Synopsis Credit Rating

8/3/2019 Synopsis Credit Rating

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SYNOPSIS ON

CORPORATE DEBT RATINGS: ANANALYSIS OF METHODOLOGIES ANDPRACTICES BY SELECT CREDIT RATINGAGENCIES IN INDIA

IN PARTIAL FULFILLMENT OF THEREQUIREMENT FOR THE DEGREE OF THEDOCTOR OF PHILOSOPHY IN THE AREAOF FINANCE

SUBMITTED BY

ARJUN (ROLL NO-E-24)COLLEGE: ASIA PACIFIC INST. OF MGT


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SCOPE OF PRESENTATION

* INTRODUCTION* RATING PROCESS

* METHODOLOGY AND CRITERIA

* RATING SCALES

* NEW DEVELOPMENTS/ PRODUCTS

* LIMITATIONS?

* OBJECTIVES

* RESEARCH GAPS


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* REVIEW OF LITERATURE

* RESEARCH METHODOLOGY

* EMPIRICAL FINDINGS

* PLAN OF STUDY


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SECTION I

INTRODUCTION


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DEFINITION Rating is a tool that enables the investor to differentiate

between debt instruments on the basis of their underlyingcredit quality. It is specific to a debt instrument and is

intended as a grade, an analysis of the credit risk associated

with the particular instrument.

It is based upon the relative capability and willingness ofthe issuer of the instrument to service the debt obligations

(both principal and interest) as per the terms of the

contract.

Rating of a security examines three factors - probabilityof default, the terms and character of the security and the

degree of protection that can be granted to investors if

the security issuer faces liquidation.


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INSTRUMENTS FOR RATING

Long Term: Bonds/ debentures

Medium Term: Fixed Deposits/ bonds/ debentures

Short Term: Commercial Paper/ Certificates of Deposits


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FUNCTIONS OF CREDIT RATING

Provides the investor with risk-return analysis.

Provides low cost and extensive information, esp. to lesser

known companies to access the money and capital markets.

Gives the investor a wider choice of instruments.

Provides intermediaries with a tool to improve efficiency

in the funds raising process.

For the issuer, it lowers the cost of borrowing.

Rating is also used as a marketing tool by the issuer.

Greater credence to financial and other institutions.

Reduction of cost in public issues. Assist the regulators inpromoting transparency in the

financial markets.


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INTERNATIONAL RATING

AGENCIES

Three leading global agencies - Standard and Poors,

Moodys Investor Services and Fitch Ibca.

Global rating agencies evaluate sovereign risks, in addition

to debt instruments.


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CREDIT RATING IN INDIA

Emergence of credit rating in India: With the growth and

globalisation of capital markets in 1980s led to a surge in

demand for credit analysis by professional and

independent bodies.

Four Credit Rating Agencies in India - CRISIL, ICRA,

CARE and Fitch India.


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SECTION II

RATING PROCESS


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Borrower/Issuer Rating Agency

Request for a Rating Assign Analysts, conduct research

Document preparation Collection of Information

Rating Committee assigns Rating

Communication of Rating to Issuers

Plant visits and Management Meetings

Appeal

Surveillance/Annual Reviews

Dissemination of Rating/Publication

RATING PROCESS


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SECTION III

RATING METHODOLOGY ANDCRITERIA


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RATING METHODOLOGY

Business Risks Financial Risks

Industry

characteristics

Market

position

Operational

Efficiency

Managementquality

New

projects

Demand drivers

environment,

competition

bargaining

power of

suppliers

Raw material, scale

of operations,

technology; location Organisation

structure,

information

systems

Funding

policies

Leverage,

shareholder

control,interest rates,

currency exposure

Financial

flexibility

Unutilised credit

limits, group

supportmanagement

reputation, liquid

investments


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RATING METHODOLOGY

Analysis of past financial performance

Accounting quality

Cash flow analysis

Future cash flow adequacy

Focus on key issues in rating


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RATING CRITERIA Group Support

Coverage: Interest Coverage & DSCR

Partial Guarantee as Credit Enhancement

Parent Company support

Capital Structure: Gearing & Net Cash Accruals to Total

Debt

Implications of buyback of shares


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SECTION IV

RATING SCALE


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LONG TERM

LONG TERM CRISIL ICRA CARE FITCH INDIA

AAA LAAA CARE AAA AAA (Ind) Highest Safety

AA

LAA+

LAA CARE AA AA (Ind) High Safety

A

BBB

(Inv.Grd)

BB

B

C

D

LAA-

LA+

LALA-

LBBB+

LBBBLBBB-

LBB+LBB

LBB-LB+LB

LB-LC+

LC

LC-LD

CARE A

CARE BBB

(Inv.Grd)

CARE BB

CARE B

CARE C

CARE D

A (Ind)

BBB (Ind)

(Inv.grd)

BB (Ind)

B( ind)

C (Ind)

D (Ind)

Adequate Safety

Moderate Safety

Inadequate Safety

Risk Prone

Substantial risk

Default


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MEDIUM AND SHORT TERM

MEDIUMTERM

CRISIL ICRA CARE FITCH INDIA

FAAA

FAA

FA

FB

FC

FD

MAAA

MAA+

MAAMAA-

MA+MA

MA-

MB+

MBMB-MC+

MC

MC-MD

CARE AAA

CARE AA

CARE A

CARE B

CARE C

CARE D

tAAA (Ind)

tAA ( Ind)

tA (Ind)

tB (Ind)

tC (Ind)

tD (Ind)

Highest safety

High Safety

Adequate Safety

Inadequate Safety

Risk prone

Default

SHORT TERM

P1

P2

P3

P4

P5

A1+A1

A2+A2

A3+

A3A4+

A4

A5

PR1

PR2

PR3

PR4

PR5

F1 (Ind)

F2 (Ind)

F3 (Ind)

F4 (Ind)

F5 (Ind)

Highest Safety

High Safety

Adequate Safety

Risk Prone

Default


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SECTION V

NEW DEVELOPMENTS


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NEW DEVELOPMENTS

Corporate Governance Grading

Foray into insurance sector.

