Credit rating
Transcript of Credit rating
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 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.
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.
There are four Major Rating agencies in India
CRISIL(Credit Rating Information Services of India Ltd)
ICRA(Information and Credit Rating Services Ltd)
CARE (Credit Analysis and Research Ltd)
FITCH India
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
Uses of Credit Rating
Investors
Issuers
Intermediaries
Regulators
Factors for successful credit rating Credible & independent structure and
procedure Objectivity & impartiality of opinions Analytical research, integrity and consistency Professionalizm and industry related expertize Confidentiality Timeliness of rating review and announcemnt
of changes Ability to reach wide range of of investors
(media)
Important issues in credit rating Investment and Speculative grades
Surveillance
Credit watch
Ownership as a rating consideration
Rating Methodologies
Industry Risk Company’s industry and market position Operating Efficiencies Accounting Qualilty Financial flexibility Earnings protection Financial leverage Cash flow adequacy Management Evaluation
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 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 subject to certain conditions. (Valid only for 3 years)
Application fee – Rs.50,000/- Regn. Fee for grant of certificate –
Rs.5,00,000/- Renewal fees – Rs.10,00,000/-
Agreement with the client• The CRA should enter into a written agreement
with each client containing ,o Rights and liabilities of each party w.r.t rating
of securities.o Fee chargedo A periodic review of the rating during the
tenureo Clients agreement to cooperate and provide
true, adequate and timely information.o Disclosure by CRA to client regarding the
rating assigned.o Clients agreement to disclose the rating
assigned in the offer document for the last 3 years
Monitoring of rating
The CRA should continuously monitor the rating of securities rated by it during their life time .
It should disseminate information regarding newly assigned rating and its changes in the earlier ratings through press releases, websites and inform the same to stock exchanges.
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 [Contd.] 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.
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. The CRA constantly monitors all rating with respect to new political ,economic, financial development and industry trends.
Analysts review new information or data available on the company. On preliminary analysis of the new information if the analyst feel that there is a possibility for change in the rating then they meet with the management and proceed with 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.
• Once a decision to either change or present the rating had been made, the issue will be removed from credit watch.
Rating Methodology
The rating methodology involves an analysis of industry risk, issuer’s business and financial risk. A rating is assigned after assessing all factors that could affect the credit worthiness of the entity. The industry analysis is done first followed by the company analysis.
Credit rating for financial service sector When rating debt instruments of financial
institutions, banks, NBFCs in addition to the financial analysis and management evaluation the following factors are considered
Regulatory and competitive environment Fundamental analysis Capital adequacy Asset quality Liquidity management Profitability and financial position Interest and tax sensitivity
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 favorable 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 structured obligations• High investment grades:• AAA(SO)- Highest safety• AA(SO)- high safety• Investment grades:• A(SO) –Adequate safety• BBB(SO)- Moderate safety• Speculative grades:• BB(SO)- Inadequate safety• B(SO) – High Risk• C (SO)- Substantial risk)• D (SO)- 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