Professional Documents
Culture Documents
Credit Rating: Post Graduate Diploma in Business Administration (Pgdba)
Credit Rating: Post Graduate Diploma in Business Administration (Pgdba)
BY
MARCH 2007
CERTIFICATE
This is to certify that the study presented by MR. DEVAL GUPTA to Thakur Institute
Of Management Studies & Research in part completion of Post Graduate Diploma in
Business Administration (PGDBA) course under the title CREDIT RATING has been
done under my guidance.
The project is in the nature of original work that has not so far been submitted for any
course of this Institute or any other Institute. References of work and relative sources of
information have been given at the end of the project.
ACKNOWLEDGEMENT
With a deep sense of pride, satisfaction and gratitude, I present my project report on:
"CREDIT RATING"
At this juncture, I feel deeply obliged to the most respected, Dr Uday Lajmi, Director of
our Institute who provided me the required Infrastructure & guidance.
This project could not have seen the light of the day without the inspiring of Prof. Ravi
Kamath who guided me like a beacon in the dark. I would like to thank him for giving
me his valuable time, suggestions and practical views throughout my project work,
without which the completion of the project would have been a difficult journey.
INDEX
SR
NO.
1
TITLE
Executive summary ,Introduction, Meaning
PAGE
NO.
1-4
Origin, Determinant
5-6
7-8
9-11
11-15
16-18
18-20
20-25
26-30
10
31-47
11
48-50
12
51-52
13
Faq
53-59
14
Conclusion
60
15
Biblography
61
EXECUTIVE SUMMARY
Credit rating is slowly being recognized in India as a significant measure towards investor protection
and self check for the corporate enterprises of their financial and operational strength. Credit rating
provide s indicative guidance to the prospective investor in the fixed income securities or fixed
deposit programs on the degree of risk involved in the timely repayment of principal and interest .
A rated company is placed higher in the estimation of the investor than a an unrated company
irrespective of better financial standing of the latter or the reputation attached as a familiar group
company of a big business houses. This makes a transition in the corporate culture in this country.
So far, the finding show that company are shy enough to opt for credit rating unless it is made
mandatory under the government directives.
With the commencement of CRISIL (1998) and ICRA in (1991) about 400 companies have under
compulsion or voluntary gone for the rating for different debt instrument or fixed deposit programs
issued by them.
It is the need of an hour to create a deeper understanding of the rating process, procedure, practices
& information requirements particularly in the minds of the persons managing the corporate
enterprises. A lot of efforts are needed to educate the people in general and the corporate executive
in particular on the systems, methodology and practices followed by them in rating the credit
instrument and debt obligations.
According to CARE: Credit ratings 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 obligation as and
when they arise.
7
According to CRISL: Credit rating is an unbiased, objective and independent opinion to an issuers
capacity to meet financial obligation, it is the current opinion as to the relative safety of timely
payment of interest and principal on a particular debt instruments. Thus, rating applies to a particular
debt obligation of the company and is not a rating for the company as a whole
According to ICRA: credit rating is a simple and easy to understand symbolic indicator of the
opinion of the credit rating agency about the risk involved in a borrowing program of an issuer with
reverence to the capability of the issuer to repay the debt as per terms of issues. This is neither a
general purpose evaluation of the company nor the recommendation to buy, hold or sell a debt
instrument.
Thus, precisely, rating is a measure of credit risks and is only element in the investment decision
making.
Credit rating does not indicate market risks or predict prices or yield of credits instrument. It
evaluates only a specific instrument and indicates risk associated with such instrument only. It is
general purpose evaluation of the issuer business or operations.
Credit rating appraises the default risk which is a combination of business risk and
financial risk.
Business Risk: Business risk relates to the market position of the company, operating efficiency and
management quality. The key factor taken into consideration are: the nature of the industry the
company is in, the demand-supply position, cyclical/ seasonal factors and government policies vis-vis the industry; and the competition its facing within the industry.
Market Position: The market share the company enjoys, it is competitive advantages and selling
and distribution arrangements.
Operating Efficiency: Locational advantages, labor relationships, cost structure, technological and
manufacturing efficiency as compared to its competitors.
Legal Position: Terms of prospectus, systems for timely payment, and for protection against fraud.
Financial Risk: Financial risk is a function of the profitability, debt leverage flexibility and
adequate cash flow. The assessment of financial risk is done on the basis of:
a)
Financial analysis, including accounting quality: accuracy of statement of profit, auditors
comments, valuation and depreciation policies.
b)
Earnings protection: Sources of future earning growth, profitability ratios and earnings in
relation to fixed income charges.
c)
Adequacy of cash flow: Sustainability of cash flows and working capital management.
d)
Financial flexibility: Ability to raise funds.
Management: An evaluation of the management, which is qualitative in nature and imparts certain
amount of subjective element, is done on the basis of track record of the management; planning and
control system, depth of managerial talent, succession plans. Evaluation of capacity to meet adverse
situations, goals, philosophy and strategies.
Environment: An analysis of environment covering regulatory and operating environment, national
economic outlook, pending litigation and unpaid taxes are also attempted.
Rating thus is not based on a predetermined formula which specifies the relevant variables
and as well as weights attached to each one of them. Further the emphasis on different aspects varies
from agency to agency. Broadly the rating agencies assures itself that there is good congruence
between assets and liabilities of a company and downgrades the rating if the quality of the assets
depreciates.
