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 borrower’s overall credit history.
Credit ratings are based on financial history and current assets and
liabilities.
Typically, a credit rating tells a lender or investor the probability of the
subject being able to pay back a loan.
Commercial credit risk is the largest and most elementary risk faced
by many banks and it is a major risk for many other kinds of financial
institutions and corporations as well.
According to CRISIL :
“Credit rating is an unbiased, objective and independent opinion as to an issuer’s
capacity to meet financial obligation.”
Credit rating are not based on mathematical formulas. Instead, credit rating agencies
use their judgment and experience in determining what public and private information
should be considered in giving a rating to a particular company or government.
Poor credit rating indicates – high risk of defaulting.
Origin
The first mercantile credit agency was set up in New York in 1841
to rate the ability of merchants to pay their financial obligations.
Later on, it was taken over by Robert Dun. This agency published its first
rating guide in 1859.
Origin in India
India’s first credit rating agency CRISIL was set up in 29 January 1987.
It is incorporated, promoted by the erstwhile ICICI Ltd along with UTI and
other financial institutions.
Credit Rating Agencies
In India:
Credit Rating and Information Services of India Ltd. (CRISIL)
Investment information and Credit Rating Agency Ltd. (ICRA)
Credit Analysis and Research Ltd. (CARE)
SME Rating Agency of India Ltd. (SMERA)
Onida Individual Credit Rating Agency of India (ONICRA)
Fitch Rating India Limited
Brickwork Ratings
Globally
Moody’s
Standard & Poor ( S & P)
Fitch Ratings
Need
Maintenance of investor’s confidence, since default shatter the
confidence of investors in corporate instruments.
Protect the interest of investors who can not investigate much into
the merits of the debt instruments of a company.
Motivate savers to invest in industry and trade.
Benefits
To Company
Improved corporate image
Good for non popular companies
Act as a marketing tool
Reduced costs of borrowings
Easy to raise resource
Helps in growth and expansion
Benefits to investors
Helps in investment decision
Choice of instruments
Easy understand ability of investment proposal
Dependable credibility of issuer
Advantages of continuous monitoring
Credit Rating Methodology
a) Business Analysis.
b) Financial Analysis.
c) Management Evaluation.
d) Geographical Analysis.
e) Regulatory & Competitive Environment.
f) Fundamental Analysis
a) Business Analysis
a) Industry Risk
b) Market Position
c) Operating efficiency
d) Legal position
e) Size of business
b) Financial Analysis:
a) Accounting quality
b) Earning profitability
c) Cash flow analysis
d) Financial Flexibility
c) Management Evaluation
The effects on company’s performance by-
a) Management goals
a) Plans and strategies.
b) Capacity to overcome unfavourable conditions.
c) Planning and controlling system.
d) Geographical Analysis:
a) Multinational Presence
b) Geographical advantages enjoyed by the company.
c) Regional subsidies.
e) Regulatory and Competitive Environment
a) Structure of the Financial System
b) Regulatory framework of the financial system
f) Fundamental Analysis:
a) Liquidity management
b) Asset quality
c) Profitability and financial position
d) Interest and tax sensitivity
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 25 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.
Grant of Certificate of Registration
SEBI will grant to eligible applicants a Certificate of Registration
on the payment of a fee of Rs 5,00,000 subject to certain
conditions.
Rating Process
The process begins with issue of rating request letter by the issuer of the instrument
and signing of the rating agreement.
CRA assigns an analytical team consisting of two or more analysts one of whom would
be the lead analyst and serve as the primary contact.
Meeting with Management- The analytical team obtains and analyses information
relating to its financial statements, cash flow projections and other relevant
information.
Discussion with management on management philosophy, competitive position,
financial policies and future plans.
Rating Process cont-
Discussions on financial projections based on objectives and growth plan , risks and
opportunities.
Rating committee- after meeting with the management the analysts present their
report to a rating committee which then decides on the rating.
After the committee has assigned the rating, the rating decision is communicated
to the issuer, with reasons or rationale supporting the rating.
Dissemination to the Public: Once the issuer accepts the rating, the CRAs
disseminate it, along with the rationale, to the print media.
Disclosure of rating definitions and Rational.
The rating agency should make public the definitions of the concerned rating along with
symbol
They should also state that the ratings do not constitute recommendation to buy, sell
or hold any securities.
It should provide the public the rational of its rating which covers analysis of various
factors justifying the assessment as well as the risk factors.
