Credit Rating

Credit rating

• 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 calculated from 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.

• many uncertain elements are involved in determining both how likely it is that an event of default will happen

• and how costly default will turn out to be if it does occur.

• Credit rating started in USA in the late 19th Century, when early rating agencies began publishing financial analyses on railroad companies.

• Gradually they expanded their reach providing investors on obligations ranging from corporate debt to bank deposits.

• In 1975, SEC established the ‘Nationally Recognized Statistical Rating Organization’ (NRSRO) designation and named ‘Moody’s Investor Services’, ‘Standard and Poor’s’, and ‘Fitch Ratings’ as NRSROs.

• In 2003, the SEC approved a fourth NRSRO, ‘Dominion Bond Rating Services’ (DBRS).

Important factors in the assessment of NRSRO status

• 1. The organizational structure of the rating organization

• 2. The rating organization’s financial resources (to determine, among other things, whether it is able to operate independently of economic pressures or control from the companies it rates.)

• 3. The size and quality of the rating organization’s staff (to determine if the entity is capable of thoroughly and competently evaluating an issuer’s credit).

• 4. The rating organization’s independence from the companies it rates.

• 5. The rating organization’s rating procedures (to determine whether it has systematic procedures designed to produce credible and accurate ratings)

• 6. Whether the rating organization has internal procedures to prevent the misuse of non-public information and whether those procedures are followed.

What is Credit Rating

• An opinion• On the issuer’s capacity• To meet its financial obligations• On a particular issue• In a timely manner

• The history of the ratings industry began in the USA in the late 19th century with the building of the country’s railway system.

• The debt instruments issued by the various railways were a tempting target for risk classification for investors.

• The precursors of bond rating agencies were the mercantile credit agencies, which rated merchants' ability to repay their financial obligations.

• In 1841, Louis Tappan established the first mercantile credit agency in New York.

• Robert Dun, subsequently,acquired the agency and published its first ratings guide in 1859.

• A similar mercantile rating agency was formed in 1849 by John Bradstreet, who published a ratings book in 1857.

• In 1933, the two agencies were consolidated into Dun and Bradstreet, which later acquired ‘Moody's Investors Service’ (in 1962).

• Gradually, the mercantile rating agencies began providing ratings on other financial instruments and securities like bonds, bank deposits and commercial papers.

• Moody’s began by rating railroad bonds (1909), and a year later, extended its ratings activity to utility and industrial bonds.

• The Fitch Publishing Company was established in 1924.

• Standard & Poor’s (S&P) was formed with the merger of Poor's Publishing Company and Standard Statistics Company in 1941.

• The major agencies were either independent or owned by nonfinancial companies.

• Moody's, a subsidiary of Dun and Bradstreet, dominated the market for commercial credit ratings.

• Standard and Poor's was a subsidiary of McGraw-Hill, a major publishing company with a strong business information focus.

• Fitch, initially a publishing company, was bought by an independent investor group in 1989.

• Credit-rating agencies are often regarded as the gatekeepers of the capital markets

• because of the impact of their opinions on the structuring and pricing of financial products.

What Is a Credit Rating?

• A credit rating is an opinion of the general creditworthiness

• of either an issuer or one of the specific issues made by the issuer.

• The rating is based on whatever risk factors the rating agency believes are relevant to the likelihood that the issuer will honor the terms of a financial contract.

• An example of an issuer rating is the rating of a company (e.g., IBM) or organization (e.g., Fannie Mae) or a sovereign country (e.g., Brazil).

• An example of an issue rating is a rating for a specific instrument of an issuer, such as Bell South’s bond with a 6.875 percent coupon and maturity of 2031.

• The risk and, therefore, the rating of an issue will depend on how it is structured in terms of its seniority relative to other issues in the capital structure and in terms of its collateral (i.e., assets pledged as security).

• Because of these structural factors, an issue may receive a different rating than the issuer

The three primary rating agencies are as follows:

• 1. Moody’s Investor Service• 2. Standard & Poor’s• 3. Fitch

• Moody’s and S&P are generally considered the most influential because they have the widest geographical coverage.

• The agencies operate without government mandate, and have remained independent from the investment community.