The rating agencies employ qualified professionals to ensure consistency and
reliability. The agencies also ensure the integrity of rating by insulating rating from conflicts of
interest.
The rating agencies employ nearly identical symbols. They examine the above
factors before assigning a grade. The symbols are A, B, C and D and each symbol is graded with
associated risk by adding two or one of the same symbol, like AAA, AA and A; BBB, BB and b; and
so on
10
UTILITY OF RATINGS
Investors have always received credit ratings with enthusiasm. But issuers do not share the
enthusiasm since they have to share their securities at higher yields if their issue gets inferior rating.
Credit rating gives an investor a simple and easy indicator to the credit quality of the debt
instrument, the risks and likely returns, thus providing a yardstick against which the risk inherent in
an instrument can be measured. An investor uses the rating to assess the risk level and compares the
offered rate of return, which is expected rate of return (for the given level of risk) to optimize his risk
return trade- off. Ratings also provide a comparative framework, which allows the investor to
compare investment opportunities.
Credit rating also benefits the issuer. If a public offer is contemplated, the financial manager
must bear in mind the rating while determining the appropriate leverage. Additional debt may lower
the rating from an investment to a speculative grade category, thus rendering the security ineligible
for investment by many institutional investors. It may well be that the advantages of debt outweigh
the disadvantages of the lower credit rating.
Junk bonds, for instance, are a high risk and a high yield (16 to 25% in USA) instruments.
Investment may be limited in such instrument to what an investor can afford to loose.
Ratings will also effect the pricing of the issue. Actually pricing should reflect the rating. The
marketability of a relatively unknown issuer who is competent is enhanced and the role of name
recognition in an investment decision is minimized.
In actual practice ratings are reflected in prices. There is no difference between the
interest rates that are paid on the fixed deposits of two companies even if they are rated differently.
Same is true of long dated debentures. But in commercial paper market where banks are major
players differentials in ratings are reflected in pricing. A reliance CP would be cheaper than of a
company, which is not rated well.
Ratings are used by brokers for opinions and as a service for their customers. Insurance
companies and mutual funds use them in the purchase of securities even though their own staff
prepares investment analysis. Portfolio managers also use them in security management. Banks
depend on them for their investment in commercial paper. Individual investors depend on them for
their decisions to place fixed deposits. Ratings are bound to assume greater importance with the
institutionalization of investors in the form of unit trusts, mutual funds, pension and provident funds.
The debt has shown considerable buoyancy in 1996 not only at the wholesale level (institutional
investors) but also at retail level in view of poor offerings of equity in the primary market. This has
come about largely on account of the availability of ratings on debt instruments, which boosted
investor confidence.
11
12
13
Manufacturing Companies
Banks
Non Banking Financial Institution
Financial Institutions
Housing Finance Companies
Municipal Bodies
Companies In Infrastructure Sector
To keep the pace with the changing credit requirements of new instruments the rating agencies have
been upgrading the technology and bringing in analytical innovation. The instrument being rated by
such agencies include:
1)
2)
3)
4)
5)
6)
With reference to India the rating agencies have been rating the following types of debts & debt
obligations:
1)
2)
3)
4)
5)
a)
b)
c)
d)
Debenture Bonds
Fixed Deposits
Commercial Paper
Structured Obligations
other ratings :
Utilities Rating
State Government Ratings
Asset Backed Securieties
Mutual Funds Rating
14
e)
f)
g)
Equity Grading/Assessment
Bank Lines Of Credit
Others
DUAL RATINGS s
Dual Rating would mean rating opinion on one or more instrument s from two different rating
agencies. Such dual rating leaves several question unanswered in the minds of the investor ,viz.
firstly, which of the two CRAS rating opinion relied upon ;secondly ,why the difference in two
rating should occur when both follow alike methodology, and thirdly, if such difference is
unavoidable why should not the rating s be rendered unreliable etc
RATING SYMBOLS
Rating agencies use symbols such as AAA, AA, BBB, B, C, D, to convey the safety
grade to the investor. Ratings are classified into three grades: High investment grades, investment
grades and speculative grades. In all ratings is classified into 14 or 15 categories. Signs + or -
are used to show the certainty of timely payment. The suffix + or may be used to indicate the
comparative position of the instrument within the group covered by the symbol. Thus FAA- lies one
notch above FA+. To provide finer gradations, rating industry attach + or to their ratings. The
rating symbols for different instruments of the same company need not necessarily be the same.
High Investment Grades AAA: - Triple A denotes highest safety in terms of timely payment of
interest and principal. The issuer is fundamentally strong and any adverse changes are not going to
affect it.
AA: - Double A denotes high safety in terms of timely payment of interest and principal. The
issuer differs in safety from AAA issue only marginally.
Investment Grades A : - denotes adequate safety in terms of timely payment of interest and
principal. Changes in circumstances can adversely affect such issues.
BB: - Triple B denotes moderate safety in terms of timely payment of interest and principal
speculative grades.
15
Speculative Grades BB: - Double B denotes inadequate safety terms of timely payment of interest
and principal. Uncertain changes can lead to inadequate financial capacity to make timely payments
in the immediate future.
B: - denotes high risk. Adverse changes could lead to inability or unwillingness to pay timely
payment.
C: - denotes substantial risk. Issue rated is vulnerable to default.
D: - denoted default in terms of timely payment of interest and principal.
These symbols are just a current opinion of an agency and they are not recommendations to
invest or not to invest. The rating assigned applies to a particular instrument of the company and is
not a general evaluation of the company.
