Submitted to Deol Avinash

What is a Credit Rating ?

Credit rating An indicator of the risk a debt instrument bears

A credit rating is a simple number which many use to determine whether or not they will give a loan or line of credit to an individual. One's credit rating is impacted by a number of factors, some of which are controllable, others of which are not. There are three main agencies lenders go to in order to acquire an individual's credit rating: TransUnion, Equifax, and Experian. Many lenders get two or more reports, as details may differ among the agencies. Opinions differ as to which of the agencies the best or most accurate, with factions is holding strong opinions on both sides for all three of the major agencies. Credit ratings are rankings of fixed income (or debt) securities -- instruments that offer investors a fixed rate of interest. Debt securities carry with them the risk that the issuer of the debt may default. The probability of this default varies considerably across different debt instruments. By publishing ratings, credit rating agencies provide investors with an objective means of evaluating these instruments. These ratings indicate the safety of the investor's principal amount, as also the likelihood that the interest payments due to him will be made in time. Debt issues with the lowest risk of default receive the highest rating: AAA, popularly known as Triple A. This signifies highest safety. The next notch is Double A (AA) then Single A, BBB, BB and so on. A 'C' rating indicates substantial risk, while a 'D' rating means that the issuer has defaulted. Generally, investments above BBB are classified as investment grade. Finer gradations are indicated by a plus or minus sign after the basic rating. The companies in business. India has four credit rating agencies, the oldest and largest being Crisil; the others are CARE (Credit Analysis and Research), ICRA (Investment Information and Credit Rating Agency) and recent entrant Duff & Phelps. They rate debentures of listed companies, their fixed deposit programmes and commercial paper programmes (a short term, 90- to 180-day instrument that companies use to raise money from banks and other corporations).

Interest rates. Ratings tell you how risky a debt instrument is; this also means a rating indicates the returns from that instrument. A Triple A security will have a lower rate of interest, with rates increasing as ratings drop. Independence. Rating agencies are independent organisations; they don't buy or sell securities. Their opinion on any debt instrument is that of an outsider. This gives a rating its credibility.

Symbols. Different rating agencies offer different symbols. But these are differences only in nomenclature. Crisil uses different symbols for different instruments. It uses the international symbol system for the debentures issued by companies and prefixes an F to the rating of a Fixed Deposit. Both ICRA and CARE have ratings given for long term (debentures) and medium term (fixed deposits) instruments with prefixes L and M attached to the rating. Ratings are not stock recommendations... A high credit rating should not be construed as a stock recommendation. It is not necessary that if the debt issue of a company has a Triple A rating, the company's stock is worth investing in. Stock market analysts are mainly concerned with a company's earnings growth prospects. Credit raters, however, are more interested in the company's solvency and its ability to repay its debt, especially during recessions. That's why their analysis is more focused on cash flows and ability of the company to liquidate assets during an emergency to pay interest and principal liabilities than future growth prospects. A credit rater's concerns reflect those of a banker making a loan-can the borrower pay back the principal and interest on the loan in time? ...and are issue specific. Ratings are given for a particular instrument or issue and not for the company. It is possible for two issues of the same company to have different ratings depending on the characteristics of the instrument. Moreover, ratings also depend on the terms and conditions of the particular instrument. For example, an instrument backed by collateral security will have a higher rating than one that is unsecured. This also means that strictly speaking, a debenture AAA rating and a fixed deposit (which is an unsecured instrument) AAA rating are not strictly comparable. Ratings are opinions... Credit ratings are opinions of the credit rating agencies on debt issues of companies. It is quite possible to get different ratings for the same company from two different agencies, and it happens often. For example, ICRA has rated Apple Credit's fixed deposit program as MAA, higher than Crisil's FA. The two agencies could have different views about the company's prospects. The difference could also stem from an agency taking a particularly harsh or lenient view of an industry. For instance, Crisil has taken a much harsher view of finance companies than others have Should not be followed blindly. Ratings are an important guide to fixed income instruments. They provide a clear indication of the risk that the debt instrument bears. But they should not be used blindly. Ratings are solicited by the issuer and paid for by the company. Since Securities and Exchange Board of India rules let issuers solicit multiple