• It is because of their independence and reputation for being objective that their opinions are accepted as credible by the investment community.

Rating agencies generate their revenues from two primary sources:

• 1. Fees from issuers that solicit ratings for their securities, which consist of both per-issue fees and annual fees.

• The amount of the fee depends on the type and size of security being rated and on the total number of securities of the issuer already rated by the agency.

• For bonds and preferred stock, per-issue fees for both Moody’s and S&P have a minimum of $25,000–$30,000 and a maximum of 225,000–$250,000. Annual fees range from $12,500 to $15,000.

• 2. The sale of research, software, and other proprietary information.

• At first glance, it may seem unusual that rating agencies are able to charge issuers to have their credit quality scrutinized.

• In particular, why should a firm pay to get a low or disappointing rating?

• The alternative, however, is to attempt to issue the security with no rating, which is tantamount to signaling the very poorest of investment quality.

• Over the years, the rating agencies have established a reputation as providing reliable assessments of risk in the capital markets

• —so much so, that a low rating is better than no rating in terms of the price paid for a new issue and the level of demand for the issue.

• On the flip side, receiving a high rating works strongly in an issuer’s favor by signaling to the market that the issue deserves favorable pricing.

• Such signaling would not be credible in the capital markets without the services of a highly reputable third party whose livelihood depends directly on its reputation for accuracy and independence.

Rating Categories

• Ratings are constructed to represent the risk of default; that is, a high (low) rating implies a low (high) probability of default.

• Default refers to any event that results in the issuer’s breaching its financial contract.

• Large companies with strong and stable cash flows are likely to be rated higher than small companies with more volatile cash flows.

• Investment grade refers to the safest levels of financial securities.

• Investment-grade securities have historically exhibited relatively low rates of default.

• Speculative grade, or noninvestment grade, refers to the riskier securities.

• Debt rated BB (Ba for Moody’s) or below is noninvestment grade, and is sometimes referred to as “high yield” or “junk.”

• Default rates among these classes of securities are comparatively high.

• Within the major rating categories (AA, A, etc.), credit ratings are often modified to show relative standing within a category.

• Moody’s uses numbers 1, 2, and 3, while S&P and Fitch use plus (+) and minus (−) signs.

For example, the three tiers of the “triple-B” category are asfollows:

Moody's S&P Fitch

Baa1 BBB+ BBB+

Baa2 BBB BBB

Baa3 BBB- BBBIntermediate

Notching

• Rating agencies recognize the relative risk of securities issued by the same firm by “notching” the issues relative to each other.

• Debt obligations have varying degrees of risk, depending on their priority in a company’s capital structure.

• For example, senior debt has priority over subordinated debt in bankruptcy and will therefore receive a higher rating.

• Similarly, secured debt will receive a higher rating over unsecured debt because of its senior claim.

• A specific example is CSX Corporation, a transportation company headquartered in Richmond, Virginia,

• which received a Moody’s rating for its equipment trust certificates (secured debt) of A1, a rating of Baa2 for its senior unsecured debt, and a Baa3 rating for its subordinated debt.

• Its subordinated debt is said to be rated one notch below its senior debt.

Rating Outlooks

• Rating agencies recognize the possibility that future performance will deviate from initial expectations.

• Rating outlooks address this matter by focusing on scenarios that could result in a rating change.

• For example, a security could be placed on Moody’s Review or S&P’s CreditWatch because of a merger announcement if it has the potential to affect, either adversely or positively, the ability of an issuer to meet its obligations.

• Rating reviews are normally completed within 60 to 90 days or as soon as the situation has been resolved.

The Rating Process

• The first step in the process is for the rating agencies to meet with company management.

• The purpose of this meeting is to discuss the proposed offering, the company’s operating and financial performance and outlook, and a host of other factors that might affect the rating.

• The company’s chief financial officer is the main participant in these discussions, with the chief executive officer participating in any strategy discussions.

• Following this meeting, the rating agencies assign a team of individuals to analyze the transaction.

• This team includes the relevant industry analyst and a product analyst if the security to be rated is specialized.

• The team reviews the offering documents, financial statements, and management’s presentation, which includes the terms of the proposed offering, use of proceeds, historical and pro forma financial analysis, competitive analysis, capital-expenditure plans, etc.

