CREDIT RATING

-Kanika Khurana

What is Credit Rating?
• Symbolic indicator of the current opinion of the rating agency regarding the relative ability and willingness of the issuer of a financial (debt) instrument to meet the (debt) service obligations as and when they arise. • Fee-based, primarily issuer-solicited, financial advisory service

Symbolic Indicator
• A simple system of gradation which is easy to understand by investors • Long term debt ratings– Investment Grades: AAA (Highest security), AA (High Safety), A (Adequate Safety), BBB (Moderate Safety) – Sub Investment/ Speculative Grades: BB (Inadequate safety), B (High Risk), C (Substantial Risk), D (Default) – ‘+’ or ‘-’ signs may be assigned to reflect comparative standing within the category • Short term debt ratings– P-1 (Highest safety), P-2 (High safety), P-3 (Adequate Safety), P-4 (Inadequate safety), P-5 (Default) – ‘+’ sign may be assigned to reflect comparative standing within the category • Various other symbols for rating of structured obligations, mutual funds, Indian states, healthcare institutions, real estate developers etc.

Current opinion
• Current- pertains to a specific period of time • Implication- needs to be reviewed

• Opinion- does not amount to recommendation to buy, hold, sell an instrument; • Does not take into account market prices, investors’ risk preferences etc.

Rating agency • Independent professional organizationopinions may differ because analysis is independent • Implication.different ratings for same instrument .

capabilities under stress. financial flexibility. other industry characteristics (demand situation. performance in relation to industry benchmarks. profitability.Level of technology. Inventory and receivables management. liquidity/ cash flow adequacy. trend of margins. litigations etc).) • Business Risk.Track record. size of company • Financial Risk.Growth prospects. parent support. succession plans . accounting quality. bargaining power. leverage. expense levels and profitability. legal position (debt covenants. market position and image of issuer. sensitivity to economic cycles etc. competence. personnel policies.Relative ability & Willingness of issuer • Detailed study of all relevant factors.existing financial position.qualitative and quantitative is essential Rating Methodology for Manufacturing Companies • Industry Risk. past debt service record. industrial relations. earnings prospects • Management Strength.

accretion to reserves. management of problem credits – Liquidity Management: capital structure. credit monitoring. cost and tenor of funds – Asset Quality: Credit risk management systems.Relative ability & Willingness of issuer Rating Methodology for Financial Companies • Regulatory Environment. liquid assets. trends in regulation/ deregulation and their impact on the company • Fundamental Analysis– Capital Adequacy: Net worth vis-à-vis volume and risk profile of assets – Resources: Funding profile.Structure and regulatory framework of the financial system. asset-liability matching – Profitability and financial position: historic profits. spread on funds deployment – Interest and tax rate sensitivity . sector risk and exposure.

pertains to a specific instrument/ facility • Takes into account specific risks/features of the instrument/facility in question .Financial (debt) instrument • Not a general purpose evaluation of the issuer.

any delays/ defaults .(Debt) service obligations • Timely payment of interest as well as principal • Past debt servicing record.

and has an option of not accepting the rating .Fee based. Primarily Issuer Solicited • Mostly done on the request of the issuer/borrower of instrument/facility • Issuer/ Borrower pays a fees to the CRA.

banks and financial institutions • Investor is informed about underlying credit quality of instrument and effect of changes in economic/business conditions or internal factors on the willingness/ability of issuer to repay .Financial Advisory Service • Useful for investors. corporates (borrowers/issuers).

mandatory credit rating of various instruments by RBI/SEBI.) started in 1988 • Since 1991. CARE in 1993. Small and Medium Enterprises Rating Agency (SMERA) in 2005.Credit Rating in India • 1st agency. Phelps Credit Rating India (now FITCH India) in 1995. Brickwork Ratings in 2007 . removal of interest rate restrictions.CR assumed a wider role • ICRA in 1990.CRISIL (Credit Rating Information Services of India Ltd.

Credit Rating Agencies • • • • • • CRISIL ICRA CARE FITCH SMERA Brickwork .

