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CREDIT RATING

presented by,
Balaraj.j
Abhishek Saraf
Introduction: credit rating
Since lot of companies are raising money in the capital market and
each company proposed to raise capital through different types of
securities and debt instruments, it is difficult for the investors to
judge which investment is safer and more reliable investment
opportunity

In order to help the investors make a decision on investments, the
need for an independent and reliable agency was felt with the
objective of rating debt obligation of companies.


ICICI and UTI promoted the credit rating information
service of India in 1988 with the objective of rating debt
obligation of companies

Credit Rating provides a simple system of gradation by
which the relative capacities of companies(borrowers) to
make timely repayment of interest and principal on a
particular type of debt/financial instrument can be noted.

As a fee based financial advisory service, credit rating is,
obviously, extremely useful to investors,
corporate(borrowers), banks and financial institutions



Definition
According to Moodys A 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. The rating measures the
probability that the issuer will default on the security
over its life.
Credit rating agencies in india
u CRISIL(Credit Rating Information Services of India
Ltd)
u ICRA(Information and Credit Rating Services ltd)
u CARE (Credit Analysis and Research Ltd)
u FITCH India

Objective of rating agency

To restore the confidence in the capital market

To provide unbiased assessment of the credit worthiness of the companies issuing debt
instruments.

Provide information about the credit worthiness of corporates at low cost

Provide sound basis for proper risk-return structure

Types of credit rating
CREDIT RATING

FINANCIAL INSTRUMENT
RATING CUSTOMER RATING
BORROWER RATING

BOND RATING

sovereign rating
COMMERCIAL PAPER RATING



RATING PROCESS
New
issue
Issuer
requests a
rating
Rating
agency
sends an
analytical
team
Analytical
team
obtains and
analyses
information
Meet companys
management and
resolve question
Interaction with
a back-up team
for industry
information
Findings
presented to
a rating
committee
Rating
committee
decides on
the rating
Notification
of rating to
issuer
Does issuer wish to
appeal by furnishing
additional data?
Rating is
released
Additional data
provided is reviewed
and rating revised if
necessary
no
yes
Registration
Credit Rating agencies are regulated by SEBI.
Registration with SEBI is mandatory for carrying out the
rating Business.
A registration fee of Rs. 25000 should be paid to SEBI

Promoter
A Credit rating agency can be promoted by:
Public Financial Institution
Scheduled Bank
Foreign Bank operating in India with RBI approval
Foreign Credit Rating agency having at least five years
experience in rating securities
Any company having a continuous net worth of minimum
100 cores for the previous five years.
Eligibility Criteria
Is set up and registered as a company
Has specified rating activity as one of its main objects in its
Memorandum of Association.
Has a minimum Net worth of Rs 5 Crore.
Has adequate Infrastructure
Promoters have professional competence, financial
soundness and a general reputation of fairness and integrity
in Business transactions , to the satisfaction of SEBI.
Has employed persons with adequate professional and other
relevant experience, as per SEBI directions.
SEBI GUIDELINES FOR RATING
The credit rating agencies cannot rate a security issued by
its promoters.
If the debt issues is more than Rs.100crores, dual rating
must compulsorily involve public and rights issue.
The company should provide correct information to the
rating agencies.
The net worth of rating agencies has been fixed at
Rs.5crore.
The rating agencies can choose their own methodology of
operation.
No chairman, director or employee of the promoters shall be
a director, chairman or employee of the rating committee.

Agreement with the client
The CRA should enter into a written agreement with each
client containing ,
o Rights and liabilities of each party w.r.t rating of securities.
o Fee charged
o A periodic review of the rating during the tenure
o Clients agreement to cooperate and provide true, adequate
and timely information.
o Disclosure by CRA to client regarding the rating assigned.
o Clients agreement to disclose the rating assigned in the offer
document for the last 3 years

CRISIL

The first rating agency Credit Rating Information Services of India Ltd. ,
CRISIL, was promoted jointly in 1987 jointly by the ICICI and the UTI.
Other shareholders included ADB, LIC, HDFC Ltd, General Insurance
Corporation of India and several other foreign and Indian Banks.
It pioneered the concept of credit rating in the country and since then
has introduced new concepts in credit rating services and has
diversified into related areas of information and advisory activities.
It became public in 1993.
In 1996, it formed a strategic alliance with S&P rating group.
Principal Objective:: Rate Debt Obligation of Indian
Companies
CRISIL Rates------Debentures, fixed deposit programmes
and short-term instruments like-CP, structural obligations
etc.

