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Topics Covered
• What is Credit Rating?
• Meaning
• Nature of Credit Rating
• Types of Credit Rating
• Financial Obligations
• Benefits of Credit Rating
• - Investors
• - Company
• - Financial Intermediaries
• Factors Responsible for the growth of Credit Rating
• Credit Rating Process
• Factors Analyzed for Rating
• Rating System
• Instruments of Credit Rating
• Recent Trends in Credit Rating
• Types of Rating
• Functions of Credit Rating
What is Credit Rating?
A Credit Rating is an opinion on the
Relative degree of risk associated with
Timely payment of interest and principle
on a Debt Instrument
Definition :
“Credit Rating is an assessment of an
entity’s ability to pay its financial
obligations.”
Meaning
i. Assesses the credit worthiness of
business(company)
ii. Based on Financial history and current Assets and
Liabilities
iii. Determined by Credit Rating Agencies
iv. Tells a lender or Investor the probability of the
subject being able to pay back a loan
Nature of Credit Rating
Rating is based on Information
Many factors affect rating
i. Quality of Management
ii. Corporate Strategy
iii. International Environment
Rating by more than one agency
Publication of ratings
Rating of Rating agencies
Rating can be done in symbols
Rating are undertaken only at the request of
the issuers in India
Rating is for instrument and not for issuer
company
Rating is not applicable to equity shares
Time taken in rating process
Success of Rating Agency
Types of Credit Rating
1. Sovereign Credit Rating
i. Sovereign Entity
ii. Risk level of the investing environment
iii. Used by investor looking to invest Abroad
iv. Political Risk into account
2. Short – Term
i. probability factor
ii. Contrast to long-term rating
iii. Commonly used
3. Corporate Credit Rating
i. Financial indicator to potential investors of
debt securities such as bonds
Financial Obligations
1.EMPLOYEE: Salaries, Bonus on time
2.SHAREHOLDERS: Dividend on time
3.GOVERNMENT: Taxes payable on time
4.FINANCIAL INSTITUTION: Installments,
interest
5.CUSTOMERS: Quality products, competitive
price
Benefits of Credit Rating
A. Benefits to investors
i. Minimization of Risks
ii. Risk Recognition
iii. Credibility of Issuer
iv. Ease in Decision Makings
v. Independent Decision Making
vi. Wider Choice
vii. Saving in Time and Resources
viii. Benefits of intensive surveillance
ix. Exploits Market Conditions
B. Benefits to Company
i. Easy to sell
ii. Lower cost of borrowing
iii. Wider Market
iv. Image Building
v. Lower cost of Public Issues
vi. Facilitates Growth
vii. Beneficial to new, unknown and Small
Companies
C. Benefits to Financial Intermediaries
i. Brokers
ii. Agents
iii. Portfolio Managers
Factors Responsible for the growth of
credit rating
i. Growth of information Technology
ii. Globalization of financial markets
iii. Increasing role of capital and money
markets
iv. Inadequate government safety measures
v. Trend towards Privatization
vi. Securitization of debt
Credit Rating Process
1. Receipt of the request
• The process begins with the receipt of formal request for
rating from a company
• Afterwards the rating agency and the issuer company enter
into an agreement which is signed by both
• Agreement covers
- Company will provide all material information to agency
- Agency promises to keep the informational confidential.
- The agreement gives to co. to accept or not the rating.
2. Assignment to Analytical team
• Credit rating agency assigns the rating task to
an analytical team
• Team comprises of to analysts who have
expertise in the relevant business area
• These analysts are responsible for carrying out
the rating assignment
3. Obtaining Information
• The analytical team obtain the information from issuer
company .
• The analytical team analyses the information relating to
the issuer financial statement , cash flow etc
• Analytical team then proceeds to have the detail meeting
with the company’s management .
4.Presentation of finding to rating
committee
• An opinion on the rating is formed and the
finding are ultimately presented to the rating
committee which then decides on the rating
• The rating committee meeting is only aspect of
the process in which the issuer does not
participate directly
5. Communication of decision to the
issuer
• The assigned rating grade is finally
communicated to the issuer along with the
reasons
• In case the issuer is not satisfied with the rating
assigned he can appeal against the assigned
rating
• The rating which are not accepted are rejected
and are not disclosed
6.Dissemination to the public
• Once the issuer accept the rating , the
rating agency disseminate the
information through printed reports
the public
7. Monitoring
• The credit rating agency constantly monitors on
rating with reference to new political , economics &
financial development etc.
• All this information is reviewed regularly .
• Any changes in the rating are made public through
published reports by credit rating agency .