Rating Fees: -In the credit rating business, the users of rating service, such as investors, financial
intermediaries and other end- users, do not pay for it. The issuer of the financial instrument pays fees
to the credit rating industry and this is the major source of revenue to the rating agency. Today
issuers fees constitute 95% of the total revenues of the rating agencies. In India rating agencies
charge 0.1 % of the instrument size as rating fees. They also charge an annual surveillance fees at a
rate of 0.03% to monitor the instrument during his life.
16
3)
them.
Rating agencies cannot assess financial instruments of their promoters who have 10 % stake in
4)
Rating agencies cannot rate a security issued by an entity, which is (a) a borrower of its
promoter. (b) a subsidiary of its promoter. (c) an associate of its promoter, if (i) there are common chairman,
directors between credit rating agency and these entities (ii) there are common employees (iii) there are
common chairman, directors, employees on the rating committee.
5)
Rating agencies cannot rate a security issued by its associated or subsidiary, if the credit rating
agency or its rating committee has a chairman, director or employee, who is also a chairman, director or
employee of any such entity.
6)
A penalty of suspension of the certificate of registration or a penalty of cancellation of
registration may be imposed on the rating agency if it fails to comply with the condition or contravenes any of
the provisions of the Act.
Grant of Certificate
i)
Any person proposing to commence any activity as a credit rating agency on or
after the date of commencement of these regulations shall make an application to the Board for the
grant of a certificate of registration for the purpose.
ii) A non- refundable application fee shall accompany an application for the grant of a certificate.
2) Promoter of Credit Rating Agency
The Board shall not consider an application under unless a person belonging to any of the
following categories promotes the applicant:
c)
d)
A foreign credit rating agency having at least five years experience in rating securities.
e)
Any company or a body corporate, having continuous net worth of minimum rupees of one
hundred crores for the previous five years prior to filling of the application with the board for the grant of
certificate under these regulations.
3) Eligibility Criteria
The Board shall not consider an application for the grant of a certificate unless the
applicant satisfies the following condition: a)
The applicant is set up and registered as a company under the Companies Act, 1956;
b)
The applicant has, in its memorandum of Association, specified rating activity as one of its main
objects;
c)
The applicant has a minimum net worth of rupees five crores.
d)
The applicant has adequate infrastructure, to enable it to provide rating service.
e)
The applicant and the promoters of the applicant have professional competence, financial
soundness and general reputation of fairness and integrity in business transactions, to the satisfaction of the
Board.
f)
Neither the applicant, nor its promoter, nor any director of the applicant or its promoter, s
involved in any legal proceeding connected with the securities market, which may have an adverse effect on
the interest of the investors;
g)
Neither the applicant, nor its promoters, nor any director, or its promoter has at any time in the
past been convicted of any offence involving moral turpitude or any economic offence.
h)
The applicant has, in its employment, persons having adequate professional and other relevant
experience to the satisfaction of the Board.
i)
The applicant in all other respects is a fit and a proper person for the grant of a certificate.
j)
The grant of certificate to the applicant is in the interest of the investors and the securities
market.
18
The Board may require the applicant to furnish such further information or clarification, as the Board may
consider necessary, for the purpose of processing of the application.
ii) The Board, if it so desires, may ask the applicant or its authorized representative to appear
before the Board, for personal representation in connection with the grant of a certificate.
6) Grant of certificate
i) The Board. On being satisfied that the applicant is eligible for the grant of a certificate of
registration, shall grant a certificate.
ii)
The grant of certificate of registration shall be subject to the payment of the registration
fee specified.
7) Conditions of Certificate and Validity Period
The certificate shall be granted subject to the following conditions, namely;
a)
The credit rating agency shall comply with the provisions of the Act, the regulations made there
under and the guidelines, directives, circulars and instructions issued by the Board from time to time on the
subject of credit rating.
b)
Where any information furnished to the Board by a credit rating agency:
i)
c)
Rating may differ with respect to different instrument of same organization . Also , different rating
assigned to different instrument of two different organizations does not indicate the superiority or
inferiority of the organizations . the steps involved in credit rating activity are given below :
MANDATE
INITIAL STAGE
ASSIGN RATING TEAM
RECEVE INITIAL INFORMATION,
CONDUCT BAIC RESEARCH
MEETING & VISIT
ANALYSIS & PREPARTION OF REPORT
PREVIEW MEETING
RATING
FINALISATION STAGE
RATING MEETNG
ASIGN RATING
COMMUNICATE THE RATING & RATIONALE
ACCEPTNCE
SURVEILLANCE
20
The entire rating process is normally completed in three stage in practical scenario1) Primary Or Initial Stages.
2) Facts Finding & Analysis Stage.
3) Rating Finalization Stage.
1)
2)
The tem consisting of professionally qualified analyst well versed with the workings of the
industry in which the company operates, first visits the company plants and inspect the operations first hand .
3)
Meeting with different levels of management follow culminating with the meeting with chief
executive officer.
4)
Generally, middle & top level management meeting cover the field of operations , finance ,
marketing , project, etc.
5)
In completion of the assignment , the tem interacts with the back up tem that has separately
collected the additional industry information and prepares a report
6)
The report is then placed before n internal committee consisting of senior executives of credit
rating agency who themselves have hands on experience in rating assignments.
7)
The internal committee then has an open discussion with the tem member and amongst themselves
arrives at rating.