• The rating agency’s analysis, projections, and opinions may vary from those of the company’s management or their investment bankers.

• When the rating team has finished its analysis, a recommendation is made to an internal rating committee that votes on the proposed rating.

• Once the rating is determined, the company is notified and the rationale behind the rating is explained.

• A rating is often assigned within two weeks, depending on the nature of the proposed transaction, the current demand for ratings by other issuers, and the urgency of the company’s request.

• Both Moody’s and S&P allow the company to respond to the rating before it is released to the media, which gives the company the opportunity to appeal and present additional data supporting a higher rating.

• After the final rating is assigned, the industry analyst tracks the company’s performance and adjusts the rating, as appropriate, over time.

• Provided there are no specific concerns or additional issuances of securities,

• the rating agency typically conducts formal quarterly reviews

• and meets with management at least once annually

• to stay current with the company’s development.

Rating Methodology

• Assigning a rating involves a comprehensive review and analysis of a number of important categories of information with respect to the issue or issuer.

• Because ratings are relative measures of default risk,

• it is not surprising that companies with stronger financial measures have higher ratings, on average.

The Role of Ratings in the Capital Markets

• Ratings provide benefits to both issuers and investors. Issuing companies with an investment-grade rating enjoy wide and relatively inexpensive access to capital.

• Many investors, such as insurance companies, can invest only a limited percentage of funds in either speculativegrade or unrated securities.

• Thus, companies that have investment-grade ratings expand their universe of potential investors considerably.

For investors

• For investors, ratings primarily reduce uncertainty. Less uncertainty encourages market growth and greater efficiency and liquidity.

• Ratings also widen investors’ horizons by providing expert analysis of issues or issuers that can be difficult for even the most sophisticated investors to examine.

• Finally, ratings provide benchmark investment limits, so that a pension fund, for example, can manage its risk by stipulating a limit on the percentage of its assets that can be invested in securities below a certain rating.

Standard & Poor's Sovereign Credit Ratings: Scales and Process

S&P’s long-term credit-rating scale establishes a letter-grade hierarchy.

• Ratings include “AAA” (“extremely strong” repayment capacity);

• “AA” (“very strong”); • “A” (“strong”); • “BBB” (“adequate”);• “BB” (“less vulnerable”); • “B” (“more vulnerable”); • “CCC” (“currently vulnerable”);

• “CC” (“currently highly vulnerable”); • “R” (“under regulatory supervision owing to

its financial condition”); • “SD” (“selective default”); • “D” (“default”); • and “NR” (“not rated”).

• Ratings of BBB and above are considered investment grade,

• while ratings of BB and below are non-investment grade, or “speculative” grade.

Short-term credit ratings

• Short-term credit ratings also consist of letter grades, but according to a simpler scale including

• “A-1” (“strong” repayment capacity); • “A-2” (“satisfactory”); • “A-3” (“adequate”); • “B” (“more vulnerable”); • “C” (“currently highly vulnerable”);

• “R” (“under regulatory supervision”); • “SD” (“selective default”); • “D” (“default”); and “NR” (“not rated”).

Rating Outlook

• A rating Outlook “assesses the potential direction of a long-term credit rating over the intermediate to longer term,” addressing “any changes in the economic and/or fundamental business conditions.”

• Outlook categories include “Positive” (rating “may be raised”); “Negative” (“may be lowered”); “Stable” (“not likely to change”); “Developing” (“may be raised or lowered”); and “NM” (“not meaningful”).

• However, an Outlook “is not necessarily a precursor of a rating change or future CreditWatch action

CreditWatch

• The CreditWatch service “highlights the potential direction of a short- or long-term rating,” addressing “identifiable events and short-term trends” resulting in “special surveillance,” which in the case of sovereigns might include referenda or regulatory actions.

• Essentially, a CreditWatch listing means that a noteworthy event has occurred and “additional information is necessary to evaluate the current rating.”

• CreditWatch designations include “positive” (rating “may be raised”); “negative” (“may be lowered”); and “developing” (“may be raised, lowered, or affirmed”).

