Introduction to Credit Analysis

Course Instructor:
Imran Mahmud
Lecturer
BICM
 Credit risk
Credit risk is the risk of loss resulting from the borrower
(issuer of debt) failing to make full and timely payments of
interest and/or principal.
Credit risk has two components:Default risk , or default
probability
Loss severity: the portion of a bond’s value including
unpaid interest an investor loses.
Loss severity is often expressed as (1 – Recovery rate),
where the recovery rate is the percentage of the principal
amount recovered in the event of default. Expected loss =
Default probability × Loss severity given default
What is Credit Ratings?
A credit rating measures the credit worthiness of a
financial security, a corporation a local government
and even a country
3 methods of credit rating: Probability of default or
Loss in case of default and Scoring method
What is Credit Ratings?
Calculated from financial history, current assets and
liabilities
CRA tells a lender or an investor the probability of the
subject being able to meet payment obligations for the
interest and capital repayments
What is Credit Ratings?
Credit rating is an opinion on;
The relative degree of risk associated with timely
payment of interest and principal On a debt instrument
An opinion on the issuer’s capacity to meet its
financial obligations in a timely manner
Poor Credit Rating
A poor CR indicates that a company or government
has a high risk to default based on the agency's
analysis
Credit Rating Agency
Company responsible for assessing the financial
strength of a company or government entity
Includes domestic and foreign firms
Responsible for providing investors with information
of a companies credit wrothiness
Credit Ratings
Credit rating issued by CRA is an assessment of the
credit worthiness of individual financial securities and
debt issued by corporations, government issued
securities and a country's ability to repay debt
CR are ratings assigned to companies and debt
instruments to gauge the likelihood that a company
will default on obligation to creditors. It gives
investors an idea of the risk associated with loaning
money to the entity
Credit Ratings
CR are forward looking opinions about credit risk;
Agencies opinion about the ability of an issuer to meet
its financial obligation in full time
Uses of Credit Ratings
CR critical to activities of securities market to manage;
Building portfolio
Financial Contracts
Regulatory requirements
Trading
Pricing
Credit Reporting Agencies
Function: provide investors unbiased review and
opinion as credit risk of various securities
Example Activities:
Perform credit and risk analysis to produce ratings
Provide unbiased ratings
Provide quality and dependable information
Provide info to investors at low or no cost
Investors rely on rating to make investment decisions
Ratings published in form of reports
Functions of a credit rating agency
Provide easy to understand information;
Gather complex information and interpret and
summarize in simple and readily understood manner
Provide basis for investment;
An investment rated by a credit rating agency enjoys
higher confidence from investors
Investors can make an estimate of the risk and return
Functions of a credit rating agency
Healthy discipline on corporate borrowers;
Higher credit rating make investment more attractive to
investors
Corporations can borrow money more cheaply if they
maintain a high credit rating on their debt
How Credit Ratings are Established
Adjusted financial data + Other company
specific data + Industry Data