Indian states. Business schools. NBFCs. P-2. P-1. AA etc. has diversified into other advisory services IPO in 1993 Strategic alliance with Standard and Poors (S&P) Group in 1996 • Rates mandated debt obligations of Indian companies. SMEs. real estate developers. • Symbols-AAA.CRISIL • • • • • • Promoted in 1987 by ICICI Ltd and UTI Commenced operations in Jan 1988 Pioneered credit rating in India Largest CRA.. P-3 etc. Grading of healthcare institutions. . chit funds. IPOs etc.

. Equity grading etc. MFIs. LIC.LAAA.ICRA • Promoted by IFCI and other shareolders (UTI. Mutual Funds. LAA etc. A3 etc. corporate governance. A1. GIC. structured finance. A2. • Symbols. HDFC Ltd etc) in 1991 • Entered into MOU with Moody’s Investor Services • Rates mandated debt obligations of Indian companies. SMEs. Grading of IPOs.

PR1. . Grading of IPOs. MFIs etc. CARE AA etc.CARE • Promoted by IDBI jointly with other financial institutions and banks • Commenced operations in 1993 • Has diversified into other financial and advisory services in a very limited way • Rates mandated debt obligations of Indian companies. • Symbols. PR2 etc. SMEs. securitization. insurance companies.CARE AAA. corporate governance.

. incorporated in 1995 • Now a subsidiary of the global rating agencyFITCH • Rates mandated debt obligations of Indian companies. SMEs. Mutual Funds. • Symbols.FITCH • Was a JV between International rating agencyDuff and Phelps. F2 etc. F1. Grading of IPOs etc. AA (ind) etc. structured finance. and JM Financials.AAA (ind).

– Details of company’s principal officers and board members – Analysis of financial statements through accounting ratios. sensitivity analysis. Cash Flow): Standalone and consolidated – Financial projections for the next 3-5 years (P/L.Rating Process.New Issues • Rating Agreement and Assignment of Analytical team • Information from issuer and analysis – Annual reports for past 5 years (P/L. . trend analysis. assessment of repayment capacity etc. inter-firm comparison. Cash Flow) – Copies of loan agreements/ Board resolution for issue of debt/ offer document/ indenture agreement/ sanction letters from banks etc. Bal Sh. Bal Sh.

strategies. marketing strategies. historical performance etc. .Discussion on: – management philosophy and plans covering past and projected financial and operating data – growth plans as reflected in projections covering expenditure on fixed and working capital. financing needs and alternatives.Rating Process. business outlook. sales growth and market demand – risks and opportunities that affect credit quality: competitive position.New Issues • Meeting with Management.

Rating Process.New Issues • Analysis and preparation of rating report – – – – Financial analysis and risk Business and operations analysis Management strength Industry outlook • Rating Committee – Rating report presented – Rating decide after assessment of all factors and key issues – Issuer does not participate in this step .

Rating Process. revised report is put up to committee which may or may not change rating – Issuer may or may not accept final rating • Dissemination to Public – If accepted.New Issues • Communication to issuer – Rating decision communicated along with rationale/ critical analytical factors – May appeal for reconsideration on the basis of new information which addresses concerns / May accept rating – If appealed. CRAs disseminate rating along with rationale for rating .

further information and analysis • Rating report may be prepared and presented to rating committee and rating action (positive/ negative) may be taken . achievement of projections. mergers etc. operating data.Review of rating • Annual Surveillance/ Periodical reviews carried out for all existing ratings • New data sought on political/ financial/ economic trends.Rating Process. internal data of company (results announcement.) • Analysis of preliminary data may suggest need for comprehensive study comprising management meeting. new plans/projects.

when imminent events may lead to a rating change eg. Mergers.Upgrade/downgrade within/outside rating band • Rating Watch/ Credit watch. 4 situations– – – – Positive Negative Stable Developing .Rating Process. Credit watch duration is normally 90 days. pending litigations etc.Review of rating • Rating Action.

What all is rated by Indian CRAs? • • • • • • Debt Ratings Structure Finance Ratings Real Estate Developer Ratings Bond Fund Ratings Bank Loan Ratings Healthcare Institutions Grading • Claims Paying Ability Rating • Mutual Fund Scheme Grading • • • • • • • • • SME Rating Equity Grading Chit Funds Rating IPO Grading Rating of Indian states LPG/ Kerosene Dealers Rating Mutual Fund Grading Corporate Governance Rating Municipal Corporations Rating .

