S.) * Baycorp Advantage (Australia) * Dominion Bond Rating Service (Canada) * Fitch Ratings (U.S.) * Moody's (U.S.) * Standard & Poor's (U.S.) * Pacific Credit Rating (Peru) Uses of ratings by credit rating agencies Credit ratings are used by investors, issuers, investment banks, broker-dealers, and by governments. For investors, credit rating agencies increase the range of investment alternatives and provide independent, easy-to-use measurements of relative credit risk; this generally increases the efficiency of the market, lowering costs for both borrowers and lenders. This in turn increases the total supply of risk capital in the economy, leading to stronger growth. It also opens the capital markets to categories of borrower who might otherwise be shut out altogether: small governments, startup companies, hospitals and universities. Ratings use by bond issuers Issuers rely on credit ratings as an independent verification of their own creditworthiness. In most cases, a significant bond issuance must have at least one rating from a respected CRA for the issuance to be successful (without such a rating, the issuance may be undersubscribed or the price offered by investors too low for the issuer's purposes). Recent studies by the Bond Market Association note that many
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S.S. COLLEGE OF BUSINESS STUDIES institutional investors now prefer that a debt issuance have at least three ratings. Issuers also use credit ratings in certain structured finance transactions. For example, a company with a very high credit rating wishing to undertake a particularly risky research project could create a legally separate entity with certain assets that would own and conduct the research work. This "special purpose entity" would then assume all of the research risk and issue its own debt securities to finance the research. The SPE's credit rating likely would be very low and the issuer would have to pay a high rate of return on the bonds issued. However, this risk would not lower the parent company's overall credit rating because the SPE would be a legally separate entity. Conversely, a company with a low credit rating might be able to borrow on better terms if it were to form an SPE and transfer significant assets to that subsidiary and issue secured debt securities. That way, if the venture were to fail, the lenders would have recourse to the assets owned by the SPE. This would lower the interest rate the SPE would need to pay as part of the debt offering. The same issuer also may have different credit ratings for different bonds. This difference results from the bond's structure, how it is secured, and the degree to which the bond is subordinated to other debt. Many larger CRAs offer "credit rating advisory services" that essentially advise an issuer on how to structure its bond offerings and SPEs so as to achieve a given credit rating for a certain debt tranche. This creates a potential conflict of interest, of course, as the CRA may feel obligated to provide the issuer with that given rating if the issuer followed its advice on structuring the offering. Some CRAs avoid this conflict by refusing to rate debt offerings for which its advisory services were sought. Ratings use by investment banks and broker-dealers Investment banks and broker-dealers also use credit ratings in calculating their own risk portfolios (i.e., the collective risk of all of their investments). Larger banks and broker-dealers conduct their own risk calculations, but rely on CRA ratings as a "check" (and double-check or triple-check) against their own analyses. Ratings use by government regulators Regulators use credit ratings as well, or permit these ratings to be used for regulatory purposes. For example, under the Basel II agreement of the Basel Committee on Banking Supervision, banking regulators can allow banks to use credit ratings from certain approved CRAs (called "ECAIs" or "External Credit Assessment Institutions") when calculating their net capital reserve requirements. In the United States, the Securities and Exchange Commission (SEC) permits investment banks and broker-dealers to use credit ratings from "Nationally Recognized Statistical Rating Organizations" (or "NRSROs") for similar purposes. The idea is that banks and other financial institutions should not need to keep in reserve the same amount of capital to protect the institution against (for example) a run on the bank, if the financial institution is heavily invested in highly liquid and very "safe" securities (such as U.S. government bonds or short-term commercial paper from very stable companies).
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CRA ratings are also used for other regulatory purposes as well. The U.S. SEC, for example, permits certain bond issuers to use a shorten prospectus form when issuing bonds if the issuer is older, has issued bonds before, and has a credit rating above a certain level. SEC regulations also require that money market funds (mutual funds that mimic the safety and liquidity of a bank savings deposit, but without FDIC insurance) comprise only securities with a very high rating from an NRSRO. Likewise, insurance regulators use credit ratings to ascertain the strength of the reserves held by insurance companies.
_________________________________________________________ What Is A Corporate Credit Rating?

