Introduction

Credit rating is the opinion of the rating agency on

the relative ability and willingness of the issuer of a
debt instrument to meet the debt service
obligations as and when they arise.

A credit rating estimates the credit worthiness of
an individual,corporation or even a country.
It is an evaluation made by credit bureaus of a
borrowers overall credit history.
A credit rating is also known as an evaluation of a
potential borrowers ability to repay debt,prepared
by a credit burearu at the request of the lender.

Definition of Credit Risk

Credit risk is the risk of default by borrower due to inability and
or unwillingness to repay his debts in accordance with the
agreed terms and conditions.

Credit Risk Rating is a rating assigned to borrowers based on
analysis of their ability and willingness to repay the debt from
the bank.
This rating is assigned on a scale which generally has to 6 to 8
levels.
companies assigned the same credit rating have similar
probability of default.
Better the rating,lower is the probability of default.
The probability of default increases in an exponential manner
as the credit risk rating deteriorates.
Credit Rating

What is Credit Rating?
Credit rating is essentially giving an expert
opinion by a rating agency on the relative
willingness and ability of the Issuer of a debt
instrument to meet the debt servicing
obligation in time and in full.
Credit Rating
Why Credit Rating?

There was an enormous increase in the
demand for capital by companies and
investors had no way to know the credit
quality of the companies whether they were
strong financially, weak in some respects but
more importantly whether they were frauds.
Risk and Credit Rating

All investments are risky and debt instruments carry a
risk less than that of
Equity.

Besides risk on debt instruments is easier to assess but
the residual risk of equity holders is unlimited.
The debt instruments only are thus credit rated.
The risk on these instruments can be known to
investors before investing in these instruments.
Why credit rating (contd)

Generally equities are not rated, as their risk is
not measurable and they being the owners of the
companies have to take the residual risk.

Bonds or debentures or any debt instruments can
be rated issued by companies.
Here again the company is not rated but the
instrument issued by the company is rated,for its
capacity to service that instrument.
Factors determining credit risk

The credit risk of a banks portfolio depends on both
external and internal factors:
External factors can be economy-wide as well as
company specific:
Economy-wide factors are:
State of the economy
wide swings in commodity prices
fluctuations in foreign exchange rates
Trade restrictions
Government policies etc.
Factors determining credit risk

some company specific external factors are:
management expertise
company policies
Labour relations

Factors ..determining credit risk

Internal factors influencing credit risk:
deficiencies in loan policies
deficiencies in appraisal of borrowers
financial position
Lack of risk pricing mechanisms
Ineffective system of monitoring of accounts
Factors ..determining credit risk

A poor credit rating indicates a high risk of
default of a loan and leads to high interest
rate,or the refusal of a loan by the creditor.

It should be noted that a credit rating is
assigned to the investment instrument and
not to the company issuing it as a whole.

CRA & Fitch Ratings (I) Ltd

A Credit Rating Agency is a company that assigns
credit ratings for issuers of certain types of debt
obligations as well as debt instruments.
Fitch Ratings (India) Ltd.
It is also a Rating Agency which is 100% owned
subsidiary of a foreign company.
It is recognized by SEBI for its operation in India.
What does a credit rating agency do?

Approaching a credit rating agency is a good
option for small & medium enterprises given the
problems they face in seeking finance.

Rating agencies assess a firms financial viability
and capability to honour business
obligations,provide an insight into its
sales,operational and financial composition
thereby assessing the risk element and highlights
the overall health of the enterprise.
What does a credit rating agency do?

Rating agencies usually have eight grades
ranging from SME1-8,with 1 denoting the
highest rating and 8 of the lowest.

For providing this service,the agencies charge
a fee based on the firms turnover & ranges
from Rs.44000 to Rs.1.21 lakh.
Credit Rating Agencies

Four Main Credit Rating Agencies in India:
Credit Rating Information Services of India Ltd.
CRISIL)
Credit Analysis & Research Ltd. (CARE)
Investment Information and Credit Rating Agency
of India Ltd. (ICRA)
Investors Service
Fitch Ratings.
CRISIL

CREDIT RATING INFORMATION SERVICES OF INDIA LTD:
Crisil was set up in 1987 jointly by ICICI Ltd. UTI, LIC, GIC
ADB,HDFC Ltd.
In Nov.1983, CRISIL went public with its maiden issue of
shares.
Crisil is to rate on the request of the Issuer company, the
debentures,fixed deposits and borrowing instruments.
It also provides regular corporate reports containing
information on their financial and technical aspects.
CRISIL together with its three subsidiaries provides four
categories of financial services.