CRISIL is the market leader in India & works as a full
service rating agency
The strategic alliance with Standard & Poors, the worlds
leading rating agency helps anticipate new market
challenges.

Services offered by CRISIL
Credit Rating Services
Advisory Services
Credibility first rating and evaluation Services
Training Services

Remarks Debenture Fixed deposit Structured
obligation
Short-term
instruments
Highest safety AAA FAAA AAA(So) P1=very strong safety
High safety AA FAA AA(So) P2=very safety
Adequate safety A FA A(So) P3=adequate safety
Moderate safety BBB ------ BBB(So) P4=minimal safety
Inadequate safety BB FB BB(So) P5=default
High risk B FC B(So)
Substantial risk C ----- C(So)
In dafault D FD D(So)
Rating symbol of CRISIL
ICRA(Investment information and credit raking
agencies
ICRA is sponsored by IFCI jointly with other leading financial institutions and banks and has
become
Operational in September 1991.
Objective: Providing guidance to the investors or creditors in determining the risk associated
with s debt instrument
Rates: debentures, bonds, preference shares, fixed deposits and short-term instrument.
In addition ICRA is an independent and professional company providing investment
information and credit rating services.
Currently ICRA providesa) rating services, b) information services & c)advisory services
Remarks Long-term instruments Medium-term instruments Short-term including
commercial papaer
Highest safety LAAA MAAA A-1
High safety LAA MAA A-2
Adequate safety LA MA ------
Moderate safety LBBB ------ ------
Inadequate safety LBB MB ------
Risk prone L B MC A-4
Substantial risk LC ----- -----
In dafault LD MD A-5
Rating symbol of ICRA
CARE(credit analysis and research limited)

Sponsored by IDBI jointly with Canara Bank, UTI, private sector banks and financial service
companies
Objective:: offer credit rating information and equity research services to Indian Industry and
Institutions.
CARE was incorporated on April 21, 1993.
Rates: all types of debt instruments like CP, fixed deposits, bonds, debentures.

Remarks Long-term instruments Medium-term instruments Short-term including
commercial papaer
Highest investment grade CARE AAA CARE AAA PR-1
Upper investment grade CARE AA CARE AA PR-2
Upper medium invetsment
grade
CARE A CARE A PR-2
Investment grade CARE BBB CARE BB PR-4
Susceptible to default CARE B CARE B
High investment risk with
livelihood of default
CARE C CARE C
Lowest category of default
Or likely to be default
CARE D CARE D PR, default
Rating symbol of CARE
ONICRA(Onida individual credit rating agency)
A private company, set up by Onida finance.
It undertakes rating for credit cards, leasing, hire/purchase
transactions, housing finance and bank finance
Objective::
restore confidence in the capital market,
provide unbiased assessment of the credit worthiness of
the companies issuing debt instruments
Provide information at low cost to the investors
However, ONICRA has been abolished in latter part!!!
DPCR(duff phelps credit rating)
DPCL India Ltd. Is another private sector credit rating agency.
It was set up in 1996.
Already rated a number of companies

FITCH Ratings::
It is the latest entrant in the credit rating Business in the country
as a joint venture between the international credit Rating agency
Duff and Phelps and JM Financial and Alliance Group.
In addition to debt instruments, it also rates companies and
countries on request.
RATING METHODOLOGY
The rating methodology involves an analysis of
industry risk, issuers business and financial risk.
A rating is assigned after assessing all factors that
could affect the credit worthiness of the entity. The
industry analysis is done first followed by the
company analysis.


RATING METHODOLOGY
A large no. of variable affect the quality of rating of a debt instrument of
an organization. The variables are:
History
The rating agency must understand the ownership, size, geographical
spread, product spread and the organizational structure of the issuer.
The history of the issuer could establish its export in certain product
market and thus have a bearing in credit quality.
Accounting quality
The accounting policies followed should strictly adhere to the concepts,
principles and conventions of accounting theory so as to ascertain a true
and fair view of the financial state of affairs of the company.
There are certain areas where the issuer has the freedom to adopt
different financial policies but such a policy should not be oriented to
distort the financial state of affairs of a company with a motive of
influencing the quality of rating.

