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Credit Rating Agency of Bangladesh Ltd. (CRAB)


(Bangladesh)

Credit Rating Agency of Bangladesh Ltd. (CRAB) was incorporated as a public limited company under the Registrar of Joint Stock Companies in August 2003 and received its certificate for commencement of business in November 2003. It has been granted license by the Securities & Exchange Commission (SEC) of Bangladesh for operating as a credit rating company in February 2004. The formal launching of the company was held on 5 April 2004.

Corporate rating criteria:

CRAB uses a comprehensive methodology for credit rating of corporate entities developed in collaboration with its technical collaboration partner ICRA Ltd of India. The methodology addresses the international standards for credit rating of corporate and incorporates the regulatory framework in Bangladesh. The major factors considered in CRABs rating analysis are described below: Industry Risk Analysis Analysis of industry risk focuses on the prospects of the industry and the competitive factors influencing it. The industry environment is assessed to determine the degree of operating risk faced by the company in a given business. Investment plans of the major players in the industry, demand supply factors, price trends, changes in technology, international/domestic competitive factors, entry barriers, capital intensity, business cycles etc. are key ingredients of industry risk. Business Risk Analysis The position of the Company within the industry is then analysed. The key areas considered in assessment of business risk are as follows: Diversification For companies that operate in several industries, each major business segment is analysed separately. The contribution of each business segment to the companys overall profitability is assessed. While diversification results in better sustainability in cash flows, the analysis specifically looks into the suitability and adequacy of management structure to operate the diversification. Analysis also considers the forward and backward linkages required for the diversified operations. Seasonality and Cyclicality Some industries are cyclical in nature with their performance varying through the economic cycle. Some industries are seen to exhibit seasonality in sales or production. The analysis aims to

be stable across seasons and economic cycles and are adjusted considering the long term fundamentals. Scale of Operation Small size presents a significant hurdle in getting higher ratings commensurate with a companys financials. Presence in selected market segments, limited access to funds leading to lack of financial flexibility etc., result in lower protection of margins when faced with adverse developments in business areas. Large firms, on the other hand, have higher sustaining power, even during troubled times. Cost Structure The cost factors and efficiency parameters of existing operations are assessed in respect of expenditure levels required to maintain its existing operating efficiencies as well as to improve its efficiency parameters in a competitive scenario. Nature of technology may also influence the cost structure. Market share A companys current market share and the trends in market share in the past are important indicators of the competitive strengths of the company. A sustained leadership position leads to ability to generate cash over the long term. A market leader generally has financial resources to meet competitive pricing challenges. Marketing and distribution arrangements Depending on the nature of the product, the rating analyses the depth and importance of the marketing and distribution of the company. For example, companies in FMCG sector require an extensive marketing and distribution network and rating gives high importance to the same when analyzing companies in those industries. Strategy & Financial Policies The companys business plans, mission, policies and future strategies in relation to the general industry scenario are assessed. An important factor is assessment of the managements ability to look into the future and its strategies and policies to tackle emerging challenges. The financial policies of the sponsors and management regarding financing its capital expenditure and working capital requirement are analysed. Operating Efficiency In a competitive market, it is critical for any business unit to control its costs at all levels. This assumes greater importance in commodity or me-too businesses, where low cost producers almost always have an edge. Cost of production to a large extent is influenced by:

Location of the production unit(s) Access to raw materials Scale of operations State of technology Level of integration Experience of operating personnel Market position All the factors influencing the relative competitive position of the Issuer are examined in detail. Some of these factors include positioning of the products, perceived quality of the products or brand equity, proximity to the markets and distribution network as well as relationship with the customers. Competitiveness is largely determined by costs. The market position is reflected in the ability of the Issuer to maintain / improve its market share and command differential in pricing. It may be mentioned that the Issuers whose market share is declining or expected to decline generally do not get favourable long term Ratings. Financial Strength Financial strength analysis involves evaluation of past and expected future financial performance with emphasis on assessment of adequacy of cash flows towards debt servicing. The analysis is mainly based on audited accounts of the company although unaudited accounts are noted. A review of accounting quality and adherence to prudential accounting norms are examined for measuring the companys performance. Accounting policies relating to depreciation, inventory valuation, income recognition, valuation of investments, provisioning/ write off etc. are given special attention. Prudent disclosures of material events affecting the company are reviewed. Financial Ratios Financial ratios are used to make a holistic assessment of financial performance of the company, as also to see the companys performance compared to its peers within the industry. (i) Growth Ratios:

Trends in the growth rates of a company vis--vis the industry reflect the companys ability to sustain its market share, profitability and operating efficiency. In this regard, focus is drawn to growth in income, PBIDT, PAT and assets. (ii) Profitability Ratios:

Capacity of a company to earn profits determines the protection available to the company. Profitability reflects the final result of business operations. Important measures of profitability are PBIDT, Operating and PAT margins, ROAE and ROAA. Profitability ratios are not regarded in isolation but are seen in comparison with those of the competitors and the industry segments in which the company operates.