by Reem Heakal Before you decide whether to invest into a debt security from a company or foreign country, you must determine whether the prospective entity will be able to meet its obligations. A ratings company can help you do this. Providing independent objective assessments of the credit worthiness of companies and countries, a credit ratings company helps investors decide how risky it is to invest money in a certain country and/or security. Credit in the Investment World As investment opportunities become more global and diverse, it is difficult to decide not only which companies but also which countries are good investment opportunities. There are advantages to investing in foreign markets, but the risks associated with sending money abroad are considerably higher than those associated with investing in your own domestic market. It is important to gain insight into different investment environments but also to understand the risks and advantages these environments pose. Measuring the ability and willingness of an entity - which could be a person, a corporation, a security or a country - to keep its financial commitments or its debt, credit ratings are essential tools for helping you make some investment decisions. The Raters There are three top agencies that deal in credit ratings for the investment world. These are: Moody's, Standard and Poor's (S&P's) and Fitch IBCA. Each of these agencies aim to provide a rating system to help investors determine the risk associated with investing in a specific company, investing instrument or market. Ratings can be assigned to short-term and long-term debt obligations as well as securities, loans, preferred stock and insurance companies. Long-term credit ratings tend to be more indicative of a country's investment surroundings and/or a company's ability to honor its debt responsibilities. For a government or company it is sometimes easier to pay back local-currency obligations than it is to pay foreign-currency obligations. The ratings therefore assess an entity's ability to pay debts in both foreign and local currencies. A lack of foreign reserves, for example, may warrant a lower rating for those obligations a country made in foreign currency. It is important to note that ratings are not equal to or the same as buy, sell or hold
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recommendations. Ratings are rather a measure of an entity's ability and willingness to repay debt. The Ratings Are In The ratings lie on a spectrum ranging between highest credit quality on one end and default or "junk" on the other. Longterm credit ratings are denoted with a letter: a triple A (AAA) is the highest credit quality, and C or D (depending on the agency issuing the rating) is the lowest or junk quality. Within this spectrum there are different degrees of each rating, which are, depending on the agency, sometimes denoted by a plus or negative sign or a number. Thus, for Fitch IBCA, a "AAA" rating signifies the highest investment grade and means that there is very low credit risk. "AA" represents very high credit quality; "A" means high credit quality, and "BBB" is good credit quality. These ratings are considered to be investment grade, which means that the security or the entity being rated carries a level of quality that many institutions require when considering overseas investments. Ratings that fall under "BBB" are considered to be speculative or junk. Thus for Moody's a Ba2 would be a speculative grade rating while for S&P's, a "D" denotes default of junk bond status. Here is a chart that gives an overview of the different ratings symbols that Moody's and Standard and Poor's issue: Bond Rating Grade Risk Moody's Standard & Poor's Aaa AAA Investment Lowest Risk Aa AA Investment Low Risk A A Investment Low Risk Baa BBB Investment Medium Risk Ba, B BB, B Junk High Risk Caa/Ca/C CCC/CC/C Junk Highest Risk C D Junk In Default Sovereign Credit Ratings As previously mentioned, a rating can refer to an entity's specific financial obligation or to its general creditworthiness. A sovereign credit rating provides the latter as it signifies a country's overall ability to provide a secure investment environment. This rating reflects factors such as a country's economic status, transparency in the capital market, levels of public and private investment flows, foreign direct investment, foreign currency reserves, political stability, or the ability for a country's economy to remain stable despite political change. Because it is the doorway into a country's investment atmosphere, the sovereign rating is the first thing most institutional investors will look at when making a decision to invest money abroad. This rating gives the investor an immediate understanding of the level of risk associated with investing in the country. A country with a sovereign rating will therefore get more attention than one without. So to attract foreign money, most countries will strive to obtain a sovereign rating and they will strive even more so to reach investment grade. In most circumstances, a country's sovereign credit rating will be its upper limit of credit ratings.
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Conclusion A credit rating is a useful tool not only for the investor, but also for the entities looking for investors. An investment grade rating can put a security, company or country on the global radar, attracting foreign money and boosting a nation's economy. Indeed, for emerging market economies, the credit rating is key to showing their worthiness of money from foreign investors. And because the credit rating acts to facilitate investments, many countries and companies will strive to maintain and improve their ratings, hence ensuring a stable political environment and a more transparent capital market. by Reem Heakal
Some FAQs about Credit Rating