• As with a rating Outlook, a CreditWatch listing “does not mean a rating change is inevitable,” and

• conversely, “rating changes may occur without the ratings having first appeared on CreditWatch.”

Standard & Poor's Rating Process

• A sovereign seeking a rating establishes a formal relationship with S&P by executing a written agreement governing the rating process.

• S&P sends information regarding its ratings criteria and requests a preliminary set of information from the sovereign.

• The analysts review the various economic and financial data made available to them (at least five years’ worth), budget and economic projections,

• and any available longer-term projections, as well as any analyses on the country “by organizations such as the IMF [International Monetary Fund] and the World Bank

• Typically, a team of two analysts (possibly more if language presents an issue, or if private-sector ratings are being done simultaneously)

• visits a country for three to four days, meeting with representatives of the finance ministry, central bank, and other governmental agencies,

• as well as “individuals and organizations outside the government who are well informed about economic and political trends in the country.”

• Upon completion of their meetings and analyses, the analysts prepare a report for submission to the “rating committee,” which discusses the report and votes on the eventual rating.

• This report generally includes all of the components of the eventual rating package in draft form.

• Once the committee has arrived at a rating the sovereign is notified of the decision,

• and if the government accepts the rating, then S&P issues it to the public

• The sovereign can appeal the rating once, typically providing new information or arguing that certain factors should be weighted differently,

• in which case the committee process is repeated for a final, unappealable decision

• The rating committee considers both “quantitative and qualitative” factors in arriving at a rating decision.

• The process involves ranking the sovereign by a one-to-six scale (one being the best) with respect to each of 10 “analytical categories,” though there is “no exact formula for combining the scores to determine ratings.”

• Specific analytical categories include • political risk; • income and economic structure; • economic growth prospects; • fiscal flexibility; • general government debt burden; • off-budget and contingent liabilities;

• monetary flexibility; • external liquidity; • public-sector external debt burden; • and private sector external debt burden.

• The issue of political risk, a fundamentally qualitative issue, “distinguishes sovereigns from most other types of issuers”;

• a sovereign has significant latitude simply to choose not to repay even when able, leaving creditors with “limited legal redress.”

• S&P has identified certain “key economic and political risks” that weigh heavily on the analysis:

• (1) political institutions and trends, and particularly “their impact on the effectiveness and transparency of the policy environment”;

• (2) economic structure and growth prospects; • (3) government revenue flexibility and expenditure pressures,

deficits and the debt burden, and contingent liabilities; • (4) Foreign exchange position

Corporate debacles

• A wave of corporate scandals emerged in the United States between late 2001 and the end of 2002.

• Hundreds of public corporations restated their financial statements, scores were sued by the SEC, and some executives were criminally prosecuted.

• The failures of Enron and WorldCom, revealed a complete breakdown in all systems of internal control and external monitoring.

• The collapse of two mammoth organizations within a few months of each other undermined the credibility of U.S. credit rating agencies.

• Until four days before Enron declared bankruptcy on December 2, 2001, its debt was rated as “investment grade” by the major credit rating agencies.

• But its debt was actually in junk status.

• Even more than Enron, WorldCom was a skyrocket that soared and then plunged.

• By 2001, WorldCom’s situation had deteriorated, its stock prices had fallen and several underwriters, mainly the commercial banks, downgraded their internal credit ratings,

• but the rating agencies had rated WorldCom’s debt as investment-grade even three months before the company filed for bankruptcy.

• These scandals caused a lot of criticism and public outcry against the efficiency of the rating agencies.

RATING AGENCIES

The External Agency Rating Process

• The issuance of bonds by corporations is a twentieth-century phenomenon.

• Soon after bonds began to be issued, companies such as Moody’s (1909), Standard & Poor’s (1916), and other agencies started to offer independent assessments of how likely it was that particular bonds would repay investors in the way they were intended to do.

• Over the last 30 years,• the introduction of new financial products has

led to the development of• new methodologies and criteria for credit

rating: • Standard & Poor’s (S&P) was the first rating

company to rate mortgage-backed bonds (1975), mutual funds (1983), and asset-backed securities (1985).

• A credit rating is not, in general, an investment recommendation for a given security.