8)
To avoid any type ort of bias, the ratings proposed are placed before an external committee
consisting of eminent people unconnected with credit rating agency .
9)
The external committee then takes the final decision which is communicated to the company .
10)
The company may volunteer ny further information at this point which could effect the ratings, it is
passed ion to the external committee again for affirmation/change.
11)
The company has the option to request the agency for review of the rating.
From
To
Initial request
Meeting with management
Initial rating indication
Time frame
4-6 weeks
4-6weeks
Time depends
Upon completion of formalities
The quantitative & qualitative factors in the case of whole sale exposure and four type
factors in the case of retail sector needed to be accorded weight or scores. The
aggregate outcome will reflect the rating /grade of an exposure against a benchmark.
Hence the mechanism must lay down the following:
1) For wholesale exposure :
The marks for each parameter , with a randge of marks for various ranges of a parameter
have to be fixed .
If the growth in the last completed year compared with the previous year is :
20% & above
15% to less than 20%
5% to less than 15%
0% to less than 5%
Negative growth:
4 marks
3 marks
2 marks
1 marks
0 marks
For qualitative factors, also, there can be suitable scoring based on excellent (maximum
marks) and the lowest one non satisfactory (zero marks) may be fixed.
2) Aggregate marks for all the applicable parameters for each category may then be
mapped into various grades taking the maximum marks as 100, as shown below.
3) Wherever a particular parameter is not applicable for an exposure , it may be
ignored and the aggregate marks be readjusted / graded accordingly
Sl. No.
1
2
3
4
5
6
7
8
86-100
71-85
61-70
51-60
41-50
36-35
31-35
0-30
23
Grade
accorded
AA+
AA
A
BB+
BB
B
C
D
Implication of grade
accorded
Excellent safety
Very good safety
Good safety
Ordinary safety
Less ordinary safety
Low safety
Unsafe safety
Loss category
24
Net Profit :
****
**
**
**
****
26
27
For this purpose, cash flow would include only operating cash flow (ignoring investing
cash flow @ financing cash flow). As a point of the stress testing scale, a reduction of a
certain percentage in incomes/sales with the simultaneous increase in the expenses (for
example. Direct costs etc ) may result in charge ( reduction) in cash flow . There is no
minimum or maximum. The stress percentage depends upon the industry, operating
envoirment and also the overall business envoirment at the time of analysis.
The above cluster is only indicative of the ratios that a commercial bank/financial
institution may find usefull from the credit risks evaluation angle. There, may be other
important ratios as well, such as :
1)
2)
3)
4)
28
29
ILLUSTRATION
Sunrise ltd, a company incorporated under the company act, is enjoying credit facilities
from mega bank. The banks want to have the account rated using its credit rating model.
the rating model comprises subjective and objective parameter . The banks has dedicated
, well trained officer in its centralized credit analysis cell.
The company manufactures seamless pipes/tubes used in industrial applications. It has a
substantial export business in Europe and some African countries. The export business
account for a major portion of its total turnover and contributes significantly to its
bottom-line.
The top management comprises technocrat with very rich and varied experience of at
least 20 yrs in manufacturing and project implementation. The company is controlled by
the miller group, which has 26% sharing in it , including the portion held by their close
relatives. Reliable sources say there are some disputes regarding the sharing of property
in the miller family. its most likely that the dispute has emerged due to the failer of a
venture capital plan initiated by one of the brother of the family this involve substantial
sums and could not take up due to the exact of strategic partner from the venture at the
crucial time also sunrise limited has no secession plan .
The financing banks (the company enjoys substantial credit facilities from the
consortium) have objected to the deployment of funds without their prior permission for
the expansion in to an unrelated area- a mini cement plant, which is incurring huge cash
losses due to its uneconomic size. The group is keeping its fingure crosses as to whether
it should continue with this business or dispose it off , even at the discounted price.
Sunrise ltd. Has been constantly upgrading its system with the latest technology
available across the world to cut costs and improve efficiency . The business is banking
on getting huge orders so that the there is optimal utilization of facilities. Thus way they
can keep margin at the minimum and make competitive price.
But there are problems. Competitors are quite aggressive. Another major area of concern
is its urgent need for backward integration into solids rods. The company is facing a
problem getting clearance ( such as pollution due to certain chemical waste discharged
during the process) and certain control mechanism have also to be put in place before
seeking the necessary permission from the government for the expansion..
