Credit Rating

A credit rating is an opinion on the future ability

and legal obligation of the issuer to make timely
payments of principal and interest on a specific
fixed income security
Features
(i) Specificity
(ii) Relativity
(iii) Guidance
(iv) Not a recommendation
(v) Broad parameters
(vi) No guarantee
(vii)Quantitative and qualitative
 Advantages
TO ISSUERS
TO INVESTORS 1. Index of faith
1. Information service 2. Wider investor base
3. Benchmark
2. Systematic risk
evaluation
3. Professional and TO INTERMEDIARIES
competent service 1. Efficient practice (e.g. Merchant
Bankers)
4. Easy to understand 2. Effective monitoring (e.g. brokers &
5. Low cost dealers)

6. Efficient portfolio
management TO REGULATORS
1. For policy formulation
 Rating Framework - Factors
1. Business factors
(i) nature of industry - level and volatility of
earnings
(ii) market position – product positioning,
perceived quality of product, distribution network etc.
(iii) Efficiency of operation – cost control
(iv) Project Risk – new projects, diversification
(v) Protective factors – project implementation,
tie-up with raw material sources,
(vi) Quality of management
 Rating Framework - Factors
2. Financial Factors
(i) Financing policies
(ii) Flexibility of financial structure
(iii) Past track record
(iv) Quality of accounting policy
(v) Financial performance indicators
(a) Profitability
(b) Leverage
(c) Coverage ratio
(d) Liquidity
(e) Cash flow
 Rating Methodology
1. Economy Analysis
2. Business Analysis
3. Financial Analysis
4. Management Evaluation
5. Fundamental Analysis
1. Economy Analysis

Economy wide factors

Policy
Environment
Regulatory oversight
2. Business Analysis
Industry risk – demand supply factors, changes
in technology, business cycles, entry barriers
Market position – vis-à-vis its competitors
Operating efficiency – production efficiency,
locational advantages, labor relationships
Legal position – accuracy of information, filing of
forms with regulatory authority
3. Financial Analysis
Past and expected financial performance
Cash flow adequacy
Accounting quality
Financial flexibility
Validity of projections and sensitivity analysis
4. Management evaluation
Track record of management
Goals, philosophy, strategies, control systems,
personnel policies and performance of group
companies
5. Fundamental analysis
Liquidity management – capital structure,
matching of assets and liabilities
Asset quality – composition of assets, credit
management, sector risk
Profitability – profitability ratios, spreads, non-
business income
Interest and tax sensitivity – exposure to interest
rate charges, hedging, tax provisions
 SEBI (Credit Rating Agencies)
Regulations, 1999
• Only commercial banks, public financial
institutions, foreign credit rating agencies are
eligible to promote credit rating agencies
• Rating agencies need a minimum net worth of Rs.
5 crores
• Cannot assess financial instruments of their
promoters or (having any other material
relationship)
• SEBI may impose penalty or cancel registration