CREDIT RATING

Chapter 13 Indian Financial System Bharati Pathak

Introduction

Concept originated in 1909 Gained popularity in early Nineteen hundreds, as investors lost a lot of money in investments in various companies, due to lack of proper information about the creditworthiness of the companies. Worlds first credit rating agency Was Moodys Investor Service , which rated the US Rail Road Bonds. Biggest Rating Agencies of the world are: Moodys Investor Service Standard and Poor (S&P) Fitch Investors Service

Introduction

Indias first among developing countries to set up Credit Rating Agency. CRISIL set up in 1988 (Credit Rating Information Services of India Limited.) ICRA set up 1990(Investor Information and Credit Rating Agency of India Ltd) CARE Credit analysis and Research Ltd. Fitch Ratings India Private Ltd. RBI has now made credit rating mandatory for all debt instruments . Certain categories of debentures and Commercial Paper.

Credit Rating - Meaning

Credit rating is the assessment of Borrowers credit quality. Performs the function of credit risk evaluation reflecting borrowers expected capability to repay the debt as per terms of the issue. Credit Rating agencies now perform the functions of financial analysis and assessment of financial products, individual institutions and governments.

Growth drivers of Credit Rating Agencies

Regulators support in making credit rating compulsory for various instruments. Declining interest rates, Shift towards market borrowing from bank loans, Steep increase in Govt. borrowings through special purpose vehicles. Private placement of Debt by many cos.

Rating Methodology

Rating assigned after in-depth study of industry and Strengths and Weakness of the company. Analytical framework has 4 broad areas : Business Analysis Financial Analysis Management Evaluation Fundamental Analysis

Rating Symbols

They convey the safety grade to the investor. Classified into three grades: High Investment Grades Investment Grades Speculative Grades

High Investment Grades

AAA Triple A Denotes highest safety, timely payment of Interest and Principal . Issuer fundamentally strong and adverse changes will not affect it. AA Double A Denotes high safety for payment of Interest and Principal Issuers differs in safety from AAA only marginally.

Investment Grades

A denotes adequate safety in terms of payment of Interest and Principal payment. Change in circumstances will adversely affect such issues. BBB triple B denotes moderate safety in term of payment of Interest and Principal

Speculative Grades

BB double B denotes inadequate safety in terms of timely payment of Interest and Principal. Uncertain changes lead to inadequate financial capacity to make future payments. B denotes High Risk. Indicates inability and unwillingness to pay incase of adverse changes.

Speculative Grades

C substantial Risk . Default may happen . D denotes default in terms of payment of interest and principal .

Rating Fees

Users of the rating do not pay for the rating. The issuers of the financial instrument pays fees to the Credit Rating Agency. Rating Fees 0.1% of instrument size Annual surveillance fees of 0.03% to monitor the instrument during its life.

SEBI Regulation for Credit Rating Agencies.

Only commercial banks, FIs, Foreign banks in India, Foreign credit Rating Agencies, with minimum net worth of Rs.100 crore ,for past 5 yrs , allowed to promote CRAs. Cannot assess the financial instruments of their promoters who have more than 10% stake in them. Cannot rate the security issued by a borrower/subsidiary /associate of promoter Cannot rate security issued by its associate or subsidiary . If above SEBI guidelines not complied with, then credit rating agency may face registration cancellation/Penalty/suspension of registration certificate.

Limitations for Credit Rating in India

Credibility of credit rating is questionable. Instruments with highest credit rating have not performed well. For eg--CARE, a leading agency, gave AAA rating at a time when the company was going down. A frequent revision of grading by CRAs. Creates confusion to investors. One third of ratings , not accepted by the clients. This has lead to competitive relaxation of rating standards. High rating to one instrument of a Co. and low rating to another instrument of same co. They fail to predict the financial health of their clients in the short term. Investors not given any warning of downgrading , so that he can liquidate his investments.