FINANCIAL SERVICES MODULE-3

CREDIT RATING
The term Credit Rating is a symbolic indicator (like A+++, A+, B+ or C or 5, 4, 3, 2, 1 etc) which indicates the overall performance and credit worthiness of an organisation. It is an evaluation made by a credit rating agency of the debtor's ability to pay back the
debt and the likelihood of default. Credit rating agencies provide quantitative and qualitative information to the people so that investor can decide to invest in riskless sources where they can find more security and safety and good return.

Credit rating is a dynamic concept and all the rating companies are constantly reviewing the companies rated by them with a view to changing (either upgrading or downgrading) the rating. They also have a system whereby they keep ratings for particular companies on rating watch in case of major events, which may lead to change in rating in the near future. Ratings are made public through periodic newsletters issued by rating companies, which also clears briefly the rationale for particular ratings. In addition, they issue press releases to all major newspapers and wire services about rating events on a regular basis. The process of Credit Rating: The rating process begins with the receipt of formal request from a company desirous of having its issue obligations rated by credit rating agency. A credit rating agency constantly monitors all ratings with reference to new political, economic and financial developments and industry trends. The process/ procedure followed by all the major credit rating agencies in the country is almost similar and usually comprises of the following steps 1. Receipt of the request: The rating process begins, with the receipt of formal request for rating from a company desirous of having its issue obligations under proposed instrument rated by credit rating agencies. An agreement is entered into between the rating agency and the issuer company. The agreement spells out the terms of the rating assignment and covers the following aspects: i. It requires the CRA (Credit Rating Agency) to keep the information confidential. ii. It gives right to the issuer company to accept or not to accept the rating. iii. It requires the issuer company to provide all material information to the CRA for rating and subsequent surveillance. 2. Assignment to analytical team: On receipt of the above request, the CRA assigns the job to an analytical team. The team usually comprises of two members/analysts who have expertise in the relevant business area and are responsible for carrying out the rating assignments.
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3. Obtaining information: The analytical team obtains the requisite information from the client company. Issuers provide a list of information for discussion. 4. Plant visits and meeting with management: To obtain classification and better understanding of the clients operations, the team visits and interacts with the companys executives. Plants visits facilitate understanding of the production process, assess the state of equipment and main facilities, evaluate the quality of technical personnel and form an opinion on the key variables that influence level, quality and cost of production. 5. Presentation of findings: After completing the analysis, the findings are discussed at length in the Internal Committee, comprising senior analysts of the credit rating agency. All the issue having a bearing on rating are identified. An opinion on the rating is also formed. The findings of the team are finally presented to Rating Committee. 6. Rating committee meeting: This is the final authority for assigning ratings. The rating committee meeting is the only aspect of the process in which the issuer does not participate directly. The rating is arrived at after composite assessment of all the factors concerning the issuer, with the key issues getting greater attention. 7. Communication of decision: The assigned rating grade is communicated finally to the issuer along with reasons or rationale supporting the rating. 8. Dissemination to the public: Once the issuer accepts the rating, the credit rating agencies disseminate it through printed reports to the public in the form of CRAs Journals, Magazines and Periodicals etc. 9. Monitoring for possible change: Once the company has decided to use the rating, CRAs are obliged to monitor the accepted ratings over the life of the instrument. The CRA constantly monitors all ratings with reference to new political, economic and financial developments and industry trends. All this information is reviewed regularly to find companies for, major rating changes. Any changes in the rating are made public through published reports by CRAs. To provide Quantitative and Qualitative information to the company and to the people, the CRA assess the following most important factors, they are: 1. Business Risk Analysis 2. Financial Analysis 3. Management Evaluation 4. Geographical Analysis 5. Regulatory & Competitive Environment and 6. Fundamental Analysis. These are explained as under: 1. Business Risk Analysis includes
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Industry Risk Market position of the company Operating efficiency Legal position and Size of the business

2. Financial Analysis includes Financial analysis aims at determining the financial strength of the issuer company through ratio analysis, cash flow analysis and study of the existing capital structure. This includes an analysis of four important factors namely: a. Accounting quality b. Earnings potential/profitability c. Cash flows analysis d. Financial flexibility
3. Management Evaluation includes the analysis the ability, strengths, weakness,

quality of management group and key persons in the management. The managements vision, mission, goal, objectives, strategies to face problem, philosophies and ability to repay the debt and etc analysed.

4. Geographical Analysis includes Geographical analysis is undertaken to determine the locational advantages enjoyed by the issuer company. An issuer company having its business spread over large geographical area enjoys the benefits of diversification and hence gets better credit rating. A company located in backward area may enjoy subsidies from government thus enjoying the benefit of lower cost of operation. Thus geographical analysis is undertaken to determine the locational advantages enjoyed by the issuer company. 5. Regulatory & Competitive Environment includes: It is important to analyse the financial system, regulatory framework, political movement, changes in government etc. because these gives the direct or indirect impact on business.

