CREDIT RATING

Prof.B.R.Mishra
 Credit Rating-Meaning
• Credit rating is an assessment of the capacity of
an issuer of debt security, by an independent
agency ,to pay interest and repay the principal as
per the term of issue of debt.
• A rating agency collects the qualitative as well as
quantitative data from a company which has to be
rated and assesses the relative strength and
capacity of company to honor its obligations
contained in the debt instrument through out the
duration of the instrument.
• The rating given is based on an objective
judgment of a team of experts from rating agency.
 ----------Meaning
• The ratings are expressed in code number
which can be easily comprehended even by lay
investors.
• The ratings are the quickest way of
understanding a company’s financial standing
without going in to the complicated financial
reports.
• Credit rating is only a guidance to the investor
and not a recommendation to a particular debt
instrument.. (The investment decision of debt
security are based up on YTM, risk tolerance,
Credit risk)
 ----------Meaning
• Credit rating, as it exist in India, is done for
a specific debt security and not for a
company as a whole.
• No rating agency tells that it is an indicator
of the financial status of the company.
• All that a rating agency claims is that the
rating symbols indicates the capacity of
the company to honor the terms of
contract of a debt instrument.
 ----------Meaning
• A debt rating is not a one time evaluation of
credit risk, which can be regarded as valid for
the entire life of the security. It is an ongoing
appraisal.
• Changes in dynamic world of business may
imply a change in risk characteristic of the
security.
• Hence debt rating agencies monitor the
business and financial condition of the issuer to
determine whether modification in rating is
warranted.
 ----------Meaning
• A credit rating does not create a fiduciary
relationship between the rating agency
and the user of rating since there is no
legal basis for such relationship.
 Functions of Credit Ratings
• Superior information on credit risk
(unbiased opinion, professional evaluation,
access to information which is not publicly
available)
• Low Cost Information (Rating firm gathers,
analyses, interprets and summarizes
complex information in simple and readily
understood format for wide public
consumption)
------Functions of Credit Ratings
• Basis for proper risk return trade off (If debt
securities are professionally rated and ratings
enjoy widespread acceptance proper risk return
trade off is established in capital market.)
• Healthy discipline on corporate borrowers
(Public exposure has healthy influence over the
management of the issuer)
• Formulation of Public Policy Guidelines on
Institutional Investment.( can be done with
greater confidence if securities are rated
professionally)
 Benefits of Rating to investors
• Low cost information
• Quick investment decision
• Independent investment decision(investors
do not depend up on advice of financial
intermediaries)
• Investors Protection(The credible and
objective rating agency can provide
increased disclosures, better accounting
standard and improved investors protection)
 Benefits of Rating to Rated
Companies
• Source of additional certificate
• Increase the Investor population
• Forewarns risks (to companies which get
lower rating)
• Encourages financial discipline
• Merchant Bankers job made easy
• Foreign collaborations made easy(Credit
standing can be known easily by rating)
---Benefits to Rated Companies
• Benefits the industry as a whole(small &
unknown companies use rating to instill
confidence in investors, higher rated companies
can raise larger amount of money)
• Lower cost of Borrowing(A company with highly
rated instrument has the opportunity to reduce
the cost of borrowing by quoting lower interest
rate)
• Rating as a marketing tool to create better
image in dealing with customers, lenders,
creditors.
 Credit rating Agencies in India
• CRISIL-Credit Rating Information Service Ltd
• ICRA-Investment information And Credit Rating
Agency of India.
• CARE-Credit Analysis and Research
• FITCH Rating India
• ONICRA- Onida Individual Credit Rating Agency
Ltd
• DCR India-Duff Phelps Credit Rating Pvt Ltd
• SMERA-Small & Medium Enterprise Rating Agency
 International Credit Rating
Agency
• Standard & Poor’s Corporation-USA
• Moody’s Investors service-USA
• Fitch Investors Service-USA
• Duff & Phelps Credit Rating-USA
• Thomson Bank Watch-USA
• IBCA Ltd-United Kingdom
• Canadian Bond Rating Service-Canada
• Japanese Credit Rating Agency-Japan
• Japanese Bond Rating Institute-Japan
 Credit Rating-Symbols-CRISIL
DEBENTURE RATING SYMBOLS
• AAA-Highest Safety
• AA-High Safety (+/=/-)
• A-Adequate Safety (+/=/-)
• BBB-Moderately Safety(+/=/-)
• BB-Inadequate safety(+/=/-)
• B-High risk(+/=/-)
• C-Substantial Risk(+/=/-)
• D-Default
• Preference share rating symbols are identical to
debenture rating symbols except the letters’pf’used.
Credit Rating-Symbols-CRISIL
FIXED DEPOSIT RATING SYMBOLS
• FAAA-Highest Safety
• FAA-High safety(+/=/-)
• FA-Adequate safety(+/=/-)
• FB-Inadequate safety(+/=/-)
• FC-High Risk(+/=/-)
• FD-Default
 Credit Rating-Symbols-CRISIL
SHORT-TERM INSTRUMENTS
• P-1-Highest safety(+/=/-)
• P-2-High safety(+/=/-)
• P-3-Adequate safety(+/=/-)
• P-4-High risk
• P-5-Default
 Credit Rating-Symbols-ICRA
LONG-TERM-DEBT(Debentures ,Bond,Pref
share)
• LAAA-Highest safety
• LAA-High safety(+/=/-)
• LA-Adequate safety (+/=/-)
• LBBB-Moderately safety(+/=/-)
• LBB-Inadequate safety (+/=/-)
• LB-Risk prone(+/=/-)
• LC-Substantial Risk(+/=/-)
• LD-Default extremely speculative
 Credit Rating-Symbols-ICRA
MEDIUM-TERM-DEBT-INCLUDING FDs
• MAAA-Highest safety
• MAA-High safety-(+/=/-)
• MA-Adequate safety-(+/=/-)
• MB-Moderate safety-(+/=/-)
• MC-Risk prone-(+/=/-)
• MD-Default
 Credit Rating-Symbols-ICRA
SHORT-TERM-DEBT-(Including CPs)
A1+/A1-Highest safety
A2+/A2-High safety
A3+/A3-Adequate safety
A4+/A4-Risk Prone
A5-Default
 Credit Rating Process
• Contract between rater and client
• Sending Expert Team to Client’s place
• Data collection (Quantitative, Qualitative)
• Data analysis
• Discussion
• Credit report Preparation
• Submission to “Grading Committee”
• Grade Communication to client
 Rating Framework
• Credit rating aims at providing an opinion on the
relative credit risk (default risk) associated with an
instrument.