(iii)

Leverage and Coverage Ratios:

Financial leverage refers to the use of debt finance. While leverage ratios help in assessing the risk arising from the use of debt capital, coverage ratios show the relationship between debt servicing commitments and the cash flow sources available for meeting these obligations. The ratios considered are: Debt/Equity Ratio, Overall gearing ratio, Interest Coverage, Net cash accruals / Debt and Debt Service Coverage Ratio to measure the degree of leverage used vis-vis level of coverage available with the company. (iv) Turnover Ratios:

Turnover ratios, also referred to as activity ratios or asset management ratios, measure how efficiently the assets are employed by the firm. These ratios are based on the relationship between the level of activity, represented by sales or cost of goods sold, and level of various assets, including inventories and fixed assets. (v) Liquidity Ratios:

Liquidity ratios such as current ratio, quick ratio etc. are broad indicators of liquidity level and are important ratios for rating short term0 instruments. Cash flow statements are also important for liquidity analysis. Cash flows Interest and principal obligations are required to be met by cash and hence only a thorough analysis of cash flow statements would reveal the level of debt servicing capability of a company. Cash flow analysis forms an important part of credit rating decisions. Availability of internally generated cash for servicing debt is the most comforting factor for rating decisions as compared to dependence on external sources of cash to cover temporary shortfalls. Cash flow adequacy is viewed by the capability of a company to finance normal capital expenditure, as well as its ability to manage capital expenditure programmes as per envisaged plans apart from meeting debt servicing requirements. Financial flexibility Financial flexibility refers to alternative sources of liquidity available to the company as and when required. Companys contingency plans under various stress scenarios are considered and examined. Ability to access capital markets and other sources of funds whenever a company faces financial crunch is reviewed. Existence of liquid investments, access to lines of credits from strong group concerns to tide over stress situations, ability to sell assets quickly, defer capex etc. are favourably considered.

Validation of projections and sensitivity analysis The projected performance of the company over the life of the instrument is critically examined and assumptions underlying the projections are validated. The critical parameters affecting the industry and the anticipated performance of the industry are identified. Each critical parameter is then stress tested to arrive at the performance of the company in a stress situation. Debt service coverage for each of the scenarios would indicate the capability of the company to service its debt, under each scenario. Management Evaluation Management evaluation is one of the most important factors supporting a companys credit standing. An assessment of the managements plan in comparison to those of their industry peers can provide important insights into the companys ability to sustain its business. Capability of the management to perform under stress provides an added level of comfort. Meetings with the top management of the company are an essential part of the rating process. Track record The track record of the management team is a good indicator for evaluating the performance of the management. Managements response to key issues/events in the past like liquidity problems, competitive pressures, new project implementation, expansions and diversifications, etc. are assessed. Performance of group companies Interests and capabilities of the group companies belonging to the same management/sponsors give important insights into the managements capabilities and performance in general. Organisational structure Assessment of the organizational structure would indicate the adequacy of the same in relation to the size of the company and also give an insight on the levels of authority and extent of its delegation to lower levels in the organization. The extent to which the current organizational structure is attuned to management strategy is assessed carefully. Control systems Adequacy of the internal control systems to the size of business is closely examined. Existence of proper accounting records and control systems adds credence to the accounting numbers. Management information systems commensurate with the size and nature of business enables the management to stay tuned to the current business environment and take judicious decisions.