• When rating a security, a rating agency focuses more on the potential downside loss than on the potential upside gain.

In the words of S&P

• “A credit rating is S&P’s opinion• of the general creditworthiness of an obligor,

or the creditworthiness of an• obligor with respect to a particular debt

security or other financial obligation,• based on relevant risk factors.

In Moody’s words

• a rating is, “an opinion on the future ability• and legal obligation of an issuer to make

timely payments of principal• and interest on a specific fixed income

security.”

• S&P and Moody’s have• access to a corporation’s internal information,

and since they are considered• to have expertise in credit rating and are

generally regarded as unbiased• evaluators, their ratings are widely accepted

by• market participants and regulatory agencies.

• Financial institutions, when• required by their regulators to hold

investment-grade bonds, use the ratings• of credit agencies such as S&P and Moody’s to

determine which bonds• are of investment grade.

There are two main classes of ratings

• With issuer credit ratings, the• rating is an opinion on the obligor’s overall

capacity to meet its financial• obligations. In the issuer credit rating category

are counterparty ratings,• corporate credit ratings, and sovereign credit

ratings.

• Another class of• rating is issue-specific credit ratings. In this case,

the rating agency makes• a distinction, in its rating system and symbols,

between long-term and• short-term credits. The short-term ratings apply

to commercial paper (CP),• certificates of deposit (CD), and put bonds. • The rating is of a specific issue, and not the

issuer.

• In rating a specific issue, the attributes of the issuer, as well as the specific terms of the issue, the quality

• of the collateral, and the creditworthiness of the guarantors, are taken

• into account.

• The rating process includes quantitative, qualitative, and legal analyses.

• The quantitative analysis is mainly financial analysis and is based on

• The firm’s financial reports. The qualitative analysis is concerned with the

• quality of management; it includes a thorough review of the firm’s competitiveness

• within its industry as well as the expected growth of the industry

• and its vulnerability to business cycles, technological changes,

• regulatory changes, and labor relations.

Process of rating an industrial company

• The analyst works through sovereign and macroeconomic

• issues, industry outlook, and regulatory trends, to specific attributes

• (including quality of management, operating position, and financial

• position), and eventually to the issue-specific structure of the financial instrument.

• The assessment of management, which is subjective in nature, investigates

• how likely it is that management will achieve operational success

• and takes the temperature of its tolerance for risk. The rating process

• includes meetings with the management of the issuer to review operating

• And financial plans, policies, and strategies.

• All the information is reviewed• and discussed by a rating committee with

appropriate expertise in the relevant• industry, which then votes on the

recommendation. The issuer can• appeal the rating before it is made public by

supplying new information.• The rating decision is usually issued four to six

weeks after the agency is• asked to rate a debt issue.

Moody’s Rating Analysis of an Industrial Company

• Issue Structure• Company Structure• Operating/Financial Position• Management Quality• Industry/Regulatory Trends• Sovereign/Macroeconomic Analysis

• Usually the ratings are reviewed once a year based on new financial

• reports, new business information, and review meetings with management.

• A “credit watch” or “rating review” notice is issued if there is reason to

• believe that the review may lead to a credit rating change. A change of

• rating has to be approved by the rating committee.

Credit Ratings by S&P and Moody’s

• Standard & Poor’s (S&P) is one of the world’s major rating agencies, operating in more than 50 countries.

• Moody’s operates mainly in the United States but has many branches internationally

• Issues rated in the four highest categories (i.e., AAA, AA, A, and BBB for S&P

• and Aaa, Aa, A, and Baa for Moody’s) • are generally considered to be of investment

grade.

• Some financial institutions,• for special or approved investment programs, are

required to invest only• in bonds or debt instruments that are of

investment grade. Obligations• rated BB, B, CCC, CC, and C by S&P (Ba, B, Caa,

Ca, and C by Moody’s)• are regarded as having significant speculative

characteristics. BB (Ba in• Moody’s) is the least risky, and C is the most

risky.

• S&P uses plus or minus signs to modify its AA to CCC ratings in

• order to indicate the relative standing of a credit within the major rating

• categories. Similarly, Moody’s applies numerical modifiers 1, 2, and 3 in

• each generic rating classification from Aa through Caa. The modifier 1,

• for example, indicates that the obligation ranks at the higher end of its

• generic rating category; thus B1 in Moody’s rating system is a ranking

• equivalent to B! in S&P’s rating system.