What is credit rating? Credit rating is, essentially, the opinion of the rating agency on the relative ability and willingness of the issuer of a debt instrument to meet the debt service obligations as and when they arise. Why do rating agencies use symbols like AAA, AA, rather than give marks or descriptive credit opinion? The great advantage of rating symbols is their simplicity, which facilitates universal understanding. Rating companies also publish explanations for their symbols used as well as the rationale for the ratings assigned by them, to facilitate deeper understanding. Why is credit rating necessary at all? Credit rating is an opinion expressed by an independent professional organisation, after making a detailed study of all relevant factors. Such an opinion will be of great assistance to investors in making investment decisions. It also helps the issuers of debt instruments to price their issues correctly and to reach out to new investors. Regulators like Reserve Bank of India (RBI) and Securities & Exchange Board of India (SEBI) often use credit rating to determine eligibility criteria for some instruments. For example, the RBI has stipulated a minimum credit rating by an approved agency for issue of Commercial Paper. In general, credit rating is expected to improve quality consciousness in the market and establish, over a period of time, a more meaningful relationship between the quality of debt and the yield from it. Credit Rating is also a valuable input in establishing business relationships of various types. Does credit rating constitute an advice to the investors to buy? It does not. The reason is that some factors, which are of significance to an investor in arriving at an investment decision, are not taken into account by rating agencies. These include reasonableness of the issue price or the coupon rate, secondary market liquidity and pre-payment risk. Further, different investors have different views regarding the level of risk to be taken and rating agencies can only express their views on the relative credit risk.
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What kind of responsibility or accountability will attach to a rating agency if an investor, who makes his investment decision on the basis of its rating, incurs a loss on the investment? A credit rating is a professional opinion given after studying all available information at a particular point of time. Nevertheless, such opinions may prove wrong in the context of subsequent events. Further, there is no privity of contract between an investor and a rating agency and the investor is free to accept or reject the opinion of the agency. Nevertheless, rating is essentially an investor service and a rating agency is expected to maintain the highest possible level of analytical competence and integrity. In the long run, the credibility of a rating agency has to be built, brick by brick, on the quality of its services. Do rating companies undertake unsolicited ratings? Not in India, at least not yet. There is however, a good case for undertaking unsolicited ratings. It will be relevant to mention here that any rating based entirely on published information has serious limitations and the success of a rating agency will depend, to a great extent, on its ability to access privileged information. Co-operation from the issuers as well as their willingness to share even confidential information are important prerequisites. On its part, the rating agency has a great responsibility to ensure confidentiality of the sensitive information that comes into its possession during the rating process. How reliable and consistent is the rating process? How do rating agencies eliminate the subjective element in rating? To answer the second question first, it is neither possible nor even desirable, to totally eliminate the subjective element. Rating does not come out of a pre-determined mathematical formula, which fixes the relevant variables as well as the weights attached to each one of them. Rating agencies do a great amount of number crunching, but the final outcome also takes into account factors like quality of management, corporate strategy, economic outlook and international environment. To ensure consistency and reliability, a number of qualified professionals are involved in the rating process. The Rating Committee, which assigns the final rating, consists of professionals with impeccable credentials. Rating agencies also ensure that the rating process is insulated from any possible conflicts of interest. Is it customary to have the same issue rated by more than one rating agency? Do the ratings for the same instrument vary from agency to agency? The answer to both the questions is yes. In the well-developed capital markets, debt issues are, more often than not, rated by more than one agency. And, it is only natural that the opinions given by two or more agencies will vary, in some cases. But it will be very unusual if such differences are very wide. For example, a debt issue may be rated DOUBLE A PLUS by one agency and DOUBLE A or DOUBLE A MINUS by another. It will indeed be unusual if one agency assigns a rating of DOUBLE A while another gives a TRIPLE B. Why do rating agencies monitor the issues already rated? A rating is an opinion given on the basis of information available at a particular point of time. As time goes by, many things change, affecting the debt servicing capabilities of the issuer, one way or the other. It is, therefore, essential that as a part of their investor service, rating agencies monitor all outstanding debt issues rated by them. In the context of emerging developments, the rating agencies often put issues under credit watch and upgrade or downgrade the ratings as and when necessary. Normally, such action is taken after intensive interaction with the issuers.