ANALYSIS

Rating Committee Rating and Recommendation

Importance of Credit Ratings
Establish a link between risk and return
Helps in investment decision: Investor uses the ratings
to assess the risk level and compares the offered return
with his expected rate of return
Necessary in view of the growing number of cases of
default
Importance of Credit Ratings
The rating agency regularly reviews the rating given to
a particular instrument. The investor can decide to
keep the instrument or sell it. E.g. If instrument is
downgraded the investor may decide to sell it and if
the rating is maintained the investor may decide to
keep the instrument
Importance of Credit Ratings
Choice of instruments: CR enables an investor to
select a particular instrument from many alternatives
available
Understandability: The CRA gives symbols to
instruments which can easily be understood by
investors
Importance of Credit Ratings
The risk perception of a common investor, in absence
of a credit rating, depends on his familiarity with the
names of company and that they might know about the
company
Saves investors Time and Effort: Not feasible for
corporate issuer to offer every prospective investor the
opportunity to undertake a detailed risk evaluation
Importance of Credit Ratings
Saves investors Time and Effort: For the typical
investor it would be difficult to assess all of the
financial information available to assign their own
ratings
Helps in investor protection; better information
disclosure, transparency etc
Improves Corporate image: Acts as a marketing tool
 Importance of Credit Ratings
Lowers cost of borrowing: Companies with high CRs
will get funds at lower cost from the market. High rating
will enable the company to offer low interest rates on
fixed deposits and other debt instruments. Investors will
accept low interest rate as they prefer low risk
instruments.
Importance of Credit Ratings
Wider audience for borrowing: a company with high
ratings can get wider audience for borrowing. It can
approach institutions, banks, investing companies.
Good for non-popular companies: CR can benefit
non-popular companies as if their CR are good the
public will invest in these companies even if they do
not know these companies
Importance of Credit Ratings
Helps in growth and Expansion: CR enables a
company to grow and expansion as a better CR will
enable a company to get finance easily for growth and
expansion
Therefore, the need for credit ratings in today’s world
is important!!!
Demerits of CRs
Possibility of bias exist: Rating teams try their best to
provide unbiased opinion of the credit quality of the
company but the information collected by the rating
team may be subject to personal bias.
Improper disclosure may happen: the company
being rated may not disclose certain material facts to
the investigating team. This can effect the quality of
the CR
Demerits of CRs
A credit rating is not a guarantee for financial
soundness of the company. Many changes can take
place in the future due to changes in economic,
political, social technological environments.
Problems for new companies: for new companies it
might be hard to collect funds from the market because
it may not be able to prove its financial soundness. So,
it might receive a lower CR
Demerits of CRs
Downgrading by Rating Agency: if the performance
of a company is not as expected then the CRA will
downgrade the instrument. This will affect the image
of the company.
Difference in rating: there are cases where different
CRs are assigned by different CRAs for the same
instrument. This can cause confusion in the minds of
the investor
Disclosure of Ratings
Rating agency should make public the definitions of
the concerned rating along with the symbol
E.g: Bangladesh government rating by S&P is BB-
Registration
Credit rating agencies are regulated by both BB and
BSEC
License is mandatory for carrying out the rating
business
Eligibility Criteria of Credit rating Company
Is set up and registered as a public company
Has specific rating activity as one of its core objects in
its Memorandum of Association
Has a minimum Nepaid up capital of Tk 5 crore
Has adequate infrastructure
Has a CEO, CRO as different person
Credit rating committee CRC has two senior Analyst
with 5 years of experience
A joint venture/technical collaboration with a reputed
foreign CRC for not less than five years
Eligibility Criteria
Promoters have professional competence, financial
soundness and a general reputation of fair integrity in
business transactions
Has employed persons with adequate profession and
other relevant experience
Grant of Certificate of Registration
BSEC will grant to eligible applicants a Certificate of
Registration on the payment of fee
Certificate of registration valid for one year, it is
renewed on payment of fee
Agreement with the client
CRA enters into a written agreement with respective
client
Fee charged
Clients agreement to cooperate and provide true and
adequate and timely information
Disclosure by CRA to client regarding the rating
assigned
Clients agreement to disclose the rating assigned
Monitoring of Ratings
CRA should continuously monitor the rating of
securities/corporations rated by it during its tenor
CRA should disseminate information regarding newly
assigned rating and its changes in the earlier rating
through press release and websites
Global Credit Rating Agencies
Three best known CRAs:
Moody’s Investors services
Standard &Poor’s
Fitch
Credit Rating Scale
Moody’s S&P Fitch Meaning
Aaa AAA AAA Highest Quality
Aa1 AA+ AA+ High quality: VERY Strong
Capacity to meet financial
Aa2 AA AA obligations. It
Differs from the top line
Aa3 AA- AA- rating only in a small degree
A1 A+ A+ High Quality: STRONG but
is somewhat more
A2 A A susceptible to adverse
effects
A3 A- A- Of changes in circumstances
and economic condition
Moody’s S&P Fitch Meaning
Baa1 BBB+ BBB+ Medium Grade: ADEQUATE capacity to meet
financial obligations
But adverse conditions or changing
Baa2 BBB BBB circumstances are more
Likely to lead to a weakened capacity to meet
financial commitments
Baa3 BBB- BBB-

BBB-/Baa3 is the lowest investment grade rating

Ba1 BB+ BB+ Lower medium grade: LESS VUNERABLE

but faces major
Ongoing uncertainties and exposure to adverse
Ba2 BB BB conditions which
Could lead to inadequate capacity to meet
financial commitments
Ba3 BB- BB-
Moody’s S&P Fitch Meaning

B1 B+ B+ Low grade: MORE VULNERABLE

and adverse business
Financial or economic conditions
B2 B B will likely impair its capacity
Or willingness to meet financial
B3 B- B- commitments