How accurate are agency ratings

• based on data from the period 1981 to 2004• the lower the rating, the higher the cumulative• default rates. The Aaa and Aa bonds experienced

very low default• rates; after 10 years, less than 1 percent of the

issues had defaulted.• Approximately 35 percent of the B-rated issues,

however, had defaulted• after 10 years.

• Historical data seem to offer a general validation of agency ratings.

• But they are useful for another reason: they allows risk analysts to attach

• an objective likelihood of default to any company that has been rated by

• an agency or that has been rated by banks in a manner thought to be equivalent

• to an agency rating.

• While the major rating agencies use similar methods and approaches to rate debt,

• they sometimes come up with different ratings for the same debt investment.

• Academic studies of the credit rating industry have shown that only just over half of the firms rated AA or Aa and AAA or Aaa in a large sample were rated the same by the two top agencies.

• The same study found that smaller agencies tend to rate debt issues higher than or the same

• as S&P and Moody’s; only rarely do they award a lower rating

DEBT RATING AND MIGRATION

• Bankruptcy, whether defined as a legal or an economic event, usually marks

• the end of a corporation in its current form. It is a discrete event, yet it is

• also the final point in a continuous process—the moment when it is finally

• recognized that a firm cannot meet its financial obligations.

• credit agencies do not focus simply on default. At discrete

• points in time, they revise their credit ratings of corporate bonds. This evolution

• of credit quality is very important for an investor holding a portfolio

• of corporate bonds.

Credit Rating Agencies in India

There are four Credit Rating agencies in India

• CRISIL• ICRA• CARE and• Fitch India

Regulatory Framework

• Credit Rating agencies are regulated by SEBI.• Registration with SEBI is mandatory for

carrying out the rating Business.

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 continous net worth of

minimum 100 crores 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 5 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.

CRISIL

• The first rating agency ‘Credit Rating Information Services of India Ltd. , CRISIL, was promoted jointly in 1987 jointly by the ICICI and the UTI.

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.

CARE Ltd.

• Credit Analysis and Research Ltd or CARE is promoted by IDBI jointly with Financial Institutions, Public/Private Sector Banks and Private Finance Companies.

• It commenced its credit rating operations in October, 1993 and offers a wide range of products and Services in the field of Credit Information and Equity Research.

• It also provides advisory services in the areas of securitisation of transactions and structuring Financial Instruments.

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 Process

• 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• Obtains and analyses information• Analysts present their report to a rating

committee• 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.

Rating Review for a possible change:

• The rated company is on the surveillance system of the CRA, and from time to time, the earlier rating is reviewed.

• Analysts review new information or data available on the company.

Rating change

• Ts feel that there is a possibility of On preliminary analysis of the new data, if the analysts feel that there is a possibility of changing the rating, then the analysts request the issuer for a meeting with its management and proceed with a comprehensive rating analysis.

Credit Rating Watch

• During the review monitoring or surveillance exercise, rating analysts might become aware of imminent events like mergers and so on, which effect the rating and warrants a rating change.

• In such a possibility, the issuer’s rating is put on ‘credit watch’ indicating the direction of a possible change and supporting reasons for review.

Rating Methodology

• Business Analysis in terms of Industry Risk, Market position, operating efficiency and legal position.

• Financial analysis on the basis of consideration of accounting quality, earnings protection and adequacy of cash flows.

• Management Evaluation.• Regulatory Environment.

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.

Questions for Revision

• What is Credit Rating ? Describe how it started and evolved ?

• How do rating agencies generate their revenue ?

• What is meant by – Investment grade securities – Speculative grade securities

• Write a short Note on – Rating Process– Rating outlook– Credit watch

• Describe briefly the regulatory framework for credit rating agencies in India ? Describe some of the important eligibility criteria for a rating agency ?

• What is the methodology followed by Rating agencies in India for Industry ? What are the basic factors considered while assessing a state ?

• Write short Notes on – CRISIL– ICRA– CARE– Fitch Ratings India

The End