Credit Rating

• Presented By:-– Pratik Patel– Jay Jariwala– Taral Patel– Sanjay Patel– Ajay Hariyani

Introduction

• Financial markets play the role of efficient intermediary.

• Link between savers and investors, mobilizing capital on one hand, and efficiently allocating them between competing users to the other hand.

• To this an investor can also base the investment decision on the grading offered by credit rating agencies.

Concept of Credit Rating

• A credit rating is a measure used by creditors to determine how much they can trust a certain borrower, whether the borrower is an individual, a corporation, or a country. The credit rating is derived using past financial data or the borrower’s credit history.

• Factors that affect credit rating:– The person’s ability to pay a loan – The amount of credit in existence – Credit history

Credit Rating Meaning

• Credit rating is an indicator that reflects how well or badly individuals and corporations manage their financial matters.

• There are several credit bureaus that compile this kind of information and later on sale it to their clients.

• According to CRISIL, “credit rating is an unbiased and independent opinion as to issuer’s capacity to meet its financial obligations. It does not constitute a recommendation to buy/sell or hold a particular security.”

• According to ICRA,” Ratings are opinion on the relative capacity of timely servicing of corporate debt and obligations. These are not recommendations to buy or sell neither the accuracy nor the completeness of the information is guaranteed.”

Origin of Credit Rating

• The credit rating concept originated in USA.

• In 1860, Henry Vannum poor started publishing financial statics of railroad companies.

• In 1909, Moody’s investor agencies started rating railroad giving more thrust to concept. Since then importance has grown extensively in the global market. System of ratings got institutionalised following the great depression.

• In 1933, the US controller of currency enacted a rule that banks could purchase the securities rated only BBB/BAA or above.

• In 1970, penn central, the largest railroad company in the world went bankrupt with just under $100 million in outstanding commercial paper. This forced investors to ask for rating for commercial paper.

• Consequently, today, almost 100% of the commercial paper volume and 99% of the corporate bond are rated in U.S.A.

Features of Credit Rating

• Specificity.• Relativity.• Guidance.• Not a Recommendation.• Broad Parameters.• No Guarantee.• Quantitative and Qualitative.

Benefits of Credit Rating

• Low cost information• Quick investment Decision• Independent Investment Decision• Investors protection

Benefits to Rated companies

• Source of additional certification• Increase the investors population• Forewarns risks• Encourages financial discipline • Merchant bankers job made easy• Foreign collaborations made easy• Benefits the industry as a whole• Low cost of borrowing• Rating as a marketing tool

Limitations of Credit Rating in India

• The credibility of rating is questionable. For e.g. CARE gave the highest rating to CRB Capital, which failed.

• A frequent revision of grading by credit agencies, that is sometimes upgrading and sometimes downgrading, creates a confusion among investors questioning again the credibility of the expertise of rating agencies.

The ratings done by credit rating agencies are not accepted by the clients. This has led to a competitive relaxation of the eating standards by credit rating agencies. It should be mandatory to obtain at least two ratings as risk perception of rating agencies differ. Both the rating should be mandatory published in the prospectus, advertisements, and newspapers.

Cont…

The rating agencies do not perform an audit but rely solely on information provided by the issuer. If the information provided is inaccurate and incomplete , the rating process is compromised.

Often a credit rating agency high rating to one instrument of a particular company on the one hand and on the other, frequently downgrades the rating of another instrument of the same company.

Rating agencies often fail to correctly predict a borrower’s financial health in the short term. The latest case is the non-convertible debenture (NCD) issue of BPL which was downgraded by CRISIL from A to D in one stroke. In other words, CRISIL downgraded the instrument by 12 stages. The investor, who depends on these ratings, is not given any warning by rating agencies to wind down his investment in time.

Credit Score

• Credit score is a number which lenders use to assess the risk of extending credit to the borrower.

• The FICO score is developed by Fair Isaac Corporation and based on credit files maintained by consumer credit reporting agencies.

• It is widely used by banks, credit unions, insurance agencies, financing companies and other lenders

FICO Score

• 760-850 -EXCELLENT • 700-759 -VERY GOOD • 660-699 -GOOD • 687 -AVERAGE FICO SCORE • 620-659 -NOT GOOD • 580-619 -POOR • 500-579 -VERY POOR

Tips to improve and maintain a good credit

score• If the persons who are managing the

clients’ financial matters are cautious enough to pay all the bills on time, they are doing the best thing to achieve higher credit rating.