Personnel policies Personnel policies laid down by the company would critically determine its ability to attract and retain human resources. Incidence of labour strikes/unrest, attrition rates etc., are seen in perspective of nature of business and relative importance of human capital. Corporate Governance The corporate governance practices prevalent in a company reflect the distribution of rights and responsibilities among different participants in the organisation such as the Board, management, shareholders and other financial stakeholders, and the rules and procedures laid down and followed for making decisions on corporate affairs. The emphasis is on companys business practices and quality of disclosure standards that address the requirements of the regulators and are fair and transparent for its financial stakeholders. Security & Relationship Risk Analysis This part is included to identify and assess the relationship history with the financers in term of credit sanctions, limit utilization, repayments, securities etc. LONGTERM CORPORATE ENTITY RATING AAA (Triple A) Companies rated in this category have extremely strong capacity to meet financial commitments. These are judged to be of the highest quality, with minimal credit risk. AA1, AA2, AA3 (Double A)* Companies rated in this category have very strong capacity to meet financial commitments. These are judged to be of very high quality, subject to very low credit risk. A1, A2, A3 (Single A) Companies rated in this category have strong capacity to meet financial commitments, but susceptible to the adverse effects of changes in circumstances and economic conditions. These are judged to be of high quality , subject to low credit risk. BBB1, BBB2, BBB3 (Triple B) Companies rated in this category have adequate capacity to meet financial commitments but more susceptible to adverse economic conditions or changing circumstances. These are subject to moderate credit risk. Possess certain speculative characteristics. BB1, BB2, BB3 (Double B) Companies rated in this category have inadequate capacity to meet financial commitments. Have major ongoing uncertainties and exposure to adverse business, financial, or economic conditions. Have speculative elements, subject to substantial credit risk. B1, B2, B3 (Single B) Companies rated in this category have weak capacity to meet

financial commitments. Have speculative elements, subject to high credit risk. CCC1, CCC2, CCC3 (Triple C) Companies rated in this category have very weak capacity to meet financial obligations. Have very weak standing and are subject to very high credit risk. CC (Double C) Companies rated in this category have extremely weak capacity to meet financial obligations. Highly speculative and are likely in, or very near, default, with some prospect of recovery of principal and interest. C (Single C) Companies rated in this category are highly vulnerable to non-payment, have payment arrearages allowed by the terms of the documents, or subject of bankruptcy petition, but have not experienced a payment default. Payments may have been suspended in accordance with the instrument's terms. Typically in default, with little prospect for recovery of principal or interest. D Default. Will also be used upon the filing of a bankruptcy petition or similar action if payments on an obligation are jeopardized.

Financial institutions rating criteria:


CRAB uses a comprehensive methodology for credit rating of FIs developed in collaboration with its technical collaboration partner ICRA Ltd of India. The methodology addresses the international standards for credit rating of financial institutions and incorporates the regulatory framework in Bangladesh. The rating methodology is built around the way NBFIs operate, and is comprehensive in its concept and approach. As in any opinion on credit quality, the credit rating agencys ratings factor the entire gamut of risks that can possibly affect the operations of a finance company. These risks can be broadly classified under three heads: Operating Risks Financial Risks Management Risks The above risks are packaged into the credit rating agencys rating scale in a manner that is consistent across time and across different issuers of debt instruments. Thus, an investor is spared the task of a detailed evaluation of the claims made by the company or an analysis of its financial statements, and can instead make an informed investment decision on the basis of the credit ratings

MAJOR DETERMINANTS OF OPERATING RISKS Volatility in Revenues and Expenses The operating risks for a finance company manifest in the form of fluctuations in the income and / or expenses, and consequently, affect the profitability and financial position. Volatility in the revenue stream of the company can arise out of the intrinsic nature of the operation and / or the fluctuations in the economy [which affects the paying capacities of the borrowers]. An increase in the cost of borrowings can temporarily derail the business plan of a finance company, as its margins would be squeezed. Similarly, the revenues from fee-based businesses are also dependent on the underlying business activities, and there are attendant fluctuations in the revenues. Regulatory Risks Since the financial sector is fairly regulated in Bangladesh, a finance companys operations are governed by the changes in regulation that occur from time to time, some of which can be sudden and unpleasant. The effect of the changes in regulation on the industry and individual companies while assigning its ratings is also evaluated by a credit rating agency. Risk of Administrative Expenses If the proportion of earning assets is low in relation to the expenses, that is, there is insufficient volume of business to spread the fixed costs over, the company runs the risk of not being able to cover its costs. The share of earning assets can decline due to other reasons as well, for example diversion of funds into other businesses that have a long gestation period, buying up large premises that lock up funds, inefficiency in collection and remittance which increases the idle cash balances, etc. Deterioration in Asset Quality Quality of loans and receivables is a key factor that determines the cash flows and consequently, the debt-servicing ability of a finance company. The loss of income and the need to provide for loan losses can seriously undermine a companys financial base. Also, even if the loans are not lost cases, a continuous delay brings down the effective yield on loans, and could jeopardize viability. The potential asset quality by analysing the concentration risks [across borrower segments, industry segments, relative size of loan, etc.], by evaluating the appraisal and monitoring systems in place for the kind of business the company is in, and examining the safeguards taken by the company is in, and examining the safeguards taken by the company to ensure that its money comes back, as scheduled, are evaluated. MAJOR DETERMINANTS OF FINANCIAL RISK