Caa CCC CCC Poor Quality: CURRENTLY

VULNERABLE and dependant on
favorable conditions to meet
commitments
Ca CC CC Poor Quality: CURRENTLY
HIGHLY VULNERABLE
C C CURRENTLY HGHY
VULNERABLE to non-payment
D D D Failed to pay anyone or more of its
financial obligations
BANGLADESH
Mandatory Ratings in Bangladesh
BSEC and Central Bank made it mandatory for
different entities to obtain credit ratings on regular
basis
Commercial Banks (regulated by BB)
Insurance companies (regulated by IDRA)
Financial Institutional Ratings
Micro finance Banks (regulated by MRA)
Asset management (regulated by BSEC)
Government Owned Enterprise rating
Securitization rating
Power Project Rating
Why Ratings Made Mandatory?
Commercial banks
 Can raise deposit; rating agencies provide independent
opinion on the likelihood that commercial banks would
not default on their deposit repaying obligations
Insurance Companies
Provide insurance coverage; rating agencies provide
independent opinion that insurance companies will honor
claims
Why Ratings Made Mandatory?
Microfinance Banks
 Can raise deposit; rating agencies provide independent
opinion on the likelihood that microfinance banks would
not default on their deposit repaying obligations
 Asset Managers
Managing investor money; provide an opinion on the
relative capacity of asset managers to manage funds
Why Ratings Made Mandatory?
Leasing Companies
Provide leasing services and also raise deposits; credit
rating agencies provide an independent opinion on the
likelihood that leasing companies would not default on
their deposit repaying obligations
Rating Agencies in Bangladesh
Alpha Credit Rating Limited
ARGUS Credit Rating Services Ltd
Credit Rating Agency of Bangladesh Ltd (CRAB)
Credit Rating Information and Services Ltd (CRISL)
Emerging Credit Rating Ltd
National Credit Ratings Ltd
The Bangladesh Rating Agency Limited
WASO Credit Rating Company (BD) Limited
 Credit category for Borrowers of Banks
Number Grading Short Score
Fully cash secured, secured by
government
1 Superior SUP
guarantee/international bank
guarantee
2 Good GD 85+
3 Satisfactory SAT 80-84
4 Acceptable ACCPT 75-79
5 Fair FA 70-74
6 Watch WA 65-69
7 Marginal MG 60-64
8 Special Mention SM 55-59
9 Substandard SS 45-54
10 Doubtful DF 35-44
11 Bad/Loss BL <35
Credit Methodology for Borrowers of
Banks

Internal Credit Risk

Credit Risk Matrix Credit Risk Grading
Grading (CIB)
 CRAB Methodology for Corporate rating
Broad Rating Broad Rating Sub Factor Sub Factor
Factors Rating Weighting
Factor
weighting

Industry Risk 5% Industry Prospect 5%

Analysis
Business Risk 10% Size and Scale (Total 3%
Analysis Revenue)
Business Model 2%
Competitive Position 3%
Diversification 2%
Operating 5% Regulatory and Political 1.5%
Environment Technological Risk 2.5%
Market Share 1%
Strategy and 5% Financial Policies 2.5%
Financial Policies Business Strategies and Plan 2.5%
Management 5% Competence of Management 5%
Evaluation
Broad Rating Broad Rating Sub Factor Sub
Factors Ratin Factor
g Weightin
Facto g
r
weigh
ting
Corporate 5% Corporate Governance 5%
Governance
Operating 5% EBITDA Margin 2.5%
Performance
EBITDA Trends 2.5%
Financial Strength 45% Leverage & Cash Flow: 22.6%
Debt Ratio (6.8%)
Debt/EBITDA (4.5%)
FCF/Debt (4.5%)
RCF/Debt (6.8%)
Coverage: 9%
FFO + Int exp / Gross Int. Expense
(4.5%)
EBITDA – CAPEX / Gross Int. (4.5%)
Broad Rating Broad Rating Sub Factor Sub
Factors Ratin Factor
g Weightin
Facto g
r
weigh
ting
Financial Strength 45% Financial Flexibility: 6.8%
FFO/ Capital Expenditure (3.6%)
Capital expenditure/Depreciation
allowance (3.2%)
Working Capital Efficiency: 6.8%
Liquidity Ratios (2.3%)
Activity Ratios (4.5%)
Security Risk 5% Security and Collateral Position 2.0%
Analysis
Credit enhancement 1.5%
Legal Certainty 1.5
Relationship Risk 5% Track Record of Banking relationship 5%
Analysis
Broad Rating Broad Rating Sub Factor Sub
Factors Ratin Factor
g Weightin
Facto g
r
weigh
ting
Generic Rating 5% Liquidity Management 2%
Factors
Financial Covenants and triggers 2%
Financial Reporting system and 1%
disclosure
Long
term
Credit
Rating
Scale
of
CRAB
Short
term
Credit
Rating
Scale
of
CRAB