Sovereign Credit Rating
A sovereign credit rating is an independent assessment of
the creditworthiness of a country or sovereign entity. Sovereign credit
ratings can give investors insights into the level of risk associated with
investing in the debt of a particular country, including any political risk.
At the request of the country, a credit rating agency will evaluate its
economic and political environment to assign it a rating. Obtaining a good
sovereign credit rating is usually essential for developing countries that
want access to funding in international bond markets.
CRISIL
The first rating agency (CRISIL) ‘Credit Rating Information Services of India Ltd. 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.
Services offered by CRISIL
Credit Rating Services
Advisory Services
Credibility first rating and evaluation Services
Training Services
ICRA Ltd
Information and Credit Rating Services (ICRA) has been promoted by IFCI Ltd as the
main promoter and started operations in 1991.
Other shareholders are UTI, Banks, LIC, GIC, Exim Bank, HDFC and ILFS.
It provides Rating, Information and Advisory services ranging from strategic consulting
to risk management and regulatory practice.
The main objectives of ICRA are to assist investors both individual and institutional in
making well informed decisions
It provides rating services, information services and advisory services.
Fitch Ratings India Ltd
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 symbols/Grades
Rating symbols are a symbolic expression of the opinion/assessment of the credit rating
agency regarding the investment, credit quality, grade of the debt, obligation instrument.
CRISIL rating symbols: The rating symbols of CRISIL with respect debentures, fixed deposits,
short term instruments(CPs), credit assessment, structured obligations, bond funds, bank
loans, collective investment schemes, Indian states, real estate developers are as follows.
Rating symbols for Debentures
High Investment Grade:
AAA-(Triple A ) Highest security- Offer the highest safety against payment of interest
and principal.
AA(Double A) High Safety - Offer high safety against payment of interest and principal.
A- Adequate safety- Offer adequate safety against payment of interest and principal. In
adverse conditions might affect such issues.
BBB(Triple B)- Moderate safety- Offer sufficient safety against payment of interest and
principal. Circumstances may lead to weakened capacity to pay interest and principal.
Speculative grades
BB(Double B)- Inadequate safety- These instruments carry inadequate safety of timely
payment of interest and principal.
B (High risk)- Instruments rated B have greater risk of default.
C (Substantial risk)-Risk of default Repayment can only be expected in favourable
conditions.
D (Default) -Such instruments are extremely speculative and default risk is highest.
Rating symbols for Fixed deposits.
FAAA( F triple A)- Highest safety
FAA( F- double A)- High safety
FA- Adequate safety
FB- Inadequate safety
FC- High Risk
FD- Default
Rating symbols for Short term instruments
P-1 (highest safety)
P-2 (High Safety)
P-3 ( Adequate safety)
P-4 (Inadequate safety)
P-5 (default)
Rating for credit assessment
It indicates the capability of entity to repay the interest and principal as per the terms of
the contract. The rating symbols are as below-
1-Very strong capability
2,3,4- Strong capability
5,6,7- Adequate capability
8,9,10- Inadequate capability
11,12,13 –Poor capability
14- Default
Ratings for bond funds
AAAf – Very Strong Protection against losses
AAf – Strong Protection against losses
Af – Adequate Protection against losses
BBBf – Moderate Protection against losses
BBf – Inadequate Protection against losses
Cf – Vulnerable to credit defaults.
Bank Loan Ratings
BLR-1: strong likelihood of repayment of interest and principal on bank loan.
BLR-2: good likelihood of repayment of interest and principal on bank loan.
BLR-3: satisfactory likelihood of repayment of interest and principal on bank
loan.
BLR-4: moderate likelihood of repayment of interest and principal on bank
loan.
BLR-5: sub standard , vulnerable to loss.
BLR-6: high likelihood of loss.
Credit Rating of Indian States
Rating of the states by the CRISIL represents a landmark in the
diversification of the rating Business in the country.
It has already rated several states.
While assessing a state, CRISIL considers two basic factors:
The Economic Risk and
The Political Risk
Economic Risk
Economic structure of the state and its finances
Macroeconomic performance
Infrastructure
Sector studies
Whether revenue and expenditure patterns are sustainable.
Deficit Management
Degree of dependence on Central support
Tax policy of the state
Performance of Public sector undertakings and their effect on the state’s finances.
Political Risk
Relations between the state and the Centre and its impact on transfer of
resources as well as centre’s influence on political stability in the state.
Various political parties in the state, their economic policies and their
effect on the state’s policies.
Quality of the current leadership and administration.
Ability of the Government to take decisions that are politically difficult.