The company is ISO certified and was given the best corporate governance practice
award last year by the manufacturer association. The operating result of last two years
were as :
30
Operating results
sales
Cost of sales
Selling and admin. cost
OPBDIT
Interest cost
depriciation
Operating profit before tax
Net non operating income
Profit before tax
Profit for tax
Net profit
ratio
Growth in sales
Growth in OPBDIT
ROCE
Total debt equity ratio
Current ratio
Debtor collection period
( days)
Inventory holding
period(days)
Finished goods holding
period(days)
Creditors payment period
(days)
Cash flow DSCR
Stress test cash flow DSCR
Stress test flow interest
coverage
Level of contingent liability
(cont liab/TNW)
31.03.03
355.42
314.91
7.04
33.47
16.47
1.62
15.38
3.66
19.04
1.28
17.76
31.03.04
388.53
351.24
5.83
31.46
15.25
1.56
14.65
1.59
16.24
1.45
14.79
14.14%
2.04
1.42
95
9.31%
-6.01%
11.71%
1.83
1.49
72
63
62
50
63
60
55
2
1.8
2.78
2.2
1.92
3
0.5
0.49
31
Objective parameters
Marks
obtained
s
s1
2
3
4
5
6
Rating parameter
Growth in sales
4
20%
Growth in operating
profit (OPBDIT)
Return on capital
employed (ROCE)
Total debt-equity
ratio
Current ratio
5%
Level of contingent
liabilities
(coverage)
Debtors collection
Inventory holding
Finished goods
holding
Creditors payment
period
Cash flow DSCR
Cash flow intersest
coverage
Stress tested CF
DSCR
Stress tested CF
interest coverage
10
11
12
13
14
3
1520%
4-5%
2
5-15%
1
0-5%
2-4%
0-2%
5-10%
0-5%
2.52.75%
1-1.17
2.75-3%
3 times
0.75-1
1 times
0.5
times
1115%
2.252.5
1.171.33
0.51.70
0
Negative
growth
Negative
growth
=0%
0.7-0.85
0.85-1
45
days
45
45-75
days
45-60
75-100
days
60-75
100-120
days
75-100
30days 30-45
45-60
60-90
30-50
days
1.75-2.0
2.5-2.75
50-75
days
1.5-1.75
1.75-2.5
120
days
100
days
90
days
75
days
1.5
1.75
1.25-1.5
1-1.25
1.75-2
1.5-1.75
1.5
15%
2.25%
1.33%
20
days
2.25
3.5
1.75
2.25
20-30
days
2-2.25
2.753.5
1.51.75
2-2.25
2
0
3
2
1
1
3
3
38
32
B subjective
parameter
Rating parameter 4
1
Laid down
If
regulatory
complied
framework,
fully
standard
2
Experience of
Very
top management
good
yrs
Succession plan
for top
management
Initiatives of
management in
new business
areas
Corporate
governance
Honoring
financial
commitments
End use of funds
mar
ks
obta
ined
1
partially
Goo
d
(1015)
Moderate
(5-10)
Littl
e
(0.5)
0
Litigation
/proceeding/n
oncompliance
Nil
Well
planned
adhoc
No plan
Success
in
initiative
s
Well
devised
&
executed
timely
Certain
problems/delay
s but executed
No initiative
moderate
No corporate
governance
Delayed but
honored
Not honored
proper
Unauthorized
diversion
npa
Affiliate concern
performance
good
Certain
diversion with
permission
average
Cyclical/seasona
l factors
Characteristis of
products of the
comapny
Threat of
substitute m
low
moderate
high
superior
Same as other
inferior
Very
low/no
threat
moderate
high
33
Module
A
B
A
B
No Of
Parameter
14
11
25
Max Marks
Total
Marks
56
44
100
Weight
Assigned
60
40
100
Marks
Obtained
38
26
Max. Marks
Weight
Net Marks
56
44
60
40
40.71
23.64
4
4
A
RATED
ACCOUNT
34
CRISIL
INTRODUCTION:
The rating industry in India was ushered in 1988 with the setting up of Credit Rating
and Information Services of India Limited (CRISIL) followed by three more, the latest entirely
devoted to rating NBFCs. The industry is sustained by mandatory requirement for rating debt
instruments. Crisil was set up by ICICI and UTI in 1988.
Standard and Poor rating service (S&P) has formed a strategic alliance in 1996 with
CRISIL for providing analytical and business development co-operation. S&P will share with
CRISIL its advanced rating methodologies and analytical criteria and assist on other aspects of credit
rating agency operations. CRISIL would in turn offer business development assistance in India and
insight into local debt market and issuers.
The purchase by S&P of 6 lakhs shares in 1997 of CRISIL from Asian development
Bank to acquire a stake of 9.6 % in CRISIL is a logical culmination of the strategic alliance into
earlier. Asian Development Bank invested in 1988 in CRISIL as an effort to play a catalystic role in
its establishment.
RATING PROCESS
CRISIL's rating process and rating committee are designed to ensure that all
assigned ratings are based on the highest standards of independence and analytical rigor.
The rating committee comprises members who have the professional
competence to meaningfully assess the credit analysis that underlies the rating, and have
no interest in the entity being rated. A team of analysts carries out the credit analysis .
Each team has at least two members. CRISIL's analysis is based on issuer meetings and
an understanding of the business environment. The analysis is carried out within the
framework of clearly spelt-out rating criteria.
Rating Process
Management Meeting
Rating Committee and assignment of rating
Confidentiality
Advice to Issuer
Publication
Surveillance and Annual Review
CRISIL ensures confidentiality of the information obtained for the rating exercise by
putting in place appropriate process safeguards. All CRISIL employees are required to
sign a confidentiality agreement. CRISIL does not disclose confidential information that
it has obtained for the purpose of credit rating to anyone (other than market regulators or
law enforcement authorities, if required).
37
38
2) Investment Grades
Debentures rated `A' are judged to offer adequate safety of
timely payment of interest and principal; however, changes in
circumstances can adversely affect such issues more than those
in the higher rated categories.
A
Adequate Safety
BBB
(Triple B) Moderate Debentures rated `BBB' are judged to offer sufficient safety of
Safety
timely payment of interest and principal for the present;
however, changing circumstances are more likely to lead to a
weakened capacity to pay interest and repay principal than for
debentures in higher rated categories.
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3) Speculative Grades
Debentures rated `BB' are judged to carry inadequate safety of
BB
timely payment of interest and principal; while they are less
(Double
B) susceptible to default than other speculative grade debentures in
Inadequate Safety
the immediate future, the uncertainties that the issuer faces
could lead to inadequate capacity to make timely interest and
principal payments.