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Do issuers have a right of appeal against a rating assigned? Yes. In a situation where an issuer is unhappy with the rating assigned, he may request for a review, furnishing additional information, if any, considered relevant. The rating agency will, then, undertake a review and thereafter indicate its final decision. Unless the rating agency had overlooked critical information at the first stage, (which is unlikely), chances of the rating being changed on appeal are rare. How much time does rating take? The rating process is a fairly detailed exercise. It involves, among other things, analysis of published financial information, visits to the issuers office and works, intensive discussion with the senior executives of issuer, discussions with auditors, bankers, etc. It also involves an in-depth study of the industry itself and a degree of environment scanning. All this takes time and a rating agency may take three to four weeks or more to arrive at a decision, subject to availability of all the solicited information. It is of paramount importance to rating companies to ensure that they do not, in any way, compromise on the quality of their analysis, under pressure from issuers for quick results. Issuers would also be well advised to approach the rating agencies sufficiently in advance so that issue schedules can be adhered to. Is it possible that not satisfied with the rating assigned by one rating agency, an issuer approaches another, in the hope of getting a better result? It is possible, but rating companies do not and should not indulge in competitive generosity. Any attempt by issuers to play one agency against another will have to be discouraged by all the rating companies. It may, however, be pointed out here that two rating companies may, and often do, arrive at different conclusions on the same issue. This is only natural, as perceptions differ. Who rates the rating companies? Informed public opinion will be the touchstone on which the rating companies have to be assessed and the success of a rating agency should be measured by the quality of the services offered, consistency and integrity. Is the rating assigned for an instrument or for the Issuer Company? Both. Rating of instruments would consider instruments specific characteristics like maturity, credit reinforcements specific to the issue etc. Issuer ratings consider the overall debt management capability of an issuer on a medium term perspective, typically three to five years. While issuer ratings are more often than not, one time assessments of credit quality, instrument ratings are monitored over the life of the instrument. Why are equity shares not rated? By definition, credit rating is an opinion on the issuers capacity to service debt. In the case of equity, there is no pre-determined servicing obligation, as equity is in the nature of venture capital. So, credit rating in the conventional sense does not apply to equity shares. However, of late, credit rating agencies offer grading of IPOs which take into account the fundamentals of the issuer. If a rating is downgraded, how would it "benefit" (or compensate ) the investor? A credit rating is a professional opinion on the ability and willingness of an issuer to meet debt-servicing obligations. It is an opinion on future debt servicing capabilities given on the
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basis, inter-alia, of past performance and all available information (from audited financial statements, interaction with company management, banks and financial institutions, statutory auditors, etc.) at a particular time. While rating agencies make all possible efforts to project corporate business prospects, industry trends and management capabilities, many events are unpredictable. Hence, such opinions may prove wrong in the context of subsequent events. On the occurrence of such an event, a rating agency can only review and make appropriate changes in the rating. Moreover, when there are recessionary trends in certain segments of the economy, companies in such segments or with large exposures to such segments are adversely affected and their credit ratings get downgraded. Such downgradations are a natural consequence of the recessionary trends. In other words, credit quality (and credit rating) is dynamic, not static and all rating agencies review their ratings periodically and make changes, wherever considered appropriate. Such changes are reported widely through the media. It is the experience of all rating agencies that some instruments initially rated as investment grade fall below investment grade or go into default, over a period of time. Further, it must be noted that there is no privity of contract between an investor or a lender and a rating agency and the investor is free to accept or reject the opinion of the agency. A credit rating is not an advice to buy, sell or hold securities or investments and investors are expected to take their investment decisions after considering all relevant factors and their own policies and priorities. A credit rating is not a guarantee against future losses. Please also note that credit ratings do not take into account many aspects which influence investment decisions. They do not, for example, evaluate the reasonableness of the issue price, possibilities for capital gains or take into account the liquidity in the secondary market. Ratings also do not take into account the risk of prepayment by issuer, or interest or exchange risks. Although these are often related to the credit risk, the rating essentially is an opinion on the relative quality of the credit risk, based on the information available at a given point of time.