Capital Adequacy The capital structure of a finance company confers varying degree of security to its lenders against the risk of going insolvent. Capital adequacy refers to the quantum of shareholders funds in the business in relation to the risk-weighted assets that the company has. While there are regulatory minimum limits for this figure, different businesses have different risks depending on a variety of factors such as location of operation, size of clients, competition, etc. which could mandate a higher level of capital adequacy for some of them. Asset Liability Management Money management is the core of the operations of all finance companies, and a critical aspect of this is the proper control on the assets and liabilities, the company is vulnerable to shortage of cash, and needs to take corrective action. There is also the problem of mismatch in the interest rates between the two, and unless the management consciously attempts to make amends, the margins can be affected seriously due to changes in the external environment. Solvency For a company to remain viable, it is vital that it is able to consistently generate a surplus in the long run, after meeting all its operating expenses and cost of funds (including shareholders equity). In the long run, it is only the plough-back of surplus earnings, that can support increasing quantum of borrowings that fund the companys growth. In the event of continuous losses or inadequate surplus generation, the company can fall into a debt trap, if it continues to increase its borrowings to fund its growth. Financial Flexibility Financial flexibility refers to the ability of the company to raise financial resources from any source under conditions of financial duress. This ability of a company enables it to dip into its pockets or borrow from lenders who are willing to finance it despite its crunch, and help meet its immediate obligations. Financial flexibility arises out of the ability of a company: To borrow from other entities maybe on the strength of ones balance sheet, corporate image or the clout of the top management. To borrow from entities, maybe, in the same group or under the same management. To utilise undrawn lines of credit or borrowing power. To liquidate some assets that have been kept for such contingencies.

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Accounting Quality There are several areas where there is freedom for different companies, and it is necessary to re compute some of the figures to make comparisons with the other companies in the peer group. MANAGEMENT RISKS Management Quality A significant weightage is attached to the quality of the companys management in its ultimate opinion on credit quality of the companys debt. In evaluating a management, the credibility of the managements plans for the company in the backdrop of the economic scenario and the outlook for the specific company is assessed. To make a judgement on the quality of management, the historical track record of the management in several areas is analysed, inter alia, [a] in overcoming adversity in operating conditions, such as, a funds crunch, strong competition, sudden deterioration in asset quality, etc. [b] attitude towards the interests of investors and other stakeholders in the company, [c] conformance to regulation and adoption of fair business practices [d] ability to professionalize and delegate decisionmaking with reference to the nature and scale of operations. Evaluation of Systems The systematic and timely flow of correct information, in the form of plans, budgets, targets, management information for review and / or control is the lifeblood of a finance companys operations. The extent of automation is a reflection of several factors such as the scale of operations, the attitude of the management, and the economics of automating the operations. LONGTERM FINANCIAL INSTITUTIONS ENTITY RATING AAA (Triple A): Have extremely strong capacity to meet financial commitments, maintains highest quality, with minimal credit risk. AA1, AA2, AA3* (Double A): Have very strong capacity to meet financial commitments, maintains very high quality, with very low credit risk. A1, A2, A3 (Single A): Have strong capacity to meet financial commitments, maintains high quality, with low credit risk, but susceptible to adverse changes in circumstances and economic conditions. BBB1, BBB2, BBB3 (Triple B): Have adequate capacity to meet financial commitments but are susceptible to moderate credit risk. Adverse changes in circumstances and economic conditions are more likely to impact capacity to meet financial commitments. BB1, BB2, BB3 (Double B): Have inadequate capacity to meet financial commitments and possess substantial credit risk, with major ongoing uncertainties