Business fundamentals
Under the category the issuer company is assessed in the area of its competitive
position as compared to the competitors operating in the similar line.
Its strategies, policies, strengths and weaknesses, goals, diversification
activities, sound track record of profitability and future projections of demand for
output can have an important bearing in rating the debt instruments issued.
Liquidity management
The issuers sources and uses of funds in terms of cost and availability have to
be studied in relation to debt issue. Volatility trends of these parameters are also
studied.
The issuers innovativeness and competitive ability to attract cheaper funds is
also analysed.
Foreign exchange and interest rate risks associated with each source and
management of such risk are scrutinized.
The rating agency must understand the quantity and quality of the liquid assets,
past trends, unutilized refinance limit available, and issuers standing in the
financial market to raise resources quickly.
Projected income and expenses statement as well as balance sheet and cash
flow statements can be computed to have an idea about the liquidity position of
the company.

Quality of management
This is judged by the team of executives, human resource policies,
organizational structure, and the extent of delegation of authority and
responsibility.
The support of group companies could also be important in determining
their success.
The managements attitude towards risk is measured as revealed by the
track record in the choice of segments, dividend policy, accounting
practices, and funding policies.
Quality of assets
Rating agency should analyze the issuers segment of operation, its
competitive environment, market share, risk profile of each segment.
The extent of non-performing assets in the portfolio and the provisions
available to meet any losses from such assets are considered as
important indicators of the quality of the asset.
The more the earning powers of the assets, the more will be the source of
funds generated to the company and more will be the positive impacts
felt in assessing the quality of the debt instruments.
Profitability
The rating agency should determine the probability of
continuance of non-fund based income in relation to sales,
component wise expenses ratios,
operating expenses ratio, and
operating net profit ratios
determined in the past and budgeted figures in the future
would also affect the quality of rating.
Return on equity and on investment
It measures the profitability of equity funds invested in the
firm after payment of taxes.
Whereas the return on total investment measures the
percentage of earnings remaining after payment of taxes.
As a matter of rule of thumb, operating profit as a
percentage of total funds employed should not be less than
the lending rate of a commercial bank.

Capital Structure
To warrant adequate safety the borrowing of the
company as a rule of thumb should not exceed
two times its shareholders fund.
A lower debt equity ratio indicates a higher degree
of protection enjoyed by the creditors and the less
is the likelihood of insolvency.
Then shareholders equity to fixed asset ratio for
the company is analyzed.
If assets are more than the shareholders equity, it
means a part of the assets has been financed by
the borrowed capital deteriorating the quality of
ratings o debt issue.
Past Performance
The increasing trend of revenues, profit after
taxes, net worth and net asset value of the firm
keeping the total investments constant indicates
the financial strength of the firm.


Effect of normal business cycle
The business activities of the firm can be categorized as normal,
recovery, boom, recession, and slump. The rating agency has to
consider the state of economic activity facing the company at the
time of assigning rating to the debt instruments.
A rating, unless changed is valid for the life of the debt instrument
being rated.
However, depending upon new information, the agency may change
the ratings either to be retained, or upgraded, or downgraded and the
change so caused is made public for the benefit of the creditors and
general public.

Interest and debt coverage ratio including tax considerations
Past trends in connection with interest and debt coverage ratio and
payment of taxes are carefully scrutinized.
To warrant adequate safety the firms operating profit before interest
and depreciation should at least be three times the interest
commitments.

Factors Involved in Credit Rating
u Credit rating depends on several factors, some of
which are tangible/numerical and some of which
are judgmental and intangible. These factors include:
Overall fundamentals and earnings capacity of the
company and volatility of the same.
Overall macro economic and business/
industry environment.
Liquidity position of the company (as distinguished
from profits). to meet irrevocable commitments.
Requirement of funds
Financial flexibility of the company to raise funds
from outside sources to meet temporary financial
needs.
Guarantee/support from financially strong external
bodies.
Level of existing leverage (borrowings) and
financial risk.

Advantages of Credit Rating
Benefits to Investors
Safety of investments.
Recognition of risk and returns.
Freedom of investment decisions.
Wider choice of investments
Dependable credibility of issuer
Easy understanding of investment
proposals
Advantages of continuous
monitoring
Benefits the Company
Easier to raise funding
Reduced cost of borrowing
Reduce cost of public issues
Ratings can build up image
Ratings facilitates growth
Recognition to unknown companies
Slide 33
Disadvantages of Credit Rating
Credit rating suffers from the following limitations:
Non-disclosure of significant information
Static study
Rating is no certificate of soundness
Rating may be biased
Rating under unfavorable conditions
Difference in rating grades
Rating becomes update soon, it has to update once in six months.

World countries by Standard & Poor's Foreign Rating
u Dark Green AAA
u Light Green AA
u Celery A
u Yellow BBB
u Orange BB
u Red B
u Dark Red CCC
u Grey - not rated

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