Rating of asset-backed securities.

Grading of construction companies.

Grading of Mutual Funds.

Rating of Real Estate

Grading of Health care


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SECTION V1

LIMITATIONS


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LIMITATIONS Rating is issue-specific and not a performance evaluation

of the rated company. It is not a recommendation to invest or not to invest in the

instrument being rated.

It is not an audit of the rated company, statutory or non-

statutory. It is not an indication of compliance with statutory or other

requirements.

Rating reports are confidential - the client only gets a finalrating & a rationale but no further details of the analysis.

Differences in rating among rating agencies - dual rating.


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SECTION V11

OBJECTIVES OF THE RESEARCH


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OBJECTIVES

Take cognizance of the research gaps

An examination of the frequency of changes made

in the ratings by the two leading CRAs in India

against the backdrop of changes in theperformance of the issuer that has been rated.

Test the reliability of ratings assigned by the twoleading CRAs in India on the basis of the actual

default rates experience on long-term debt.


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The default statistics would be analyzed

sector-wise, company-wise and period wise over a span of ten years.

The objective would also be to do acomparative in- depth analysis of the creditrating procedures and practices beingfollowed in India by the CRAs and globallyto identify the differences in criteria ofrating and the reasons for the same.


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To identify whether rating agencies are alsowatchdogs: can rating methodology be made

more preemptive

The objective of the study would be to evaluatethe concept of awareness among investors and

issuers on ratings to ensure reliability.

To identify the accountability criteria for ratingagencies.

To study the impact of dual rating of issuers andits impact.


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SECTION V111

RESEARCH GAPS


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RESEARCH GAPS

Rating performance as indicators of default

Failure of CRAs to warn investors of the defaults

in advance.

Rating process being reactive and not proactive

The revenue models of the rating agencies needs

to be examined since the rating is done at the

behest of the issuers


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Governance of credit rating

Ratings areforward looking assessments,

not a forecast of future performance.

The issuers have the option of going in for

dual rating if the rating given by agency is

not satisfactory.


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SECTION 1X

REVIEW OF LITERATURE


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REVIEW OF LITERATURE

Hickman (1958): Analyzed the large bond issues

and found that riskier the bond, the higher thepercentage of bonds that subsequently default.

Atkinson and Simpson (1967): analyzed the trendsin corporate bond quality from 1900 to 1965 andfound that the default rate peaks coincide with the

periods of economic distress. Altman and Nammacher (1985): Examined the

default experience of corporate bonds over theperiod of 1970 to 1984. Bonds with a speculative

grade rating at the time of issue subsequently hada much higher default rate than bonds that wereinitially of investment grade.


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Raghunathan and Verma (1992): Evaluated the ratinggiven by Indias leading credit rating agency

(CRISIL), and showed that the ratings are far tooliberal by international standards and lack consistency.

Sherwood(1996): The grades assigned did not revealthe investors problem of default risk. Ratings arealtered only when agencies deem that sufficientchanges have occurred

Gupta, Gupta and Jain (2001): The study revealed thatthe major reason for lack of confidence among theretail investors in the bonds of private sector

companies is the high default rate. The studyconcluded that the credit rating standards followed bythe Indian credit rating agencies are rather lax,showing greater consideration to the issuers needsthan for the investors interests.


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RESEARCH METHODOLOGY

The research methodology would comprisePrimary and Secondary data analysis.

Analysis would include statistical and non-

statistical techniques.

Comparative analysis on the last ten years data

of the two leading agencies onupgrades/downgrades sector-wise, company-wise and period-wise.


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Taking a view of the investors on reliability ofrating, by administering a questionnaire on severalparameters relating to rating.

A separate questionnaire would be administered to

the companies which had gone in for dual rating inthe last ten years and an analysis on thediscrepancy in rating methodology and criteria.

The questionnaire so designed would be inconsultation with a leading rating agency alongwith one corporate and subsequently administered.


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EMPIRICAL FINDINGS

Default statistics: sector-wise, company-wise and

period-wise. Analysis of ratings prior to default

Reasons for default

Discrepancy in rating methodology being

followed by the rating agencies in case of dual

rating.

Identification of the differences in rating process

and criteria adopted by Indian and Globalagencies.

Surveillance of ratings

Regulations, if any on the rating agencies.


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SECTION X1

PLAN OF STUDY


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PLAN OF STUDY

Chapter 1. Introduction on credit rating.

Chapter 2. Theoretical perspective to credit ratingand overview.

Chapter 3. Literature Review

Chapter4. Data and Research Methodology

Chapter5. Operating Performance and defaultindicators (sector-wise, period-wise and company-wise).


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Chapter6.Comparative analysis of rating criteria

and methodology between the two LeadingAgencies (for companies following dual rating)

Chapter7. Empirical Findings for defaultfrequencies and dual ratings

Chapter8. Rating Methodology of IndianAgencies- Comparative analysis with globalagencies criteria

Chapter 9. Issuers' perspective of Rating

Agencies: A survey Chapter10. Bibliography

Synopsis Credit Rating

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