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and exposure to adverse business, financial, or economic conditions. B1, B2, B3 (Single B): Have weak capacity to meet financial commitments and are subject to high credit risk. Currently meeting the financial commitments, but adverse business, financial, or economic conditions are likely to impair capacity to meet obligations. CCC1, CCC2, CCC3 (Triple C): Currently vulnerable, and are dependent upon favourable business, financial, and economic conditions to meet financial commitments. Have very weak standing and are subject to very high credit risk. CC (Double C): Currently highly vulnerable, highly speculative and are very near to default, with some prospect of recovery. C (Single C): Currently very highly vulnerable to non-payment, may be subject of bankruptcy petition or similar action, though have not experienced payment default. C is typically in default, with little prospect for recovery. D Default. 'D' rating also will be used upon the filing of bankruptcy petition or similar action if payments on an obligation are jeopardized

General insurance companies rating criteria:


CRABs analyses incorporate an evaluation of the rated companys current financial position as well as an assessment of how the financial position may change in the future. The rating methodology includes an assessment of both quantitative and qualitative factors based on indepth discussions with the management. CRABs insurance ratings generally appoint equal weights on quantitative and qualitative elements, though such weightings can vary in unique circumstances. The evaluation of financial strength and credit quality centres on the ability of the company to meet all of its obligations. The companys ability to meet its obligations is evaluated under a variety of stress scenarios, not just the most likely scenario. In all cases, both the perceived margin of safety, and the stability/volatility of that margin of safety, play important roles in the evaluation of credit quality in the insurance industry. CRABs analysis makes a review of the company specifically, as well as the macro trends affecting the industry in general. Rating determinations are based on factors which may vary by company or market. Insurance rating methodology focuses on the following five areas of analysis: Industry Review

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Operational Review Organizational Review Management Review Financial Review Industry Review: Industry Review The starting point for rating is a thorough understanding of the industry segment(s) in which the insurer operates. One of the objectives is to judge the extent industry dynamics can impact the ratings levels that individual insurers operating in a given industry segment can achieve. Industry analysis helps analysts to make better judgments on the unique attributes of individual insurers by being able to understand them on a relative as well as absolute basis. The specific evaluation of the non-life insurance industry focuses on: Level of competition in specific sectors The basis for competitive advantage in the sector Barriers to entry and threats of new products Relative bargaining power of insurers relative to that of buyers and intermediaries The potential tail of losses and ability to make accurate pricing decisions, as well as exposure to large unexpected losses Regulatory, legal and accounting environment and framework Generally the non-life is considered among the riskier insurance industry segments compared to life, health, or financial guarantee insurance. This reflects the volatility of year-to-year results, intense competition in most sectors, challenges in predicting losses for products with long reporting and claims settlement tails, and exposures to large losses such as property catastrophes. Positively, non-life insurers face limited competition from outside the industry. Further, the demand for a number of products is supported by third party requirements that individuals and companies carry certain types of insurance. Competition in most sectors has been intense and at times irrational. Ambitious growth plans have often led to buying of market share. Operational review: Operational Review Operational review focuses on a given companys unique competitive strengths and weaknesses, operating strategies, and business mix. The analysis focuses on both the historical and current business position, and how it is expected to change over time. Operational analysis is among the most critical parts of its ratings review. Companies that have strong balance sheets and acceptable risk exposures can provide near-term financial strength. However, for high levels of credit quality and financial strength to be maintained over the long-term, the company must exhibit favorable operating characteristics. In fact, at the highest end of the rating scale, at which solvency risks are generally very low, differences in the operating profile of individual companies are typically the most influential ratings factor.

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Included in CRABs operational review is an evaluation of: Underwriting expertise and market knowledge Distribution capabilities and mix Classes of business and changes in mix Market share and growth Brand name recognition and franchise value Expense efficiencies and operational scale Product and geographical mix Unique product offerings available through specialized underwriting capabilities Administrative and technological capabilities The operational review includes a significant degree of qualitative judgment. There is a delicate balance that needs to be maintained between attaining growth and market share, and maintaining underwriting discipline. Since non-life insurers do not know their largest cost loss and loss adjustment expenses at the time policies are sold, insurers need to exercise extra care when growing in a competitive environment. Thus, CRAB places underwriting expertise and market knowledge as the most important operational attributes of a highly rated non-life insurer. Organizational review: Organizational Review Due to the high level of solvency regulation within the insurance industry, legal organizational structure can have a significant impact on capital management, cash flows and the overall credit quality of the parent and individually rated insurance company subsidiaries. The analysis evaluates the company on a free-standing basis. In specific cases, it makes adjustments based on affiliate relationships. These adjustments, which can be significant, are affected by the following: Parent financial strength and financial flexibility Upstream dividend requirements, and availability of parent capital contributions Potential need to divert capital to support underperforming affiliates Business synergies with parent or affiliates Strengths and weaknesses of subsidiary companies Formal guarantees or support agreements; track record of affiliate support Management review: Management Review One of the most critical aspects of CRABs rating process is the level of confidence we develop in the management team and its stated strategies. The ability of management to establish a performance-based culture, and have in place an appropriate risk/reward system, is a key determinant to overall success.