B
High Risk
Debentures rated `B' are judged to have greater susceptibility to
default; while currently interest and principal payments are met,
adverse business or economic conditions would lead to lack of
ability or willingness to pay interest or principal
Substanti C Substantial Risk
D In Default
Debentures rated `C' are judged to have factors present that make them
vulnerable to default; timely payment of interest and principal is possible
only if favourable circumstances continue.
Debentures rated `D' are in default and in arrears of interest or
principal payments or are expected to default on maturity. Such
debentures are extremely speculative and returns from these
debentures may be realized only on reorganisation or
liquidation.
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1) A general-purpose credit or performance evaluation of the rated entity: CRISIL Credit Ratings
are always issue-specific
2) A recommendation to invest in, or not to invest in, any shares, debentures or other instruments
issued by the rated entity, or derivatives thereof.
3) An opinion on associate, affiliate or group companies of the rated entity, or on promoters,
directors or officers of the rated entity
CARE
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42
CARE's rating analysis begins by assessing the characteristics of the industry/industries in which the
borrower operates. Some important factors are:
1) Effect of economic cycles on the industry.
2) Business cycles in the industry and their severity.
3) Tariff structure, threat from imports, price competitiveness of the domestic industry, and pace of
technological change.
4)
Business Risks
Against the backdrop of the issuer's industry, CARE then assesses the issuer's strengths and
weaknesses vis-a-vis its competitors. Factors considered include:
1)
2)
3)
4)
5)
6)
Technology.
Financial Risk
1)
Financial management philosophy and track record (capital structure, profitability, liquidity
position, financial flexibility and cash flow adequacy).
2)
Financial projections (with particular emphasis on achievability of sales targets, the
components of cash flow and ability to meet debt obligations as and when they fall due).
3)
Free cash flows and their sensitivity to various economic, industrial and business risks over
the term of the instrument.
4)
5)
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Management Assessment
1)
2)
3)
4)
Instrument Terms
Rating may vary according to such factors as:
1)
Maturity of instrument.
2)
Nature of security - secured or unsecured, senior or subordinated, covenants and other
provisions that may reduce the amount of recovery in case of default.
3)
4)
5)
6)
.
The criteria discussed above are specific to industrial companies. Credit rating
methodology for banks, financial institutions and non-banking finance companies, in addition to
some factors discussed above, focuses on the CRAMEL model:
Capital adequacy
Asset quality
Management quality
Earnings quality
Liquidity
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CARE'S
RATING
DEFINITIONS
Definition
45
CD
SO
CPS
RPS
Certificate
of
Structured
Convertible
Preference
Redeemable Preference Shares
Deposit
Obligations
Shares
PR 2
PR 3
PR 4
PR 5
Definition
Instruments would have superior capacity for repayment of short-term
promissory obligations. Issuers of such instruments will normally be
characterized by leading market positions in established industries,
high rates of return on funds employed etc.
Instruments would have strong capacity for repayment of short- term
promissory obligations. Issuers would have most of the characteristics
as for those with PR-1 instruments but to a lesser degree.
Instruments have an adequate capacity for repayment of short- term
promissory obligations. The effect of industry characteristics and
market composition may be more pronounced. Variability in earnings
and profitability may result in changes in the level of debt protection.
Instruments have minimal degree of safety regarding timely payment
of short-term promissory obligations and the safety is likely to be
adversely affected by short-term adversity or less favorable
conditions.
The instrument is in default or is likely to be in default on maturity.
CARE 3
CARE 4
CARE 5
Definition
Excellent debt management capability. Such companies will normally
be characterized as leaders in the respective industries.
Very good debt management capability. Such companies would be
regarded as close to those rated CARE-1, but with a lower capability
to withstand changes in assumptions.
Good capability for debt management. Such companies are considered
medium grade; assumptions that do not materialize may impair debt
management capability in future.
Barely satisfactory capability for debt management. The capacity to
meet obligations is likely to be adversely affected by short- term
adversity or less favorable conditions.
Poor capability for debt management. Such companies are in default
or are likely to default in meeting their debt obligations.
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Definition
Definition
Superior capacity for repayment of interest and principal on the loan.
Strong capacity for repayment of interest and principal on the loan.
They are rated lower than PL-1 because of somewhat lower margins
of protection. Changes in assumptions may have a greater impact.
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PL 3
PL 4
PL 5
as
notified
by
Govt.
of
India.
CARE 2 (CIS)
CARE 3 (CIS)
CARE 4 (CIS)
CARE 5 (CIS)
Definition
Schemes carrying this rating are considered to be very strong, with high
likelihood of achieving their objectives and meeting the obligations to
investors.
Schemes carrying this rating are considered to be strong, with adequate
likelihood of achieving their objectives and meeting the obligations to
investors. They are rated lower than CARE 1 (CIS) rated schemes because of
relativesly higher risk.
Such schemes are considered to have adequate strengths for achieving their
objectives and meeting the obligations to investors. They are considered to be
investment grade.
Schemes carrying this rating are considered to have inadequate capability to
achieve their objectives and meet the obligations to investors. They are
considered to be speculative grade.
Such schemes are considered weak and are unlikely to achieve their
objectives and meet their obligations to investors. They have either failed or
are likely to do so in the near future.
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The rating process takes about three to four weeks, depending on the complexity
of the assignment and the flow of information from the client. Rating decisions are made
by the Rating Committee.