• If they make payments late, not only it adversely affects their company's credit rating but also the added interest makes their organization indebted for a longer period of time.

Introduction of Credit Rating Agency

• Credit Rating Agency means any “commercial concern engaged in the business of credit rating of any debt obligation or of any project or programme requiring finance, whether in the form of debt or otherwise, and includes credit rating of any financial obligation, instrument or security, which has the purpose of providing a potential investor or any other person any information pertaining to the relative safety of timely payment of interest or principal.”

SEBI Guidelines for Credit Rating Agency

• The Credit Rating Agency is set up and registered as a company under the Companies Act, 1956.

• It has in its Memorandum of Association, specified rating activity as one of its main objects.

• It has a minimum net worth of rupees five cr.• It has adequate infrastructure.• Its promoters have professional competence, financial

soundness and a general reputation of fairness and integrity in business transactions to the satisfaction of the SEBI.

• The promoters or any director of the CRA is not involved in any legal proceeding connected with the securities market, which may have an adverse impact on the interests of the investors.

• It has employed persons with adequate professional and other relevant experience, as per the SEBI directions.

• Neither the applicant, nor any person directly or indirectly connected with the applicant has in the past been –

• (i) Refused by the SEBI or• (ii) Subjected to any proceedings for a contravention of the

Act or of any rules or regulations made under the Act.• The applicant, in all other respects, is a fit and proper

person for the grant of certificate. Grant of certificate to the applicant is in the interest of investors and the securities market.

• No CRAs shall rate a security issued by its promoters.

• SEBI has decided to incorporate a clause in the listing agreement of stock exchanges requiring companies to cooperate with agencies by providing correct information. Refusal to do so may lead to breach of contract between rating agencies and client.

• Period of validity of the registration shall be 3 years.

 

Growth of Credit Rating Agencies

• 1841- Mercantile Credit Agency (USA)• 1900- Moody’s Investors Services (USA)• 1916- Poor Publishing Company (USA)• 1922- Standard Statistics Company (USA)• 1924- Pitch Publishing Company (USA)• 1941- Standard and Poor (USA)• 1074- Thomson Bank Watch (USA)• 1975- Japanese Bond Rating Institution (JAPAN)• 1987- CRISIL by ICICI (INDIA)• 1991- ICRA by IFCI (INDIA)• 1993- CARE by IDBI (INDIA)

Rating Process Flow Chart

Rating Methodology

• In India, the rating exercise starts at the request of the company.

• The rating of a financial instrument requires a thorough analysis of relevant factors that affect the credit worthiness of the issuer.

• Rating are based on an in- depth study of the industry and an evaluation of the strengths and weakness of the company

Cont…

• Four broad areas for analytical framework.• Business Analysis: This cover an analysis

of industry risk, market position in the country, operating efficiency of the company, legal position.

• Financial analysis: financial analysis includes an analysis of accounting quality, earnings protection, cash flow adequacy, and financial flexibility

Cont...

• Management Evaluation: This includes a study of the track record of the management, the management’s capacity to overcome adverse situations, goals, philosophy, and strategies.

• Fundamental Analysis: this covers an analysis of liquidity management, asset quality, profitability and interest, and tax sensitivity.

Credit Rating Agencies in India

• Credit Rating Information Services of India Limited. (CRISIL)

• Investment Information and Credit Rating Agency of India Limited (ICRA)

• Credit Analysis and Research Limited (CARE)

Credit Rating Information Services of India Limited. (CRISIL)

• CRISIL is India's leading Ratings, Research, Risk and Policy Advisory Company. CRISIL, the first credit agency was set up in January 1998.

• It was started jointly by ICICI & UTI with an equity capital of Rs-4 cr. Each of them holds 18% of the capital.

• Other contributions to the capital are as follows.Asian Development bank 15%LIC, GIC & SBI 5% eachHDFC 6.2%Banks (Indian) 19.25% Banks (Foreign) 13.55%

• CRISIL Ratings is India's largest rating agency, having rated more than 24,541 debt instruments, of more than USD 655 billion (Rs.30,71,459 cr.), issued by over 7938 companies.

• CRISIL has strong 60% penetration in the domestic bond market and a 53% market share in the bank loan rating segment.

• CRISIL Ratings rates virtually every kind of organization, including industrial companies, banks, SMEs, non-banking financial institutions, insurance providers, mutual funds, infrastructure entities, state governments, and urban local bodies. It also rates securitized paper.

Objectives

• To assist both individual & institutional investors in making investment decisions in fixed income securities.