Debt Obligations. certificates of deposits. commercial papers. Bank Loans • Debentures. fixed deposits. working capital loans etc. preference shares. term loans. .

asset backing etc. • 4 major categories: Asset backed Securitisation (ABS). Collateralised Debt Obligation (CDO). under various possible scenarios • Factors: arrangements for payment of instrument like guarantors. Mortgage backed Securitisation (MBS). Future Flow Transaction (FFT) .Structured Finance • Estimation of expected loss (probability of default X severity of loss) to the investor on the rated instrument.

timeliness of delivery) and developer risk (track record. quality of construction. help prospective investors to narrow down on investment options . financial flexibility.Real Estate Developers • Ability of developer to build agreed quality levels within reasonable time and transfer title to customers (specific to a project) • Both project risk (legal title of property. management evaluation) factors are assessed • Help developers mobilize funds for projects and market them. existing financial position.

Bond Fund • Opinion on credit quality of bond funds underlying portfolio holdings (mainly money market instruments) • Factors considered: Credit associated with securities in fund portfolio. Systems and procedures followed by funds. Management quality and expertise .

Collective Investment Schemes • For plantations and other companies • Degree of certainty of the scheme to deliver assured returns in terms of quantity of produce and/or cash (Does not offer comments on quality of produce) .

nursing care • Benefits. hospital mission and policy. • Based on medical specialties. quality of support services. Insurance companies-linking level of premium with grades assigned.Hospitals: improved credibility which enhances potential business revenues. patient rights. suitability of organization for any ailment. recommendation to provide funds to that institution etc. management evaluation. regulatory compliance.Healthcare Institutions • Opinion on relative quality of healthcare delivered by the institution to its patients (Grade is applicable for single facility) • Not an opinion on outcome of any treatment/ surgery. Third-party administrators: objective criteria in selection of hospitals . Patients: ability to choose healthcare institutions on basis of unbiased assessment. financial performance.

Claims Paying Ability • Rating for Insurance Companies giving opinion on ability of insurer to honour policyholder claims and obligations on time • Based on asset-liability management method. • With multiple private players in insurance. management. competitive position. investment strategies etc. rating will help investors in choice of insurance companies and products .

Board structure. stakeholder relations. information disclosure. management processes .ownership structure. financial transparency.Corporate Governance • Opinion regarding extent to which organization accepts and agrees to codes and guidelines of corporate governance practices that serve interests of stakeholders • Aspects examined.

operational efficiency. liquidity. management effectiveness. technological development. competitive position. pas debt servicing record. cash flow trends. government policies relating to industry . financial flexibility.SME Rating • Opinion on relative degree of capability to repay interest and principal • Based on factors like marketing strategies.

Equity Grading • Opinion on relative quality of equity shares on the basis of assessment of underlying fundamentals of the company • Done by ICRA under EPRA (Earnings Prospects and Risk Analysis) Scheme at the instance of issuers .

current leadership and administration) . deficit management strategy. attitude of political parties towards industry. power sector) • Assessment of credit quality of the state and SEBs • Based on economic risk (current finances. availability of infrastructure. labour. reforms. future economic policies. tax policy. performance of its PSUs) and political risk (relationship between state and centre.Rating of Indian States • Ratings have been done mostly on request of foreign infrastructure investors (esp. central support.

relative degree of risk associated with subscription to chit series floated by chit funds • Rating enhances marketability of chits. widens access to subscription and provides objective valuation of its strengths and weaknesses .Chit Funds • Ability to make timely payment of prize money to the subscribers.

LPG/ Kerosene Dealers • To help consumers identify genuine companies before applying for connection • Was made mandatory in 1995 and has to be disclosed in every advertisement • Parameters for assessment include market standing. marketing skills. storage and distribution arrangements. bottling facilities. financial stability .

provide benchmark of performance .Mutual Fund Grading • Independent opinion on performance and risks associated with investing in individual mutual fund schemes • For Investors: opinion on performance. fund’s management. credit quality. meeting of investment objectives • For Intermediaries: offer products matching risk appetite of investors. differentiate various schemes • For AMC: marketing tool. provide informed advice. interest rate sensitivity.

Municipal finances.Administrative and legal structure. quality of administration and management .Municipal Corporations • Evaluation of inherent financial strength of corporation • Factors considered. Debt profile and future borrowing needs. Economic factors and service provision.

IPO Grading • Class Presentation .

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