Client
Care
Interacts with the team, responds to queries 3. The team interacts with clients,
raised and provides any additional data undertakes site visits, and analyses data
necessary for the analysis
submitted by the client
4. Internal committee previews analysis.
5. RATING COMMITTEE awards rating
to client
Accepts rating * , **
6. Notification in press
7. Periodic Surveillance
* : Client may ask for a review of the rating assigned and furnish
additional
information
for
the
purpose.
** : Client has option not to accept the final rating in which case, CARE
will not publish the rating or monitor it.
SMERA
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SMERA is the country's first rating agency that focuses primarily on the Indian SME
segment. SMERA's primary objective is to provide ratings that are comprehensive,
transparent and reliable. This would facilitate greater and easier flow of credit from the
banking sector to SMEs.
SME Rating Agency of India Limited (SMERA) is a joint initiative by SIDBI
(www.sidbi.in), Dun & Bradstreet Information Services India Private Limited (D&B)
(www.dnb.co.in), Credit Information Bureau (India) Limited (CIBIL) (www.cibil.com)
MEANING :
1)
2)
3)
4)
5)
SMERA FEATURES :
SMERA is the only rating agency dedicated to SMEs and its rating model takes into
consideration financial and non-financial factors for assigning rating to a SME unit.
SMERA ratings will also factor-in payment score obtained from CIBIL indicating the
payment track record of the SME unit being rated. Dun & Bradstreets expertise on rating
SME units is also an important factor that distinguishes SMERA rating from any other
ratings
ELIGIBILITY OF SMEs
All types of SMEs including manufacturing, service sector, trading etc can approach
SMERA directly or through the banks for a rating from SMERA. However,
NBFCs/finance companies/Nidhis/chit funds etc., are not rated by SMERA.
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The rating certificate issued by SMERA is based on the latest financial statement
available, the site visit report and management interview carried out as on a recent date.
Thus, the validity of SMERA rating of an SME unit is as on a given date and based on
the assumption of a going concern.
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Rating agencies all across the world have often been accused of not
being able to predict future problems. In part, the problem lies in the rating process itself,
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which relies heavily on past numerical data and standard ratios with relatively lower
usage of judgment and understanding of the underlying business or the country
economics. Data does not always capture all aspects of the situation especially in the
complex financial world of today. An excellent example of the meaningless over reliance
on numbers is the poor country rating given to India. Major rating agencies site one of the
reasons for this as the low ratio Indias exports to foreign currency indebtedness. This
completely ignores two issues firstly, India gets a very high quantum of foreign
currency earnings through remittances from Indians working abroad and also services
exports in the form of software exports which are not counted as "merchandise" exports.
These two flows along with other "invisible" earnings accounted for almost US$11bn in
FY 99. Secondly, since India has tight control on foreign currency transactions, there is
very little error possible in the foreign currency borrowing figure. As against this, for a
country like Korea, the figure for foreign currency borrowing increased by US$50bn after
the exchange crisis began. This was on account of hidden forward liabilities through
swaps and other derivative products.
In general, Indian rating agencies have lost some amount of their
credibility in the last two years due to their inability to predict defaults in many
companies, which they had rated quite highly. Sometimes, some of the agencies had an
investment grade rating in place when the company in question had already defaulted to
some of the fixed deposit holders. Further, rating agencies resorted to mass downgrading
of 50-100 companies as a reaction to public criticism, which further eroded their
credibility. The major reasons for these downgrades are as follows :
1) Biased raiting and misrepresentation:
In the absence of quality ratings , credit rating is a curse for capital market industry. To
avoid biased rating ,the expert in rating agency ,carrying out detaild analysisi of the
company , should have no links with the company or the persons intersete din the
company so that they can make their report impartial and judicious recommendation for
rating committee.
2) Static study :
Rating is done on the present and the past historical data of the company and this is only
a sttsic study . prediction of the company health through rating is momentary and
anything can happen after assignment of rating sybols to the company .dependence for
the future result on the rating,therefore defeat the vary purpose of the risk indicative of
the rating.
3) Concealment of material information :
Rating company might conceal material information from the investigating team of the
credit rating company, in such cases quality of rating suffer and renders the rating
reliable.
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Human bias :
Finding of the investigation team at times may suffer from with the human bias for
unavoidable personal weakness of the staff and might effect the rating .
6)
Down grade:
Once the company has been rated and if it is not able to maintain its working result and
performance ,credit rating agency would review the grade or downgrade the rating
resulting into impairing the image of the company .
7)
Validity of rating
Validity of the rating ends with the maturity of a debt instrument and its no longer
subsequently benefits the issuer company becsuse the rating is valid for the life time
of the debt instrument being rated .
8)
Rating done by two different credit rating agencies for the same instrument of the same
issuer company in many cases would not be identical. Such difference is likely to occur
because of the because of the value judgment differences on qualitative aspect of the
analysis in two different rating agencies whereas quantitative analysis might be the same
and identical .
Limitations cont
Corporate earnings fell very sharply due to persistent recessionary conditions prevailing
in the economy. Many of the corporate are in commodity sectors where fluctuations in
selling prices of products can be very sharp - leading to complete erosion of profitability.
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This problem was compounded by the Asian crisis, which led to increased competition
from cheap imports in many product categories.
Rating agencies substantially overestimated financial flexibility of
corporate especially from traditional corporate houses. Much of the financial flexibility
was implicit on raising money from new issues from the capital market, which has been
impossible in the last 3 years.
