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PAPER PRESENTATION

ON

CREDIT RATING





D.RAJ KUMAR
MBA 1ST YEAR
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CONTENTS

  

    
 

 

  


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CREDIT RATING

An Introduction-

The role of financial markets in a market economy is that of an efficient intermediator,

mediating between savers and investors, mobilizing capital on hand and efficiently allocating
them between competing uses on the other.

An investor in search of investment avenues has recourse to various sources of information-

offer documents of the issuer(s), research reports of market intermediaries, media reports etc.
In addition to these sources, Credit Rating Agencies have come to occupy a important role as
information providers, particularly for credit related opinions in respect of debt instruments;
a role that has been strengthened by the perception that their opinions are independent,
objective, well researched and credible.

Merchant bankers, underwriters and other intermediaries involved in the debt market also
found rating useful for planning and pricing the placement of debt instruments.

It was this growing demand on rating services that enabled credit rating agencies to charge
issuers for their services. This was much in variance with the mode of financing used
hitherto-with no fees charged to the issuers, a credit rating agency used to provide rating
information through the sale of their publication and other materials.

Historical perspective: The Origins

The origins of credit rating can be traced to the 1840¶s. Following the financial crisis of 1837,
Louis Tappan established the first mercantile credit agency in New York in 1841. The
agency rated the ability of merchants to pay their financial obligations. It was subsequently
acquired by Robert Dun and its first rating guide was published in 1859. Another similar
agency was set up by John Bradstreet in 1849, which published a ratings book in 1857. These
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two agencies were merged together to form Dun & Bradstreet in 1933, which became the
owner of Moody¶s Investors Service in 1962.

Further expansion of the credit rating industry took place in 1916, when the Poor¶s
Publishing Company published its first ratings, followed by the Standard Statistics Company
in 1922, and Fitch Publishing Company in 1924. The Standard Statistics Company and the
Poor¶s Publishing company merged in 1941 to form Standard & Poor¶s.

Credit Rating: The Concept

Ratings, usually expressed in alphabetical or alphanumeric symbols, are a simple and easily
understood tool enabling the investor to differentiate between debt instruments on the basis of
their underlying credit quality. The credit rating is thus a symbolic indicator of the current
opinion of the relative capability of the issuer to service its debt obligation in a timely
fashion, with specific reference to the instrument being rated. It is focused on communicating
to the investors , the relative ranking of the default loss probability for a given fixed income
investment, in comparison with other rated instruments.

A rating is specific to a debt instrument and is intended as a grade, an analysis of the credit
risk associated with the particular instrument. It is based upon the relative capability and
willingness of the issuer of the instrument to service the debt obligations( both principal and
interest) as per the terms of the contract. Thus a rating is neither a general purpose evaluation
of the issuer, nor an overall assessment of the credit risk likely to be involved in all the debts
contracted or to be contracted by such entity.

The primary objective of rating is to provide guidance to investors/ creditors in determining

a credit risk associated with a debt instrument/credit obligation. It does not amount to a
recommendation to buy, hold or sell an instrument as at does not take into consideration
factors such as market prices, personal risk preferences and other considerations which may
influence an investment decision. The rating process is itself based on certain µgivens.¶ The
agency, for instance, does not perform an audit . Instead It is required to rely on information
provided by the issuer and collected by analysts from different sources, including interactions
in-person with various entities. Consequently, the agency does not guarantee the
completeness or accuracy of the information on which the rating is based.
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The Use of Credit Rating

By Investors

d For the investor, the rating is an information service , communicating the relative
ranking of the default loss probability for a given fixed income investment in
comparison with other rated instruments.

d A professional credit rating agency is equipped with the required skills, the
competence and the credibility, all of which eliminates, or at least minimizes, the role
of µname recognition¶ and replaces it with well researched and scientifically analysed
opinions as to the relative ranking of different debt instruments in terms of their credit
quality.

d A rating provided by a professional credit rating agency is of significance not just for
the individual/small investor but also for an organized institutional investor. Rating
for them provides a low cost supplement to their own in-house appraisal system.

d Large investors may use credit rating spectrum of investment options. Such investors
could use the information provided by rating changes, by carefully watching upgrades
and downgrades and altering their portfolio mix by operating in the secondary
market. Banks in some developed countries use the ratings of other banks and
financial intermediaries for their decisions regarding inter-bank lending, swap
agreements and other counter-party risks.
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By Issuers

d The benefit of credit rating for issuers stems from the faith placed by the market on
the opinions of the rating provided and the widespread use of ratings as a guide for
investment decisions.

d The issuers of rated securities are likely to have access to a much wider investor base
as compared to unrated securities , as a large section of investors not having the
required resources an skills to analyse each and every investment opportunity would
prefer to rely on the opinion of a rating agency.

d The opinion of a rating agency enjoying investor confidence could enable the issuers
of highly rated instruments to access the market even under adverse market
conditions.

d Credit rating provides a basis for determining the additional return( over and above a
risk free return) which investors must get in order to be compensated for the
additional risk that they bear. They could be a useful benchmark for issue pricing.

The differential in pricing would lead to significant cost savings for highly rated instruments.