• This calls for estimating the cash generation capacity
of the issuer, through primary cash flows operation.
• While doing so, an assessment is also made of the
secondary cash flows available through the sale of
marketable securities. These can be liquidated, if
required to supplement the primary cash flow.
• Secondary cash flows have a greater bearing in the
short-term ratings, while the long term ratings are
generally based on adequacy of primary cash flows.
 Major Factors determining Rating
BUSINESS FACTORS
• Nature of Industry (Low industry risk, high
industry risk)
• Market Position (Product positioning,
perceived quality, proximity to market,
distribution network)
• Efficiency of operation (Operational
efficiency, Relative efficiency)
---Major Factors determining Rating
BUSINESS FACTORS:
• Project Risk (Scale and nature of new
projects)
• Protective Factors (Track record of project
implementation team, experience & quality
of project implementation team, track
record of technology supplier etc)
• Quality of management
---Major Factors determining Rating
FINANCIAL FACTORS
• Financing Policies (Level of leveraging, currency
risk, asset liability matching)
• Flexibility of financial structure (Liquid
investments, unutilized lines of credit, financial
strength of Group companies, market reputation,
relationship with financial institution.)
• Past track record( (Review of previous financial
statements to determine the future cash flow
adequacy)
---Major Factors determining Rating
FINANCIAL FACTORS:
• Quality of accounting policy (accounting
policies, notes to accounts,finacial
evaluation & inter firm comparisons)
• Financial performance indicators
(analyzed for 5 years & comparison with
peers- Profitability,Gearing,Coverage
ratios,liquidity,cash flows)
 IPO Grading/Equity Grading
• The rating of equity issues of companies is
known as equity grading.
• It is aimed at contributing towards
enhancement of the capital mobilizing
process by providing authentic
information, particularly when the
dominant fund raising option is through
equity.
 ICRA’s IPO Grade
• ICRA’s Grading of Initial Public Offerings (IPOs) is a service
aimed at facilitating assessment of equity issues offered to the
public.
• The Grade assigned to any individual IPO is a symbolic
representation of ICRA’s assessment of the “fundamentals” of
the issuer concerned relative to other listed securities.
• IPO Grades are assigned on a five-point point scale, where
IPO Grade 5 indicates the highest grading and IPO Grade 1
indicates the lowest grading, i.e a higher score indicates
stronger fundamentals.
• An IPO Grade is not an opinion on the price of the issue, pre-
or post-listing.
 Why IPO Grading?
• An investor in a hitherto unlisted company may
either have limited access to information on it,
or may find it challenging to appropriately
assess, on the basis of the information
available, its business prospects and risks.
• An IPO Grade provides an additional input to
investors, in arriving at an investment decision
based on independent and objective analysis.
 ------Why IPO Grading?
• In recent times, with the stock market
participation of new and foreign investors
increasing, there is need for greater value-
added information on companies tapping the
capital market and their intrinsic quality .
• In this context, IPO Grades, being simple,
objective indicators of the relative fundamental
positions of the issuers concerned, could help
in both widening and deepening the market.
 IPO Grading-Other Dimension
• As already stated, IPO Grading is NOT a
recommendation to buy sell or hold the securities
Graded.
• Similarly, it is NOT a comment on the valuation or pricing
of the IPO Graded nor is it an indication of the likely
listing price of the securities Graded.
• The IPO grading is a comment on the “fundamentals” of
the company being graded. All other things remaining
equal, an entity with stronger fundamentals and better
growth prospects should be able to generate higher
shareholder returns related indicators in the long run
 ---IPO Grading-Other
Dimension
• The assigned grade would be a one time assessment
done at the time of the IPO and meant to aid investors
who are interested in investing in the IPO.
• While the grading itself is valid for a period of 6 months
from the date of issuance, the grading letter will have a
validity of 2 months from the date of issue and would
need to be revalidated subsequently- there would not be
any additional charges for the revalidation.
• ICRA however reserves the right to change the grading
after the same has been assigned should the
circumstances so warrant.
 ICRA’s –IPO Grading Symbols
• It is intended that IPO fundamentals would be graded on a
five point scale from grade 5 (indicating strong
fundamentals) to grade 1 (indicating poor fundamentals).
• The grade would read as:“ Rating Agency name " IPO
Grade 1 viz ICRA IPO Grade 1.
• The full scale is as follows:
• ICRA IPO Grade 5: Strong fundamentals
• ICRA IPO Grade 4: Above-average fundamentals
• ICRA IPO Grade 3: Average fundamentals
• ICRA IPO Grade 2: Below-average fundamentals
• ICRA IPO Grade 1: Poor fundamentals
 Credit Rating-Drawbacks
• Guidance ,not recommendation
• Based on assumption (Rating is done on
the basis of information provided by the
issuer)
• Competitive Rating (Chance of surrogated
rating-due to completion between rating
firms)
THANK YOU