CRISIL (contd)

1. Credit Rating Services

2. Advisory Services

3. Credibility, First Rating & Evaluation Services

4. Training Services
CRISIL (CONTD)


CRISIL has also launched several share indices
including NIFTY, Crisil-500 Equity Index and
CRISIL Midcap 200 Equity Index to provide
information to Investors in respect of share
prices of different companies listed at NSE.

ICRA

Investment Information and Credit Rating Agency of
India:
It was promoted in 1991 by IFCI Ltd. Together with UTI,
LIC GIC HDFC Ltd. And commercial banks.
It has entered into MOU with Moodys Investors
Services and provides:
credit education
research and consultancy services to banks,Instns.and
mutual funds in India and
Risk management software.
ICRA (contd)
Objectives of ICRA are to assist issuers in raising
funds in large amount and at a lower cost and to
assist investors in making well informed
decisions.

ICRA Information Services provides exhaustive
and reliable information on different corporate
perspective including company background,
industry overview, operational performance and
Financial performance.
CARE

Credit Analysis & Research Ltd.:
CARE was set up in 1993 by IDBI in
collaboration with other financial
institutions,banks and finance companies.
It provides a variety of products and services
in the area of equity research and credit
rating.
CARE
It provides credit rating in respect of
debentures,fixed deposits,certificate of
deposits, commercial papers etc.

It also provides credit rating in respect of
debentures,fixed deposits,certificates of
deposits,commercial papers etc.
It also provides advisory services in respect of
securitization of debts.
Fitch Ratings India Pvt.ltd.

It is 100% subsidiary of an international rating
agency.

It provides credit rating of loan securitization
programmes also.
Who needs credit ratings?

Commercial Banks
Mutual Funds
Investment Banks
Leasing companies
Insurance companies
Bond Issuers.
Why the need of Credit Rating:

Credit rating is an opinion expressed by an
independent professional organisation,after
making a detailed study of all relevant factors.

Such an opinion is of great assistance to investors
in making investment decisions.
It also helps the issuers of debt instruments to
price their issues correctly and to reach out to
investors & win their confidence.
Why the need of Credit Rating (contd)

Regulators like RBI and SEBI often use credit
rating to determine eligibility criteria for some
instruments.
For example: the RBI has stipulated a
minimum credit rating by an approved agency
for issue of Commercial Paper.

Rating Methodology

A certain methodology is adopted by rating agencies
to ascertain the credit worthiness of the debt
issuers.
In brief,following aspects are taken into consideration
while assigning a rating:
Business Risk Analysis
Industry Risk : Macroeconomic factors, Industry
structure,Industry demand supply,Industry growth
prospects,Industry profitability, Market size, Extent
of competition,Extent of cylical nature,
Regulatory Environment
Rating Methodology (contd)

Market Position : Key competitive
advantages,Brand strength,Product profile,
Pricing power,Distribution Network.
Operational Efficiency : Cost structure,
Technological factors,Access to resources,
Labour Relations,Capacity Utilisation,
Integration (Forward & Backward),R & D
capabilities

Rating Methodology (contd)

Accounting Quality : Accounting Policies,
Reporting and Disclosure,Integrity of Data.

Existing & Future Financial Position:
Capital structure,Profitability Analysis,Debt
protection ratios,Off Balance-sheet
obligations,Liquidity/short-term factors
Working Capital Management..
Rating Methodology (contd)

Cash Flow Adequacy :
Sources & Uses of funds,Cash accruals in relation
to debt payments,Capital expenditure plans,
Funding profile, Working capital needs.
Financial Flexibility :
Bank limits Utilisation,Cash & marketable
securities,Access to capital markets, Relationship
with bankers,Contingency Plan Ability to defer
capital expenditure.

Rating Methodology (contd)

Integrity : Adherence to laws & regulations, Track
record of debt payments,Inter group
transactions,Reputation in financial markets.
Risk Appetite: Financial Policy,Growth Plans,funding
profile,Unrelated diversification,Attitude business risk,
Risk management practices,Competence,Track
record,Consistency of Performance,Success of past
strategies,Quality of Senior Management,Ability to
attract/retain talent.

Rating Methodology (contd)
Governance Practices:
Equitable treatment of shareholders,
Transparency & disclosures, Value creation to
stakeholders,Board composition,Vision.
Project Risk Anaylysis : Project
Evaluation,Project size,Implementation risk,
Funding Risk,Technology Risk,Cost
overruns,contingency..
Rating Methodology (contd)

Govt. support policy role :
Strategic importance to the Govt., Criticality
of sector to economy.
Group support : Relevance of the entity to
the group,Percentage ownership by the
group/promoters,Eco Incentives to the group.