ratings and use the best, an investor cannot know if the rating she is shown is the only one issued. One way to counter this is to look up rating information published by the rating agencies. Rating agencies routinely reveal results of all rating exercises carried out by them. Review lag. Rating agencies do not review ratings in depth unless there is a new issue by the company. This means that there might have been a change in the credit quality of the company in the interim that the rater would have missed. In that sense, a rating will always lag the stock market in terms of the performance of the company. Countries are issued sovereign credit ratings. This rating analyzes the general creditworthiness of a country or foreign government. Sovereign credit ratings take into account the overall economic conditions of a country including the volume of foreign, public and private investment, capital market transparency and foreign currency reserves. Sovereign ratings also assess political conditions such as overall political stability and the level of economic stability a country will maintain during times of political transition. Institutional investors rely on sovereign ratings to qualify and quantify the general investment atmosphere of a particular country. The sovereign rating is often the prerequisite information institutional investors use to determine if they will further consider specific companies, industries and classes of securities issued in a specific country. Credit ratings, debt ratings or bond ratings are issued to individual companies and to specific classes of individual securities such as preferred stock, corporate bonds and various classes of government bonds. Ratings can be assigned separately to short-term and long-term obligations. Long-term ratings analyze and assess a company's ability to meet it's responsibilities with respect to all of its securities issued. Short-term ratings focus on the specific securities' ability to perform given the company's current financial condition and general industry performance conditions.. History Of Credit Rating Agencies Credit ratings provide individual and institutional investors with information that assists them in determining whether issuers of debt obligations and fixedincome securities will be able to meet their obligations with respect to those securities. Credit rating agencies provide investors with objective analyses and independent assessments of companies and countries that issue such securities. Globalization in the investment market, coupled with diversification in the types and quantities of securities issued, presents a challenge to institutional and individual investors who must analyze risks associated with both foreign and

domestic investments. Historical information and discussion of three companies will facilitate a greater understanding of the function and evolution of creditrating agencies. Credit Ratings John Knowles credit rating founded the credit Publishing Company in 1913. Credit rating published financial statistics for use in the investment industry via "The credit Stock and Bond Manual" and "The credit Bond Book." In 1924, john introduced the AAA through D rating system that has become the basis for ratings throughout the industry. With plans to become a full-service global credit rating agency, in the late 1990s merged with IBCA of London, subsidiary of Fimalac, S.A., a holding company. Fitch also acquired market competitors Thomson BankWatch and Duff & Phelps Credit Ratings Co. Beginning in 2004, Fitch began to develop operating subsidiaries specializing in enterprise risk management, data services and finance industry training with the acquisition of Canadian company, Algorithmics, and the creation of credit

Why a credit rating is essential for small companies?
With a 10% increase in business failures in the second quarter of 2008, Equifax believes it has never been more important for small companies to maintain a good credit rating - especially sole traders and partnerships. With this in mind, the credit agency has provided the following essential tips to maintain a good business credit score and a low risk profile: Top tips to maintain a good business credit score • Pay bills on time, as businesses will be looking for early signs of difficulty • Monitor your own business credit profile • File accounts on time, as any delays looks like you may have something to hide • Avoid County Court Judgments, as any firm monitoring your status will view this as an early sign of financial trouble • Conduct credit checks on all new accounts • Implement data sharing systems to monitor customers for signs of financial stress • Look for early warning signs, such as prompt payers suddenly falling behind on payments • If you suspect a customer or supplier is in trouble, run a credit check and reassess your relationship if necessary

• Set strict deadlines on accounts that are continually overdue. Don’t let unpaid invoices mount up • Conduct ongoing monitoring of all customers and key suppliers. Equifax Portfolio Monitoring helps businesses quickly identify potential bad debt and act quickly to prevent it • Beware customers who switch to new suppliers at the point they reach their credit limit with you. This is often a sign of problems looming.

What else should small companies do? “New lines of credit are already harder to find as both lenders and other businesses become increasingly selective about who they do business with. This means all types of business – from the one man bands through to the larger limited companies - need to keep a close eye on their own financial status as well as that of both prospective customers and suppliers. "In our most recent Business Failures Report we saw a 5.8% increase in the number of failed businesses with a zero credit limit. Any company checking on these organisations in the lead up to their insolvency would have seen this zero rating, providing them with an important warning to only trade based on receiving upfront payments. “In this tough economic climate SMEs are the most vulnerable. It’s crucial, therefore, that they do everything possible to ensure their own credit rating is kept as positive as possible – and this means making sure that none of their customers fall behind with payments. It only takes one customer going under to turn their own financial fortunes. “We also believe it’s important that suppliers are checked and monitored on an on-going basis too, in order for companies to ensure they have a good source of raw materials and services to support their own business. This factor often gets overlooked, yet it can have a huge impact on an already struggling business.”

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