CREDIT RATING

Why Credit Rating?

What is credit rating?

 Opinion on credit quality of a debt instrument.

 Tool to gauge the risk level of instrument.
 Not issuer rating.
 Simple and easily understood.
 To differentiate between debt instruments on the basis
of underlying credit quality.
 Features
 Specificity
 Relativity
 Guidance
 Not a recommendation
 Broad Parameters
 No Guarantee
 Quantitative and Qualitative
 Advantages

 To investors
1. Information service
2. Systematic risk evaluation
3. Professional competency
4. Easy to understand
5. Low cost
6. Efficient portfolio management
7. Other benefits
 To issuers
1. Index of faith
2. Wider investor base
3. Bench mark

 To intermediaries
1. Efficient practice
2. Effective monitoring

 To Regulators
1. Mandatory rating requirements
 Major Issues

1. Investment Vs. Speculative Grades

 Non- investment grade or Speculative grade or junk bonds.

2. Continuous Monitoring
 Constant surveillance during the life of the instrument for any
developments, until it is serviced by the company.

3. Grade Surveillance
 Where any major deviation from the expected trends , the rating
agency put such ratings under grade surveillance.
4. Rating Ceiling
 Sovereign credit ratings give investors insight into the level of
risk associated with investing in a particular country and also
include political risks.
 At the request of the country, a credit rating agency will
evaluate the country's economic and political environment to
determine a representative credit rating.

5. Ownership Considerations
 Ownership by a strong enterprise enhances the credit rating of
an entity.
 Mutual dependence, legal relationship, the entity’s ability to
influence the business of the other, and the importance of the
operation of the subsidiary to the owner.
GLOBAL CREDIT RATING AGENCIES

1. Moody’s investors service (Moody’s)

2. Standard & Poor’s corporation (S&P)
3. Duff and Phelps Credit Rating Co (DCR)
4. Japan Credit rating agency (JCR)
5. IBCA ltd
6. Thomson bank watch
Domestic Credit Rating Agencies

1. CRISIL (Credit Rating and Information Services of

India).
2. ICRA (Investment Information and Credit Rating
Agency of India Ltd)
3. CARE (Credit Analysis and Research)
Regulatory Framework

1. SEBI
2. RBI
3. MoP
1. SEBI
 A public issue of debentures and bonds convertible/ redeemable
beyond a period of 18 months , needs credit rating.

2. RBI
 Conditions for issuance of Commercial paper in India- The issue
must have a rating not below the P2 grade from CRISIL / A2 grade
from ICRA / PR2 from CARE.
 NBFCs having Net Owned funds of more than Rs. 2 crore must get
fixed deposit programmes rated.
 NBFCs to be eligible to raise fixed deposits should have a
minimum rating of : FA from CRISIL/ MA from ICRA/ BBB from
CARE.
 NHB has introduced similar regulations for housing finance
companies.
3. MoP
 The parallel marketers of Liquefied Petroleum Gas (LPG) and
Superior Kerosene Oil (SKO) in India , are subject to mandatory
rating.
 A common approach for rating , and the dealers are categorised
into 4 grades, between 1to 4 , indicating good, satisfactory, low
risk and high risk respectively.

4. ICA- Indian Companies Act

 There is a proposal for making the rating of fixed deposit
programmes of limited companies, other than NBFCs.
Credit rating Process
Rating Methodology
Business Factors
1. Industry Analysis
 Analysis of the industry in the which the firm belongs.
 Most important factor in credit risk assessment.
 Stable business (low risk industry) with lower level of cash
generation- viewed more favourably.
2. Market position
 Competitive position of the issuer need to be examined.
 Product positioning, perceived quality of products or brand
equity, proximity to the markets, distribution network and
relationship.
 Reflects the ability to main/improve its market share.
3. Operational Efficiency
 To control costs at all levels.
 Location of the production units, access to raw materials, scale of
operations, quality of technology, level of integration, experience
and efficiency of the unit.

4. Project risks
 Risk profile influenced by the scale and the nature of new
projects.
 Assessment in greater detail needed of unrelated diversification
into new projects.
 Main risks in new projects- time and costs overruns, non-
completion in extreme cases, financing tie-ups, operational risks,
market risks etc.
5. Protective factors
 Track record of the management in project implementation,
experience and quality of the project implementation team,
experience and track record of technology supplier,
implementation schedule, status of the project etc.

6. Management Quality
 Quality of the management.
 Even when the business conditions are adverse, it is the strength
of the management that provides resilience.
 Detailed discussion on its objectives, plans and strategies,
competitive position, past performance and future outlook of the
business.
Financial Factors
1. Financing policies
 Level of financing risk is determined by the type of funding
policies.
 Future funding requirements, level of leveraging, views on
retaining shareholder control, returns for shareholders, views on
interest rates, asset-liability tenure matching etc.
2. Flexibility of financial structure
 An assessment is also made of the ability of the issuer to draw
on other sources.
 These include liquid investment, unutilized line of credit,
financial strength of group of companies, market reputation,
relationship with other banks and financial institutions, and
investor’s experience of tapping funds from different sources.
3. Past track record
 Past performance of the issuer assessed.
 A detailed review of the previous financial statements made to
determine the future cash flow adequacy for servicing debt
obligations.

4. Quality of accounting policy

 Consistent and fair accounting policy prerequisite for a fair
financial evaluation and inter-firm evaluation.
 Rating analysts review the accounting policies, notes to the
accounts and auditor’s comments in detail.
 Where necessary , rating analyst adjust the financial
statements to reflect the correct position.
5. Financial performance indicators

 Financial performance of the firm spanning over a period of

five years are analyzed for the purpose of comparison with its
peers.
 Better understanding of the industry trends, and determining
the relative position of the issuer.
 Some of the important financial performance parameters that
are analyzed are Profitability, Gearing, Coverage ratios,
Liquidity, Cash flow etc.
EQUITY GRADING

 IPO grading is the grade assigned by a Credit Rating

Agency registered with SEBI, to the initial public
offering (IPO) of equity shares or any other security
which may be converted into or exchanged with equity
shares at a later date.

 The grade represents a relative assessment of the

fundamentals of that issue in relation to the other listed
equity securities in India.
 Five point scale.
IPO grade 1: Poor fundamentals
IPO grade 2: Below-average fundamentals
IPO grade 3: Average fundamentals
IPO grade 4: Above-average fundamentals
IPO grade 5: Strong fundamentals
 
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