In the case of finance companies, widespread defaults like CRB and tightening of
regulations made it virtually impossible for them to raise money in any form. These
finance companies had been in the habit of investing in longer term, illiquid assets by
borrowing shorter term fixed deposits. When the flow of credit stopped, they faced
liquidity problems. These were further compounded by defaults by some of the
companies to which they had on lent money.
The experience is no different from the international scenario where
reputed and highly experienced rating agencies like Standard & Poor (S&P) and Moodys
were unable to predict the Asian crisis and had to face the embarrassment of seeing the
credit rating of South Korea as a country go from A+ to BB+ in a short span of 3 months.
By and large, the rating is a very good estimate of the actual creditworthiness of the
company; however, it is not able to predict extreme situations such as the ones described
above, which are unlikely to have been predicted by most investors in any case. Investors
should realize that a credit rating is not sacrosanct and that one has to do ones own due
diligence and investigation before investing in any instrument. They should use the rating
as a reference and a base point for their own effort.
One good way of doing this is examining the behavior of the stock
price in case the stock is listed. As a collective, the market is far smarter at predicting
problems than any credit rating agency. Witness the sharp erosion in stock prices of
companies much before their credit ratings were downgraded. Witness also the fact that
foreign currency bonds from Indian issuers trade at yields lower than countries which
have been rated higher by rating agencies.
Code of Ethics
to be followed by Rating Agencies
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Member Credit Rating Agencies shall put in place systems and procedures to ensure the
following :
1) The proceedings of a credit rating board / rating committee, are kept confidential
at all times, and not revealed to any external parties or agencies. If any records of
the proceedings are made, credit rating agencies must take steps to keep such
records properly safeguarded, except where required to be disclosed by the
provisions of laws or regulations.
2) When the credit rating board decides on a rating, it shall be announced as a joint
decision and the individual votes shall be kept confidential, even if recorded. This
requirement of confidentiality shall apply to rating board members for their own
votes as well.
Member Credit Rating Agencies shall put in place systems and procedures to ensure the
following :
1) When and after a credit rating board / rating committee member or credit rating
agency employee terminates his/her employment or work association with the
rating agency, the requirement of confidentiality with respect to the information
received during the period of work association shall continue as information held
in trust.
2) A credit rating board / rating committee member does not take undue material
advantage of any confidential information received through his or her
participation in a credit rating process. Persons involved in the ratings process
should also be made vigilant to prevent abuse of prior knowledge of ratings
changes.
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2) 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.
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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 risk.
7) 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
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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.
8) 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.
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a matter for further discussion, so that a generally acceptable industry practice emerges.
Once a rating is accepted, it will be published and subsequent changes emerging out of
the monitoring by the agency will be published even if such changes are not found
acceptable by the issuers.
13) 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
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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.
15) Is the rating assigned for an instrument or for the Issuer Company?
The rating is for a particular issue and not for a company. It is, therefore, quite possible
that two instruments issued by the same company carry different ratings, particularly if
maturities are substantially different or one of the instruments is backed by additional
credit reinforcements like guarantees. In many cases, short term obligations, like
commercial paper carry the highest rating even as the long term debt of the same issuer
may be assigned a rating several levels below the highest rating. This is only natural, as
the risk profile changes very dramatically for longer maturities. It is, however, not
unusual for lenders and business counterparties to consider the long term bond rating as a
rating of the issuer.
17) In what way is a credit rating different from an analysis by any financial analyst?
Credit rating is essentially, business analysis, which has a much broader connotation than
financial analysis. One significant factor, which adds value to the analysis of a rating
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agency, is that the rating is normally done at the request of and with the active cooperation of the issuer. So, the rating agency has access to unpublished information and
the discussions with the senior management of issuers give meaningful insights into
corporate plans and strategies. The rating agencies also make necessary adjustments to
published accounts for the purpose of their analysis and juxtapose the issuer against the
backdrop of the industry in question and the general economic environment. And, at the
culmination of this detailed process, the rating emerges as the well considered view of a
dozen or more highly qualified and experienced professionals. The rating agencies
zealously safeguard their independence and scrupulously avoid any conflict of interest
with the various players in the capital market. If any analyst or group of analysts is able
to ensure all these, we probably have another rating agency in the making.
18) Are rating standards specific for each country? If CARE gives AAA and if S&P
assigns AAA, are they at the same level?
CARE rates only Rupee denominated debt while S&P rates debt of any currency. A
CARE AAA rating indicates that the companys rupee debt stands in good comparison to
debt issued by the Government of India (considered safest relatively) and is considered to
be of the best quality. The sovereign ceiling, if any, does not apply. However, all S&P
ratings will have a cap in the form of the rating ceiling for a particular currency
denominated debt.
19) 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 basis, inter-alia, of past performance and all available information (from audited
financial statements, 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
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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.
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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 .
They can best serve markets when they operate independently, adopt and enforce internal
guidelines to avoid conflicts of interest and protect confidential information received
from issuers. Credit rating agencies cannot afford to commit too many mistakes as it the
investors who pays the price for their mistakes. Credit rating agencies should be made
accountable for any faulty rating by panelizing them or even de-recognizing them, if
needed.
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BIBLIOGRAPHY
BOOKS 1) CREDIT RATING DR. JC VERMA.
WEBSITES
1) www.crisil.com
2) www.icra.com
3) www.careratings.com
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