• To enable corporate to raise large amounts at fair cost from a wide spectrum of investors.

• To enable intermediaries in placing their debt instruments with investors by providing them.

CRISIL Group Businesses

RatingsResearchAdvisory

CRISIL Ratings

• CRISIL Ratings plays a leading role in the development of the debt markets in India. The Rating Criteria & Product Development Centre, responsible for policy research, new product development and ratings' quality assurance, has developed new ratings methodologies for debt instruments and innovative structures across sectors.

CRISIL Research

• CRISIL Research is India's largest independent integrated research house providing accurate and reliable research, analysis and forecasts on the Indian economy, industries and companies to over 500 Indian and international clients across financial, corporate, consulting and public sectors.

Advisory

• CRISIL Infrastructure Advisory• CRISIL Infrastructure Advisory blends the

best global practices with analytical excellence and a deep understanding of the local environment to provide policy, regulatory and transaction level advice to governments and leading organizations across sectors.

Investment and Risk Advisory

• CRISIL Risk Solutions: business provides integrated risk management solutions and advice to Banks and Corporate by leveraging the experience and skills of CRISIL in the areas of credit and market risk.

CRISIL Rating Symbols CRISIL Rating Symbols For Long Term Ratings

(Debentures) • AAA:Instruments rated 'AAA' are judged to offer the highest

degree of safety with regard to timely payment of financial obligations. Any adverse changes in circumstances are most unlikely to affect the payments on the instrument

AA: Instruments rated 'AA' are judged to offer a high degree of safety with regard to timely payment of financial obligations. They differ only marginally in safety from `AAA' issues. A: Instruments rated 'A' are judged to offer an adequate degree of safety with regard to timely payment of financial obligations. However, changes in circumstances can adversely affect such issues more than those in the higher rating categories. BBB : Instruments rated 'BBB' are judged to offer moderate safety with regard to timely payment of financial obligations for the present; however, changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal than for instruments in higher rating categories.

Cont…• BB: Instruments rated 'BB' are judged to carry inadequate safety

with regard to timely payment of financial obligations; they are less likely to default in the immediate future than instruments in lower rating categories, but an adverse change in circumstances could lead to inadequate capacity to make payment on financial obligations.

• B: Instruments rated 'B' are judged to have high likelihood of default; while currently financial obligations are met, adverse business or economic conditions would lead to lack of ability or willingness to pay interest or principal.

• C: Instruments rated 'C' are judged to have factors present that make them vulnerable to default; timely payment of financial obligations is possible only if favorable circumstances continue.

• D: Instruments rated 'D' are in default or are expected to default on scheduled payment dates.

• NM: Instruments rated 'NM' have factors present in them, which render the outstanding rating meaningless. These include reorganization or liquidation of the issuer, the obligation being under dispute in a court of law or before a statutory authority etc.

CRISIL Rating Symbols For Fixed Deposits

• FAAA :This rating indicates that the degree of safety regarding timely payment of interest and principal is very strong.

• FAA : This rating indicates that the degree of safety regarding timely payment of interest and principal is strong. However, the relative degree of safety is not as high as for fixed deposits with 'FAAA' ratings.

• FA : This rating indicates that the degree of safety regarding timely payment of interest and principal is satisfactory. Changes in circumstances can affect such issues more than those in the higher rated categories.

• FB: This rating indicates inadequate safety of timely payment of interest and principal. Such issues are less susceptible to default than fixed deposits rated below this category, but the uncertainties that the issuer faces could lead to inadequate capacity to make timely interest and principal payments.

• FC: This rating indicates that the degree of safety regarding timely payment of interest and principal is doubtful. Such issues have factors at present that make them vulnerable to default; adverse business or economic conditions would lead to lack of ability or willingness to pay interest or principal.

CRISIL Rating Symbols For Short Term Instruments

• P1: This rating indicates that the degree of safety regarding timely payment on the instrument is very strong.

• P2: This rating indicates that the degree of safety regarding timely payment on the instrument is strong; however, the relative degree of safety is lower than that for instruments rated 'P1'.

• P3: This rating indicates that the degree of safety regarding timely payment on the instrument is adequate; however, the instrument is more vulnerable to the adverse effects of changing circumstances than an instrument rated in the two higher categories.

• P4: This rating indicates that the degree of safety regarding timely payment on the instrument is minimal and it is likely to be adversely affected by short-term adversity or less favorable conditions.

• P5: This rating indicates that the instrument is expected to be in default on maturity or is in default.