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Our specific evaluation of management focuses on the following: Strategic vision Appetite for risk Credibility and track record for meeting expectations Controls and risk management capabilities Depth, breadth, and succession plans Accomplishments of key executives Financial review: Financial Review The financial review includes the calculation of numerous financial ratios and other quantitative measurements. These are evaluated based on industry norms, specific rating benchmarks, prior time periods and expectations specific to the rated entity. Though the financial review is largely a quantitative exercise, the interpretation of the results and weighing them into the final rating includes significant elements of subjectivity and qualitative judgment. Since capital & surplus plays an important role in the financial ratio analysis, CRAB makes adjustments to a companys reported capital & surplus in order to more accurately reflect true levels of capitalization and to provide better comparability in its financial analysis across international boundaries. Adjustments made to a companys reported capital & surplus include the addition of non-specific liability items such as contingency, catastrophe and equalization reserves. In addition, capital & surplus is adjusted to reflect the difference between the net market value and book value of investments where a company reports investments at book value. The adjustment of capital & surplus for unrealized gains/losses which are not reflected in a companys balance sheet is a very important feature of financial analysis as these values can be material and have a significant impact on many of the key quantitative financial tests measuring leverage and liquidity. All audited and regulatory filings are examined. In addition, financial statements prepared using other internationally accepted accounting principles are considered, as are unaudited financial statements, management reports, actuarial evaluations and company projections are assessed when available. The analysis always tries to understand major differences in reported results under different forms of accounting. The financial review is broken into seven main segments: Underwriting quality Profitability Investments and liquidity Reinsurance utilization Loss reserve adequacy Capital adequacy Financial flexibility

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Underwriting Quality The evaluation of underwriting quality, especially for insurers in higher risk classes of business, is the first part of the financial review and in many ways the most important. In conducting its review, CRAB recognizes that the need for sophisticated underwriting processes can vary dramatically by class of business. CRABs goal is to judge the overall health of the book of business, and managements understanding of its risks and ability to control them. Key areas considered include: Underwriting expertise in each class of business Targeted pricing margins including impact of investment income on pricing decisions Actuarial pricing credibility Appropriate style of underwriting based on nature of risks (i.e. individually underwritten, template underwritten, etc.) Pricing flexibility given competitive and regulatory environment Exposure to large losses such as catastrophes Balance of premium growth and underwriting discipline Controls over any third party underwriters, such as managing general agents Claims management and expertise Expense efficiencies, and impact of ceding commissions on expense ratios The underwriting performance is measured using two common ratios the loss ratio and the expense ratio. To properly interpret these ratios, CRAB considers the companys business mix, pricing strategy, accounting practices, distribution approach and reserving approach. These ratios are approached for the company as a whole, and by product and market segment. The analysis also looks at ceded reinsurance, as well as on a calendar and accident year basis. It also evaluates underwriting quality in the context of growth in premiums and revenues. It tries to understand how premium growth is influenced by changes in pricing versus growth in exposures, and generally prefers to see reasonably steady, even growth trends, and is concerned by both excessive growth and negative growth. Growth is evaluated in the context of market conditions and strategic initiatives of the insurer. Profitability The focus of analysis of profitability is to understand the sources of profits, the level of profits on both and absolute and relative basis and potential variability in profitability. Profits for general insurers are sourced from two primary functional areas -- underwriting and investment income. As indicated above, profits from underwriting are generated when operating revenues (generally premiums) exceed the sum of losses and administrative expenses. The underwriting margin, and its volatility, generally correlates with the level of risk that is being assumed. Profits derived from investments can take the form of interest, dividends and capital gains and can vary as to their taxable nature. The level of investment earnings is dictated by the investment allocation strategy and the quality of management. Like underwriting income, investment returns and their volatility are also correlated with the level of risk assumed.