6. Fundamental Analysis:
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Fundamental analysis includes an analysis of liquidity management, profitability and financial position, interest and tax rates sensitivity of the company. This includes an analysis of liquidity management, profitability and financial position, interest and tax rates sensitivity of the company. 1. Liquidity management involves study of capital structure, availability of liquid assets corresponding to financing commitments and maturing deposits, matching of assets and liabilities. 2. Asset quality covers factors like quality of companys credit risk management, exposure to individual borrowers and management of problem credits etc. 3. Profitability and financial position covers aspects like past profits, funds deployment, revenues on non-fund based activities, addition to reserves. 4. Interest and tax sensitivity reflects sensitivity of company following the changes in interest rates and changes in tax law. Fundamental analysis is undertaken for rating debt instruments of financial institutions, banks and non-banking finance companies. Mechanisms of Credit Rating S.NO. 1 2 3 4 5 6 7 8 9 TOTAL SCORE 86-100 71-85 61-70 51-60 41-50 31-40 21-30 11-20 01-10 GRADE ACCORDED AAA+ AA A BBB+ BB B CC D E IMPLICATION OF GRADE ACCORDED Most Excellent Safety Excellent Safety Very Good Safety Safety Ordinary Safety Less Ordinary Safety Low safety Unsafe Loss category

CREDIT RATING AGENCIES IN INDIA Currently there are five credit rating agencies in India: 1. Credit Rating Information Service India Ltd (CRISIL) 2. Investment Information and Credit Rating Agency (IICRA) 3. Credit Analysis and Research (CARE)
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4. Fitch Ratings India Pvt. Ltd (FRIPL)& 5. Onida Individual Credit Rating Agency Ltd. (ONICRA)

1. CRISIL: The first Credit Rating Agency (CRA) was started on January 1, 1988. It was started by ICICI and UTI. The principal objective of CRISIL is to rate the debt obligations of Indian Companies. Its rating guides investors about the risk of timely payment of interest and principal on a particular debt instrument. In 1994-95 CRISIL forged alliance with Standard & Poor Rating Group, New York. CRISIL provides ratings to Debentures, FDs, Term deposits, Mutual funds, bank loan, and public finance and various SME etc.

2. IICRA: The IICRA was set up by Industrial Finance Corporation of India on 16th January 1991. It is a public limited company with an authorised share capital of Rs. 101 crores. The initial paid up capital of Rs. 3.50 crores is subscribed by IFC, UTI, LIC, GIC, SBI and 17 other banks. IICRA started its operation from 15th March 1991. It provides ratings to Debentures, Bonds, Preference shares, FDs, and commercial papers etc.

3. CARE: The CARE was promoted in 1993 jointly with investment companies, banks and finance companies. Services offered by CARE are i. ii. iii. iv. v. Credit rating Information services Equity research Rating of parallel market and kerosene Rating to debentures, certificate of deposits, commercial papers and fixed deposits.

4. FRIPL:

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Earlier known as Duff Phelps credit Rating Pvt. Ltd. (DCR) DCR India was a joint venture between Duff and Phelps of USA and Alliance Capital Ltd, Kolkata. These two have been merged together to form FITCH INDIA. On special request it may undertake rating of companies and countries as well. The popular symbol employed by DCR is D1, D2 and D3 etc, depending upon the credit status.

5. ONICRA: It was sponsored by Onida Finance Ltd. In all credit transaction relating to credit cards, housing finance, personal loan etc. it becomes more important that one should know the size and impact of risk associated with such transactions before entering into those transactions. Thus ONICRA helps the users with the rating to know the risk associated with credit transactions while dealing with individuals. ONICRA is gaining more popularity among financial institutions.

Types of Credit Rating: The types of rating depend upon the instrument to be rated by an agency. These can be: 1. Bonds Rating 2. Equity Rating 3. Commercial Paper Rating 4. Fixed Commercial Rating (Fixed Deposits, Bonds etc which have fixed commitments) 5. Borrower Rating (Credit Worthiness of Company) 6. Sovereign Rating (Rating of a nation as a whole and its credit worthiness, risks etc).

S&P Standard & Poor: Standard & Poor's (S&P) is an American financial services company. It is a division of The McGraw-Hill Companies that publishes financial research and analysis on stocks and bonds. The company is one of the Big Three credit-rating agencies, which
also include Moody's Investor Service and Fitch Ratings.

SEC: Securities and Exchange Commission

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The U.S. Securities and Exchange Commission (frequently abbreviated SEC) is a federal agency which holds primary responsibility for enforcing the federal securities laws and regulating the securities industry, the nation's stock
and options exchanges, and other electronic securities markets in the United States. The main reason for the creation of the SEC was to regulate the stock market and prevent corporate abuses relating to the offering and sale of securities and corporate reporting. The SEC was given the power to license and regulate stock exchanges, the companies whose securities traded on them, and the brokers and dealers who conducted the trading.

Benefits of Credit Rating: The main four stakeholders viz. Investors, Company, Government (As a Whole Economy) and Rating Agencies are going to enjoy the benefits Credit Rating Systems. We will discuss the each stakeholders benefits in detail: 1. INVESTORS:

Availability of the proper information at low cost from the CRA Investors confidence will increase because these CRAs are totally unbiased, impartial and independent. Each and every investor the risk undertaken by him and decides the amount of investment. Enjoy high returns by investing in highly graded instruments. Investors cannot be cheated or misguided by the company.

2. COMPANY BEING RATED:

Increase the goodwill and reputation of the company. Act as a powerful marketing tool and factor for attraction. Enjoy domestic and overseas market with more confidence. Helps raising funds with less cost because of good rating. Helps to improve performance and credit worth with rating scale.

3. GOVERNMENT (ECONOMY AS A WHOLE):

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Helps to improve financial markets of the nation Helps to increase industries and productivity of the country. Reduces the burden of controlling and monitoring of the economy. Saves and secures investors money within the companys cost. Motivates the people and companies to participate in market at faster rate.

4. RATING AGENCY:

LIMITATIONS:

Honest and quality rating increases reputation of the CRA. Efficiency in rating the companies helps gain more market and more returns. Encourages bringing more new methods and techniques in Credit Rating area. Motivates the CRAs to focus on industries and economy.

Rating is only indicates the risk but the final decision is left to the investors. Ratings vary from agency to agency which do not provide proper information. It is very difficult to get the genuine information from the companies. Companies do not remain with single Rating Agency. CRA charge more fees. Companies may request to review/reject the Rating provided by the CRA.

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