Investment Information and Credit Rating Agency of India

(IICRA)The IICRA was set up by industrial finance corporation of India on 16th January 1991. It is a public ltd company with an authorized share capital of Rs 101 cr. The initial paid up capital of Rs. 3.50 cr. is subscribed by IFC, UTI, LIC, GIC, SBI & 17 other banks. IICRA started its operation from 15thmar. 1991.IICRA was set up by ICICI and other leading investment institutions and commercial banks and financial services companies. IICRA is a Public Limited Company, with its shares listed on the Bombay Stock Exchange and the National Stock Exchange. 

Cont…

• During 09-10 IICRA rated over 3300 debt instruments covering a debt volume of Rs. 17,638 cr.

Objective•Provide information and guidance to institutional and individual investors/creditors.• Enhance the ability of borrowers/issuers to access the money market and the capital market for tapping a larger volume of resources from a wider range of the investing public. • Assist the regulators in promoting transparency in the financial markets . • Provide intermediaries with a tool to improve efficiency in the funds raising process.

Range of Services1. Rating Services :IICRA Rates rupee denominated debt instruments issued by manufacturing companies, commercial banks, non-banking finance companies, financial institutions, public sector undertakings and municipalities, among others.

IICRA also Rates structured obligations and sector-specific debt obligations such as instruments issued by Power, Telecom and Infrastructure companies.

IICRA, along with National Small Industries Corporation Limited (NSIC), has launched a Performance and Credit Rating Scheme for Small Scale Enterprises in India.

2. Grading Services The Grading Services offered by ICRA

employ pioneering concepts and methodologies, and include Grading of Construction Entities, Real Estate Developers and Projects, Healthcare Entities, Maritime Training Institutes, and Initial Public Offers (IPOs).

3. Information Services The Information Services Division focuses

on providing authentic data and value-added products used by intermediaries, financial institutions, banks, asset managers, institutional and individual investors, and others.

4. Research & Publications ICRA has built up a research programme

to analyse contemporary developments that influence the Indian money and finance world. The ultimate objective is to develop analytical models that can explain the inter-related movements of the principal macro-variables that define the monetary and fiscal sector of the Indian economy.

5. The ICRA BulletinMoney & Finance is a periodical

publication directed towards institutions and individuals with an interest in understanding the reasons underlying policy initiatives and outcomes.

IICRA’s Ratings Scale

1. Long-Term rating ScaleAll Bonds, NCDs, and other debt instruments (excluding Public Deposits) With original maturity exceeding one year.

1. LAAA The highest-credit-quality rating assigned by IICRA.

2. LAA The high-credit-quality rating assigned by IICRA.3. LA The adequate-credit-quality rating assigned by

IICRA.4. LBBB The moderate-credit-quality rating assigned by

IICRA. 5. LBB The inadequate-credit-quality rating assigned by

IICRA. 6. LB The risk-prone-credit-quality rating assigned by

IICRA.7. LC The poor-credit-quality rating assigned by IICRA.8. LD The lowest-credit-quality rating assigned by IICRA.

 

2. IICRA’s Medium-Term Rating Scale(only for Public Deposits)

• MAAA The highest-credit-quality rating assigned by IICRA. • MAA The high-credit-quality rating assigned by IICRA.• MA The adequate-credit-quality rating assigned by IICRA. • MB The inadequate-credit-quality rating assigned by IICRA. • MC The risk-prone-credit-quality rating assigned by IICRA. • MD The lowest-credit-quality rating assigned by IICRA.

3. ICRA’s Short-Term Rating ScaleAll instruments with original maturity

within one year.

•A1 The highest-credit-quality rating assigned by IICRA to short-term debt instruments.•A2 The above-average-credit-quality rating assigned by IICRA to short-term debt instruments. •A3 The moderate-credit-quality rating assigned by IICRA to short-term debt instruments. •A4 The risk-prone-credit-quality rating assigned by IICRA to short-term debt instruments.•A5 The lowest-credit-quality rating assigned by IICRA to short-term debt instruments.

Credit Analysis and Research Ltd. (CARE)

The CARE was promoted in 1993 jointly with investment companies, banks & finance companies. CARE was promoted by leading financial institutions, banks and private sector finance companies. Services offered by CARE are –

(1) Credit rating (2) Information service (3) Equity research (4) Rating & Parallel market of LPG & kerosene.

Missions of CARE• To offer a range of high quality services to investors, issuers of debt, equity and other instruments and other participants in the capital market.