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The analysis measures overall profitability (underwriting and investing) by calculating the companys operating ratio, which is the combined ratio less the investment income ratio (investment income divided by premiums earned). Operating margin is evaluated on a consolidated basis and by major product and market. To further understand the quality of earnings, evaluates the diversification of earnings, including the balance by market, product, and regulatory jurisdiction. In general, earnings that are well diversified tend to be less volatile. The analysis also calculates the following standard profitability ratios: return on assets (ROA), return on revenue (ROR), and return on equity and surplus (ROE and ROS). Investments/Liquidity The analysis of the investment portfolio focuses on credit risk, market risk, liquidity and historical performance. The investment portfolio is evaluated in the context of the liabilities based on the matching principle, with recognition, however, that most non-life insurers do not match to the extent of their life counterparts. As part of CRABs analysis, the companys investment guidelines and management controls are also evaluated to understand how the investment portfolio may change over time. CRAB examines credit risk by looking at the companys exposure to higher risk investments relative to the total investment portfolio and capital base. Overall diversification of the investment portfolio by major asset class and industry sector is also evaluated to identify any concentration issues. Market risk is evaluated to identify potential changes in asset valuation due to a change in market conditions, including the equity markets, real estate markets and the interest rate environment. Equity securities are also evaluated as to diversity and risk profile, and the impact on the volatility of capital levels is considered. Historical investment performance is evaluated to determine how well the companys investment strategies are executed. CRAB examines the companys investment yield, total return, duration and maturity structure, and historical default experience. Volatility of investment valuations is considered in the context of both book value and underlying market (liquidation) values. In short-tail insurance sectors, liquidity is particularly important. CRAB judges liquidity based on the marketability of the investments. The manner in which the company values its assets on the balance sheet is also closely examined. For classes exposed to catastrophic loss, CRAB reviews how an insurer would plan to raise sufficient liquidity to fund claim costs. CRAB evaluates trends in operating and underwriting cash flows to judge liquidity at the operating company level. It also considers cash flows in the context of future levels of investment income generated by a shrinking or growing portfolio.

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Reinsurance Utilization In assessing an insurers use of reinsurance, the analysis tries to determine if capital is adequately protected from large loss exposures, and to judge if the ceding companys overall operating risks have been reduced or heightened. Further, CRAB also looks for cases in which financial reinsurance is being used to hide or delay the reporting of emerging problems that may ultimately negatively impact performance or solvency. In the traditional sense, reinsurance is used as a defensive tool to lay off risks that the ceding company does not want to expose to its earnings or capital. When reinsurance is used defensively, CRABs goal is to gain comfort that: Sufficient amounts and types of reinsurance are being purchased to limit net loss exposures given the unique characteristics of the book Reinsurance is available when needed The cost of purchasing reinsurance does not excessively drive down the ceding companys profitability to inadequate levels, and weaken its competitive pricing posture The financial strength of re-insurers is strong, limiting the risk of uncollectible balances due to insolvency of the re-insurer. Exposure to possible collection disputes with troubled or healthy re-insurers is not excessive Loss Reserve Adequacy The most challenging area in analyzing a non-life insurer, and the area most susceptible to analytical error, is the evaluation of loss reserve adequacy. That said, losses resulting from strengthening of reserves for previously undetected deficiencies (i.e. adverse reserve development) have been the most common direct cause of insolvency. Thus, loss reserve adequacy is a critical part of the financial review, and a demonstrated ability to maintain an adequate reserve position is a crucial characteristic for a highly rated insurer. The greatest challenge in assessing loss reserve adequacy is that the data available to conduct the review, be it the information available from statutory returns, or loss development triangles available from management as used for internal analysis, are extremely difficult to interpret. Trends observed from this data can be influenced by a multitude of causes, including changes in business mix, underwriting practices, claims management, reinsurance arrangements, policy terms and other factors, making the ability to draw solid conclusions very difficult. While the analysis of reserve adequacy includes a robust quantitative element, much of the reserve review is qualitative in nature. Accordingly, our review focuses on the following: Statistical analysis of statutory filing data or other quantitative data Historical track record in establishing adequate reserves Managements reserving targets relative to the point estimate on the actuarial range (high, low, middle) Key reserving assumptions Managements propensity to reflect expected future improvements (such as claim handling