GLOSSSARY
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Intermediator:institution that provide the market function of matching borrowers and lenders or traders Disintermediation: Withdrawal of funds from a financial_institution in order to invest them directly Moodys investor service:performs financial research and analysis on commercial and government entities. The company also ranks the credit-worthiness of borrowers using a standardized ratings scale. The company has a 40% share in the world credit rating market. Standard & Poors: a division of McGraw-Hill that publishes financial research and analysis on stocks and bonds. It is one of the top three companies in this business Audit : An examination of a company's accounting records and books conducted by an outside professional in order to determine whether the company is maintaining records according to generally accepted accounting principles Underwriting: To guarantee, as to guarantee the issuer of securities a specified price by entering into a purchase and sale agreement. To bring securities to market RBI: Reserve bank of India SEBI: Securities and exchange board of India CRISIL: Credit Rating and Information Services of India Ltd. ICRA Ltd: Investment Information and Credit Rating Agency of India Limited. CARE: Credit Analysis and Research Ltd. FITCH: JV between Duff & Phelps, US and Alliance Capital Limited , Calcutta. Equity Grading : A service offered by the credit rating agency, ICRA Limited, under which the agency assigns a grade to an equity issue, at the request of the prospective is
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IFCI Ltd.: The Industrial Finance Corporation of India, the first Development Financial Institution in the country to cater to the long-term finance needs of the industrial sector. SBI: State bank of India,the biggest PSU bank in India. LIC: Life Insurance corp. of India, the biggest life insurer in India and under control of govt of India. UTI: Unit trust of India PNB: Punjab National Bank GIC: General insurance corp. a psu and biggest insurer in india,formed for the purpose of superintending,controlling and carrying on the business of general insurance Forward integration: The expansion of a business' products and/or services to related areas in order to more directly fulfill the customer's needs. Switching costs: cost of Liquidating a position and simultaneously reinstating a position in another futures contract of the same type Leveraging :Use of debt to increase the expected return on equity. Financial leverage is measured by the ratio of debt to debt plus equity. Currency exposures: The part of a portfolio that is denominated in a currency (or currencies) other than the base currency and is not hedged. Currency risk arises from a combination of currency exposure and currency volatility. Currency hedges reduce (direct) currency exposure Gross operating margin What remains from sales after a company pays out the cost of goods sold. To obtain this margin, divide gross profit by sales. Gross operating margin is expressed as a percentage. Interest coverage ratio(OPBIT/Interest) :The ratio of earnings before interest and taxes to annual interest expense. This ratio measures a firm's ability to pay interest
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S.S. COLLEGE OF BUSINESS STUDIES Debt service coverage ratio: Earnings before interest and income taxes, divided by interest expense plus the quantity of principal repayments divided by one minus the tax rate Net cash accruals:??? Equity assessment:??? Great depression: The Great Depression (also known in the U.K. as the Great Slump) was a dramatic, worldwide economic downturn beginning in some countries as early as 1928. Lien :A security interest in one or more assets that lenders hold in exchange for secured debt financing Collateral : In the context of project financing, additional security pledged to support the project financing Securitization: the process of conversion of financial assets into tradable securities. Franchise value: franchise value refers to the popularity of a particular brand or product with consumers. Capital adequacy : A measure of the financial strength of a bank or securities firm, usually expressed as a ratio of its capital to its assets. Enron debacle: After a series of revelations involving irregular accounting procedures bordering on fraud perpetrated throughout the 1990s involving Enron and its accounting firm Arthur Andersen, Enron stood on the verge of undergoing the largest bankruptcy in history by mid-November 2001. Enron filed for bankruptcy on December 2, 2001. In addition, the scandal caused the dissolution of Arthur Andersen, which at the time was one of the world's top accounting firms. Volatility: A measure of risk based on the standard deviation of the asset return. Volatility is a variable that appears in option pricing formulas, where it denotes the volatility of the underlying asset return from now to the expiration of the option Financial disclosure: A company's release of all information pertaining to the company's business
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S.S. COLLEGE OF BUSINESS STUDIES activity, regardless of how that information may influence investors Differential: A small charge added to the purchase price and subtracted from the selling pr Liquidation Occurs when a firm's business is terminated. Assets are sold, proceeds are used to pay creditors, and any leftovers are distributed to shareholders. Any transaction that offsets or closes out a long or short position Financial engineering: Combining or carving up existing instruments to create new financial products
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S.S.