•To build a pre-eminent position for ourselves in India in securities analysis, information and related services and to be an international credit rating agency.

•To earn customer satisfaction and investor confidence through fairness and professional excellence.

•To be deeply committed to our customers, our employees and the community in which we serve.

•To apply the most advanced techniques of securities analysis and information and communications technology for ensuring efficiency and high quality.

Cont...•To apply the most advanced techniques of securities analysis and information and communications technology for ensuring efficiency and high quality.

•To provide state-of-the-art services of securities rating, information and related services of international standard.

• To provide state-of-the-art services of securities rating, information and related services of international standard.

Range of Services

1. CARE Research CARE Research & Information Services is an

independent division of CARE. CARE Research services a variety of business research needs with credible, high quality research and analysis on various facets of the Indian Economy and Industries.

The research division has a two pronged objective of providing an in-house support to the ratings division as also high quality sectoral research to financial intermediaries, corporate, analysts, policy makers etc, as an aid to their decision making process.

CARE Research is committed to provide accurate, reliable research to its clients with consistent updates in timeframe.

2. Customized ResearchThe rising level of volatility in complex markets with lots of opportunities to tap necessitates thorough understanding and guidance provided by a well known research firm. To address such needs CARE Research offers need-based solutions by completely checking the facts, market scenario, past trends, etc to help you realize your futuristic goals and transform your businesses.

3. Sector ResearchIn depth analysis of business environment of industry, trends, future direction, coverage on sectors in India,

including updates at regular intervals for a year forward. A dedicated team of sector specialists track various industries on daily basis.

4. Sector ResearchIn depth analysis of business environment of industry, trends, future direction, coverage on sectors in India, including updates at regular intervals for a year forward. A dedicated team of sector specialists track various industries on daily basis.

5. The Research Report includesSWOT analysis of the industry along with three year forward analysis and free updates one year forward. The industry research report incorporates demand/supply situation, price variations, cost estimation, analysis on new and existing policies, business trends, etc.

6. Research Report servicesCARE Research is known as a leading provider of value research. Investors, bankers, analyst, etc use CARE Research reports for in-depth understanding of present situation, issues etc to arrive at opinion. The reports contain high quality data, trends, opinions and outlook. The services are today subscribed to by a vast number of clients.

Credit Rating Scale

Credit Rating of Debt instruments

A.Long/medium term instrumentsCARE AAA Instruments with this rating are considered to be of the best credit quality offering highest safety for timely servicing of debt obligations. Such instruments carry minimal credit risk.CARE AA Instruments with this rating are considered to offer high safety for timely servicing of debt obligations. Such instruments carry very low credit risk.CARE A Instruments with this rating are considered to offer adequate safety for timely servicing of debt obligations. Such instruments carry low credit risk.

CARE BBB Instruments with this rating are considered to offer moderate safety for timely servicing of debt obligations. Such instruments carry moderate credit risk.

CARE BB Instruments with this rating are considered to offer inadequate safety for timely servicing of debt obligations. Such instruments carry high credit risk.

CARE B Instruments with this rating are considered to offer low safety for timely servicing of debt obligations and carry very high credit risk. Such Instruments are susceptible to default.

CARE C Instruments with this rating are considered to be having very high likelihood of default in the payment of interest and principal.

CARE D Instruments with this rating are of the lowest category. They are either in default or are likely to be in default soon.

B. Short term instruments PR1Instruments with this rating would have strong capacity for timely payment of short-term debt obligations and carry lowest credit risk. Within this category, instruments with relatively better credit characteristics are assigned PR1+ rating. PR2Instruments with this rating would have adequate capacity for timely payment of short-term debt obligations and carry higher credit risk as compared to instruments rated higher. PR3Instruments with this rating would have moderate capacity for timely repayment of short term debt obligations at the time of rating and carry higher credit risk as compared to instruments rated higher. PR4Instruments with this rating would have inadequate capacity for timely payment of short-term debt obligations and carry very high credit risk. Such Instruments are susceptible to default.

PR5 The instrument is in default or is likely to be in default on maturity. As instrument characteristics or debt management capability could cover a wide range of possible attributes whereas rating is expressed only in limited number of symbols, CARE assigns'+' or '-' signs to be shown after the assigned rating to indicate the relative position within the band covered by the rating symbol.

Rating Experience of CARE: (As on March 2010)

Total Assignments

Completed

7654

Total Instruments Rated 7206

Total Volume of Debt Rated Rs.23121 bn

Total Issuers Rated 2811

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