By Intermediaries

d Rating is a useful tool for merchant bankers and other capital market intermediaries
in the process of planning, pricing, underwriting and placement of issues.

d The intermediaries, like brokers and dealers in securities, could use rating as an input
for their monitoring of risk exposures. Regulators in some countries specify capital
adequacy rules linked to credit rating of securities in a portfolio.
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By Regulators

d Regulatory authorities worldwide have promoted the use of Credit Rating by issuing
mandatory requirements for issuers. Specific rules, for instance restrict entry to the
market of new issues rated below a particular grade, stipulate different margin
requirements for mortgage of rated and unrated instrument and prohibit institutional
investors from purchasing or holding of instruments rated below a particular level.

In India , credit rating has been made mandatory for issuance of the following instruments:

a) as per the requirements of SEBI, public issue of debentures and bonds

convertible/redeemable beyond a period of 18 months need credit rating;

b) as per the guidelines of RBI, one of the conditions for issuance of CP in India is that the
issue must have a rating not below the P2 grade from CRISIL/A2 grade from ICRA/PR2
from CARE;

c) there is a proposal for making the rating of fixed deposit programmes of limited
companies, other than NBFCs also mandatory, by amendment of the Companies
Act,1956.



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CREDIT RATING AGENCIES IN INDIA

The rating coverage in India is not too old, beginning 1987 when the first rating agency,
CRISIL was established. At present there are three main rating agencies ±CRISIL(Credit
Rating and Information Services of India Ltd.),ICRA Ltd. (Investment Information and
Credit Rating Agency of India Limited) and CARE(Credit Analysis and Research). The
fourth rating agency is a JV between Duff & Phelps, US and Alliance Capital Limited ,
Calcutta.

CRISIL:

d It was promoted by ICICI, nationalized and foreign banks and insurance companies in
1987. it went public in 1992 and is the only listed credit rating agency in India.

d In 1996 it entered into a strategic alliance with Standard & Poor¶s to extend its credit
rating services to borrowers from the overseas market. The services offered are
broadly classified as Rating, Information services , Infrastructure services and
consulting.

d Rating services cover rating of Debt instruments-long, medium and short term,
securitised assets and builders. Information services offer corporate research reports
and the CRISIL 500 index. The Infrastructure and consultancy division provide
assistance on specific sectors such as power, telecom and infrastructure financing.

ICRA:

d It was promoted by IFCI and 21 other shareholders comprising nationalized and

foreign banks and insurance companies. Established in 1991 , it is the second rating
agency in India.

d The services offered can be broadly classified as Rating services , Advisory services
and Investment Information services. The rating services comprise rating of debt
instruments and credit assessment.
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ICRA

d Ministry of Finance, Department of Economic Affairs accorded approval for the

establishment of a second Credit Rating and Information Agency in the country to
meet the requirements of companies based in North in 1990.
d The approval was granted subject to the following conditions viz .

(1) The Agency shall be self-supporting after a maximum period of 2 years and
accordingly shall not require any subvention thereafter from IFCI;

(2) The agency should be managerially independent.

(3) The major shareholders are:- Moody¶s Investment Company India private Ltd., IFCI
Ltd., SBI, LIC, UTI, PNB, GIC, Central Bank of India, Union Bank of India,
Allahabad Bank, United Bank of India, Indian Bank, Canara Bank, Andhra Bank ,
Export-Import Bank of India, UCO Bank HDFC Ltd., Infrastructure Leasing and
Financial Services Ltd., Vysya Bank.

d The main objective of ICRA like any other Credit Rating Agency is to assess the
credit instrument and award it a grade consonant to the risk associated with such
instrument.

d ICRA¶s main objectives include providing guidance to the investors/creditors in

determining the credit risk associated with a particular debt instrument or credit
obligation and reflecting independent, professional and impartial assessment of such
instruments/obligations.

d The ratings done by ICRA are not recommendations to buy or sell securities but
culminate symbolic indicator of the current opinion of the relative capability of timely
servicing of the debts and obligations.


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d An issuer can derive multiple advantages from structured finance products like
lowering the cost of funds, accessing new markets and investors on the strength of a
higher rating vis-à-vis a stand-alone corporate credit rating, improving capital
adequacy, reducing asset-liability mismatches and increasing specialization.

d Credit rating is an opinion expressed by an independent professional organisation,

after making a detailed study of all relevant factors.

d Such an opinion will be of great assistance to investors in making investment

decisions.

d It also helps the issuers of debt instruments to price their issues correctly and to reach
out to new investors.

d Regulators like Reserve Bank of India (RBI) and Securities & Exchange Board of
India (SEBI) often use credit rating to determine eligibility criteria for some
instruments.

d For example, the RBI has stipulated a minimum credit rating by an approved agency
for issue of Commercial Paper.

d In general, credit rating is expected to improve quality consciousness in the market

and establish, over a period of time, a more meaningful relationship between the
quality of debt and the yield from it.
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Rating Scale

Standard & Poor's Grade Risk

AAA Investment Lowest Risk

AA Investment Low Risk

A Investment Low Risk

BBB Investment Medium Risk

BB, B Junk High Risk

CCC/CC/C Junk Highest Risk

D Junk In default
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BIBLIOGRAPHY

1. Credit Rating, ICRA ,

2. www.crisil.com

3. www.businessstandard.com

4. Financial services book

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