(contd)

To sum up, risk analysis in the above framework
is of immense value not only to the lending bank
but also the borrower entity as also its various
stakeholders viz.investors,
creditors,customers,employees and the Govt.
At the same time the analysis can become a
guideline for the entity towards making the
necessary improvements in various spheres of its
working.
Credit Rating is done for the following schemes/instruments:-
1. Medium/long term debt obligation (debentures, bonds)
2. Fixed deposit schemes
3. Equity grading and assessments
4. Structured obligations
5. Commercial papers
6. Municipal bonds
7. Debt funds
8. Mutual funds schemes
9. Plantation schemes (Collective Investment Schemes)
10. Real estate projects
11. Infrastructure related debt
12. Banks
13. Insurance companies
14. Cellular and basic telecom services
15. Credit enhanced structure rating based on overseas guarantees
16. ADR/GDR issues etc.
Rating: Enhancing Factors
Rating can be enhanced by the following factors:
Leadership position in the market
Consistency in production,turnover and profitability
Consistency in cash flows
Consistency in quality of products
Wide acceptance & uses of the product
Wide market (non dependence on certain regions,
customers)
Wide distribution of network (domestic & overseas)


Rating: Enhancing Factors (contd)

Good quality of receivables
Adherence to norms of corporate governance
such as transparency in accounts,compliance
with accounting standards,compliance with
environment regulations,compliance with
various statutes,dealings with employees,
customers, Govt..,banks etc)
Rating : Enhancing Factors (contd)

Integrity,competence and experience of promoter and
key managerial personnel
Good record of timely implementation of projects
Proven technology to withstand competition
Favourable industry scenario
Strong presence of brand
Low gearing
Favourable key financial ratios like current ratio,
TOL/TNW, PAT/Net Sales, PBDIT/INTT, etc.

Rating : Enhancing Factors (contd)

Strong business model with suitable forward
and backward linkages

Strong risk management system involving
identification of risks attached with every
aspect of business & putting into place
measures to mitigate them to the extent
possible & feasible
Rating : Constraining Factors
Rating can be constrained by the following factors :
Cyclical nature of industry
Dependence on monsoon
Unhedged forex risk
High gearing
Small market share
Inconsistency in production,turnover and profitability
Inconsistency in cash flows
Inconsistency in quality of products
Limited acceptance and uses of the product


Rating : Constraining Factors (contd)

Limited market
Poor quality of receivables
Low on adherence to norms of corporate governance
such as non transparency in accounts,non compliance
with accounting standards,non-compliance with
various statutes, govt. banks etc)
Low managerial competence of promoter & key
managerial personnel.

Rating Methodology (contd)

Unsatisfactory record of timely implementation
of projects.
Outdated techonology
Unfavourable industry scenario
Unfavourable key financial ratios like C/R,
PAT/Net sales etc.
Non existent or incomplete risk management
system

INDICATIVE RATING SCALE


Long term credit facilities What does the ratings
denote?
AAA Highest credit quality rating.
Shows lowest credit risk.
Highest safety for timely
servicing of loan obligations
AA High credit quality rating.
Shows very low credit risk.
High safety for timely servicing
of loan obligations
A Adequate credit quality rating.
Shows low credit risk.
Adequate safety for timely
servicing of loan obligations

BBB Moderate credit quality rating.
Shows moderate credit risk.
Moderate safety for timely
servicing of loan obligations.

B
INDICATIVE RATING SCALE (contd)
Long term credit facilities What does the ratings denote?
BB Inadequate credit quality rating.
Shows high credit risk.
Inadequate safety for timely servicing of
loan obligations
B Risk prone credit quality rating.
Shows very high credit risk.
Low safety for timely servicing of loan
obligations
C Poor credit quality rating.
Very high likelihood of default in servicing
of loan obligations.

D Lowest credit quality rating.
Shows very low prospect of recovery.
Either in default or likely to be in default
soon .
Monitoring & Revision of Ratings
A rating assigned does not remain static forever.
It may go revision due to factors like change in
economic environment,corporate
restructuring,management of the organisation
etc. therefore the need of revision arises.
One needs to note that, a rating is an opinion
given on the basis of information available at a
particular point of time. As time goes by,many
things change affecting the debt servicing
capabilities of the issuer,one way or the other.

Monitoring & Revision of Ratings
(contd)

It is therefore essential that as a part of their
investor service,rating agencies monitor all
outstanding debt issues rated by them.
Each rating agency uses different rating scales for
different kinds of ratings.
Most common rating scales are:
AAA, AA, A,BBB,BB, B, A+ AA+ B+ and so on.