COLLEGE OF BUSINESS STUDIES

CREDIT RATING-An Introduction

2. Increasing securitization of borrowing and lending consequent to

3. Globalisation of the credit market; The continuing growth of information

The Use of Credit Rating

S.S. COLLEGE OF BUSINESS STUDIES

c) as per the guidelines of RBI , NBFCs having net owned funds of

funds of more than Rs fixed deposit programme

for housing finance companies also; programmes of

S.S. COLLEGE OF BUSINESS STUDIES

3) A credit rating agency

service, exercise due diligence, ensure proper

come to its knowledge, without making disclosure to the concerned person

S.S. COLLEGE OF BUSINESS STUDIES

S.S. COLLEGE OF BUSINESS STUDIES

CREDIT RATING AGENCIES IN INDIA

CRISIL ICRA CARE Duff& Phelps

S.S. COLLEGE OF BUSINESS STUDIES

ICRA - A Detailed Study

S.S. COLLEGE OF BUSINESS STUDIES

studies/publications, corporate reports and mandate based customized research.

Structured Finance Rating

housing loans as the underlying asset for the transaction.

Claims Paying Ability Rating (for Insurance companies)

Corporate Governance Rating

Grading of Construction Entities

Grading of Mutual Fund Schemes

Operating Risk Diagnostic analysis of risk for a company

S.S. COLLEGE OF BUSINESS STUDIES

S.S. COLLEGE OF BUSINESS STUDIES

Rating request: Ratings in India are initiated by a formal request

Rating team: The team usually comprises two members. The

ICRAs Rating Process

Receive initial information Conduct basic research

Fact findings and analysis

Communicate the rating and rationale

Request for Review

S.S. COLLEGE OF BUSINESS STUDIES

Financial risk drivers Funding policies Financial flexibility

Bargaining position of suppliers Availability of raw material

Total debt as a % of net worth

S.S. COLLEGE OF BUSINESS STUDIES

S.S. COLLEGE OF BUSINESS STUDIES

S.S. COLLEGE OF BUSINESS STUDIES

RATING OF STRUCTURED OBLIGATION

financial assets and/or

CASH FLOW STRUCTURE

Company holding financial assets LENDER

Issuer Spl Purpose Vehicle

S.S. COLLEGE OF BUSINESS STUDIES

S.S. COLLEGE OF BUSINESS STUDIES

S.S. COLLEGE OF BUSINESS STUDIES

S.S. COLLEGE OF BUSINESS STUDIES

S.S. COLLEGE OF BUSINESS STUDIES

S.S. COLLEGE OF BUSINESS STUDIES

S.S. COLLEGE OF BUSINESS STUDIES

S.S. COLLEGE OF BUSINESS STUDIES

_________________________________________________________ What Is A Corporate Credit Rating?

S.S. COLLEGE OF BUSINESS STUDIES

S.S. COLLEGE OF BUSINESS STUDIES

Some FAQs about Credit Rating

S.S. COLLEGE OF BUSINESS STUDIES