Factors Analyzed for Rating
1. Business Risk Analysis
i. Country and macroeconomic Risk
ii. Industry Risk
iii. Competitive Position
- Market Position
- Diversification
- Operating Efficiency
- Ownership/governance
- Profitability
2. Financial Analysis
i. Accounting
ii. Cash flow adequacy
iii. Financial Governance and policies/risk
tolerance
iv. Liquidity/Short term Factors
3. Management Evaluation
i. Management Goals, plans and strategies
ii. Capacity to overcome unfavorable
conditions
iii. Staff’s own experience and skills, planning
and control system
4. Geographical Analysis
i. Diversification
ii. Subsidies from the government
iii. Undertaken to determine the locational
advantages
5. Regulatory and Competitive Environment
i. Evaluate the impact of
regulation/deregulation on the issuer
company
6. Fundamental Analysis
Includes Analysis of-
i. Liquidity Management
ii. Profitability & Financial Position
iii. Interest and tax rates sensitivity of the
company
Rating System
• Usually expressed in alphabetical or
alphanumeric symbols
• Symbols helps to differentiate between
debt instruments on basis of their
underlying credit quality
A typical Credit Rating Scale
Instruments for Credit Rating
Preference shares issued by a company
Bonds, Debentures issued by Corporate,
Government etc.
Commercial Paper issued by manufacturing
companies, finance companies, banks, and
financial institutions for raising short term
loans
Fixed deposits raised for medium term
ranking as unsecured borrowings
Borrowers who have borrowed money
Individuals
Mutual Fund Debt Scheme
Asset backed securities
Bank Certificate of Deposit
Initial Public Offers (IPO)
Recent Trends in Credit Rating
Country rating
Rating of states
Rating of real estate builders and developers
Chit funds
Industry specific rating
Short term rating
Regulatory trends
1. Country Rating
i. When loan is extended or
major investment made by
international investors,
ii. With the purpose of safety and
security of their investments,
iii. Factors such as Growth rate,
government policies, fiscal
deficit etc. are taken for
making the rating
2. Rating of States
i. Helps the state to attract investors
from India and abroad,
ii. Investors also keen to know about
the safety of their funds while
investing,
iii. If there is positive rating then
foreign and domestic companies
prefer to set project in that states
3. Rating of real estate builders and
developers
i. The credit rating agency
CRISIL start assigning rating
to builders and developers,
ii. For the purpose of helping
prospective buyers,
iii. For these the past experience
of builder, properties built by
builder, financial strength etc.
are taken into account for
taking their final decision,
4. Chit Funds
i. Chit fund company rated on the bases of their ability of
making timely payment of prize money to subscribers,
ii. It helps the chit fund company in better marketing of their
fund and widening of their subscribers,
5. Industry Specific Rating
i. Industry outlook over a short as well as long
term period depending on global and
domestic trends now,
ii. Rating is Not just firm specific
6. Short Term Rating
i. States the probability factor of an individual
going into default within a year,
ii. Rating should be made within one year
7. Regulatory Trends
In India credit rating agencies(CRAs) are regulated by
SEBI. It has been entrusted with the power to oversee all
matters pertaining to the operations of these agencies
operating in capital market so, there are some guidelines
issued by SEBI time to time that are:
(A) SEBI(credit rating agencies) regulations 1999
1.Registration of CRAs,
2.General obligations of CRAs,
3.Restrictions on rating of securities issued by promoters
or by certain other persons and
4.Procedure for action in case of default
(B) Internal audit for credit rating agencies (CRAs)
dated January 06,2010
i. Conducted on a half yearly basis.
ii. Conducted by chartered accountants, company secretaries
or cost and management accountants
iii. Cover all aspects of CRA operations and procedure
iv. Report shall state the methodology adopted, deficiencies
observed, and considerations of response of the
management on the deficiencies
v. Report shall include the summary of operations and of the
audit covering size of operations, number of transactions
audited and number of instances where violations were
observed.
(C) guidelines for credit rating agencies dated may
03,2010
1. Rating Process
2. Default Studies
3. Dealing with conflicting Interest
4. Obligations in respect of Rating
structured finance products
5. Unsolicited Credit Ratings
6. Disclosers
Types of Rating
Education Grading
Real Estate Developers Grading
Broker Quality Grading
Financial Strength Ratings
GVC (Governance & Value Creation) Ratings
Fund Ratings
Recovery Risk Ratings
MFI (Micro Finance Institution) Grading
Functions of a Credit Rating
1. Provides Reliable Information
2. Provides Unbiased opinion
3. Provides information at low cost
4. Statement of risk and return
5. Investor Confidence
6. Best Price
7. Enhance corporate image
8. Formulate public policy
9. Facilitates growth
10. Facilitates stock brokers and other financial
intermediaries
Limitations of Credit Rating
i. Concealment of Material Facts
ii. Static in Nature
iii. No Conclusive Proof of Soundness
iv. Human Bias
v. Rating under Unfavorable Conditions
vi. Lack of Objectivity
vii. Difference in rating grades