Precautions of Credit Rating

1. Credit ratings are not recommendations to buy or sell or
hold a specified rated security nor are they offered as
guarantees or protections against default. They are
opinions only.
2. Specific credit rating opinions are not intended to
measure many of the other factors that fixed- income
investments must consider in relation to risk such as
liquidity risk,pre-payment risk,interest rate risk,risk of
secondary market loss, or exchange loss risk
3. The rating is specific to the instrument and is not the
rating of the Issuer.

CIBIL

Credit Information Bureau (I) Limited,
Incorporated in the year 2000,plays a vital role
in credit ratings in India.
CIBIL : Indias first credit information bureau
is a repository of information contains the
credit history of commerical & consumer
borrowers.

CIBIL (contd)

CIBIL provides this information to its members in
the form of credit information reports.
CIBIL provides a vital service which allows its
members to make informed,objective and faster
credit decisions.
CIBILs aim is to fulfill the need of credit granting
institutions for comprehensive credit information
by collecting,collating and disseminating credit
CIBIL (contd)

credit information pertaining to both
commercial and consumer borrowers to a
closed user group of members.
Banks, Financial Institutions, NBFCs, Housing
Finance Companies & Credit Card Companies
use CIBILs services.
BENEFITS OF CREDIT RATINGS

To Corporates:
For corporates, a good credit rating enables
them to have lower interest costs,win
confidence of investors.

Also there is a compulsion from the regulators
to have credit rating assigned certain debt
issues.
Benefits of Credit Ratings(contd)

To Investors:
For Investors,it is a boon since they can take
informed investment decisions, can rely on
the issues/offers, they get an ease of selection
of investment products.
Benefits of Credit ratings (contd)
Given the benefits of credit ratings,recently, the
role of rating agencies has come under the
scanner during the global financial crisis,as many
companies and their issues collapsed despite high
rating.
Reasons for this being like,abnormally high
payment of fees to the rating agencies for getting
a high/good rating,biasedness of agencies in
analysis and judgement etc.


Benefits of Credit Rating System
Benefits to Investors Benefits to Issuers Benefits to Regulators
1. Enables the investor to
measure risk associated
with the investment.
1. Helps to market his
instrument.
1. Helps in ensuring that
public money is
mobilized by
fundamentally strong
companies.
2. Helps to trade off
between risk and
reward.
2. Helps to raise money at
relatively lower cost.
2. Helps in differentiating
good companies from
the bad ones without
incurring any financial
burden.
3. Enables to take
decisions based on
independent and
scientific methodology.
3. Inculcates financial
discipline and in creating
good image among the
general public.
3. Helps in taking timely
action on erring
companies.
4. Provides information
relating to the instrument
at no cost.
4. Helps to gain access to
non traditional markets
like ECB, GDR, foreign
financial institutions.
4. Helps in knowing that
the end money is used
for the purposes for
which it was raised.
Credit Rating on personal level

Having a good credit rating is important to
individuals as well since a good credit rating can
help individuals to finance a car, rent an
apartment, obtain employment etc.
Factors that may influence a persons credit
rating are:ability to pay a loan,interest,amount of
credit used, savings patterns,spending
patterns,debt etc.


Benefits of credit rating

Tools for self-improvement:
Another advantage of rating is that the highlighting of
strengths and weaknesses acts as a trigger for self-
correction.

A regular renewal of ratings not only improve a firms
performance but also builds confidence within the
lender fraternity and trading chsannel.

It is like a report card for SMEs.
Benefits of credit rating:Example

Company : STJ Electronics
Turnover : 2010-11 Rs.18 crore
CMD : Binoj Cherian
His company got rated in 2005 for the first time and got an
SE 2B rating which indicates high performance
capability,moderate financial strength.

He has had his firm rated ever since.
Last year the rating improved to SE1-A which implies
highest performance capability and high financial strength.
Example contd:

Benefits derived from rating:

The rating report enabled banks to understand his loan
requirements faster.

He got credit on better terms.

It became easier to request for additional loans from
the Bank.

Conclusion

Credit Rating is the need of the time since
investors should be equipped with easy
methods to make their investment decisions.
If ratings are assigned in a proper,systematic
transparent way,then it will be a boon for
investors and will go a long way in making the
investment world a safe place.
Conclusion (contd)

However, investors should not forget the Contract
Law tenet CAVEAT EMPTOR .
Caveat Emptor means : Let the Buyer beware
It should be forgotten that everything cannot be
guaranteed and investments cannot be risk free.
Investors should observe caution while investing
their money and be aware themselves before
taking their investment decisions.

Conclusion (contd)

The exercise of rating also points towards greater
emphasis on quality of cash flow,proper business
model and adherence to good governance rather
than security coverage.
Unlisted companies,small businesses etc. can
particularly be benefited out of the rating
exercise if only they can make it it as a stepping
stone towards reforming their organisation
structures and management styles.