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enhancements designed to lower claim costs) in current reserves before proven Speed at which negative trends in frequency or severity are reflected in reserves General market and competitive pricing environment, and propensity of management to carry weaker reserves during down cycles Use of discounting, financial reinsurance or accounting techniques that reduce carried reserves Comparison of company loss development trends relative to industry and peers There is significant overlap in qualitative analysis of underwriting quality and reserve adequacy, as the two generally go hand in hand. Most insurers with lax underwriting standards will also have ineffective reserving standards, and vice versa. Also, experience on prior years business influences pricing targets on current business. Inadequate reserving can thus result in poor pricing decisions on current and future business. The evaluation of capital adequacy and profitability are also closely linked with its assessment of reserve adequacy. Reserve deficiencies lead to an overstatement of both historical profits (often over a multi-year period) and capitalization. Capital Adequacy CRABs analysis of capital adequacy first focuses on the level and quality of the insurers statutory capital position at the operating company level. Capital adequacy is evaluated on a legal entity basis and on a consolidated statutory basis in the case of a group. The review incorporates both risk-based and traditional measures. The analysis evaluates the level of capital in relation to a companys risk exposures, including investments, underwriting, business and reinsurance. Future capital needs based on business growth and other factors are also considered in analysis. It calculates operating leverage ratios on a gross, net and ceded basis. In evaluating the quality of the capital position, analysis considers reserve adequacy, asset valuation, goodwill, accounting practices, financial and other reinsurance arrangements, and other off-balance sheet exposures (such as guarantee fund assessments). Financial Flexibility Financial flexibility, or the companys ability to access internal and external capital sources, is an important ratings factor. In good times, the ability to access capital to support growth is critical to maximising the franchise value while maintaining capital adequacy. In bad times, maintaining the confidence of the capital markets and lenders can prove critical in allowing a company to avoid problems such as an inability to refinance maturing debt. Financial flexibility is derived first from the overall quality and reputation of the company as reflected in all of the ratings factors discussed throughout this report. However, financial flexibility is also strongly linked to the companys financial leverage, debt service coverage and liquidity. CRAB uses traditional balance sheet measures of financial leverage including the ratios of debt to equity, debt plus trust preferred to equity, debt to total capitalization, debt plus trust

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preferred to total capitalization, and double leverage. If necessary, these balance sheet measures are adjusted to take into account quality of capital issues. The debt maturity structure is also evaluated to determine the amount and timing of debt repayment (i.e., refinancing risk). In general, CRAB believes that an appropriate mix of shortterm and long-term debt is that which is consistent with its intended use (matching principle). With regard to short-term debt, CRAB expects companies to maintain backup bank facilities to cover short-term disruptions in the commercial paper markets. With regard to lines of credit and other bank facilities, analysis reviews each companys bank agreements, with a special emphasis on the facilitys tenor, financial covenants, and any material adverse change language. After determining the levels of funds both actually provided to and available to the holding company, CRAB will determine the debt service coverage profile of the organization. CRAB calculates various interest and fixed charge coverage ratios based on operating earnings, cash flow and statutory dividends, as well as various other methods. LONGTERM GENERAL INSURANCE COMPANIES ENTITY RATING AAA (Triple A): Have EXTREMELY STRONG financial security characteristics. AAA is the highest Insurer Financial Strength Rating assigned by CRAB. AA1, AA2, AA3* (Double A): Have VERY STRONG financial security characteristics, differing only slightly from those rated higher. A1, A2, A3 (Single A): Have STRONG financial security characteristics, but are somewhat more likely to be affected by adverse business conditions than Insurers with higher ratings. BBB1, BBB2, BBB3 (Triple B): Have GOOD financial security characteristics, but are more likely to be affected by adverse business conditions than higher rated insurers. BB1, BB2, BB3 (Double B): Have MARGINAL financial security characteristics. Positive attributes exist, but adverse business conditions could lead to insufficient ability to meet financial commitments. B1, B2, B3 (Single B): Have WEAK financial security characteristics. Adverse business conditions are likely to impair their ability to meet financial commitments. CCC1, CCC2, CCC3 (Triple C): Have VERY WEAK financial security characteristics, and are dependent on favorable business conditions to meet financial commitments.. CC (Double C): Have EXTREMELY WEAK financial security characteristics and are likely not to meet some of their financial commitments.

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C (Single C): Currently highly vulnerable to non-payment, having obligations with payment arrearages allowed by the terms of the documents, or have obligations subject of a bankruptcy petition or similar action though have not experienced a payment default. C is typically in default, with little prospect for meeting its financial commitments. D (Default): 'D' is assigned to insurance companies which are in DEFAULT. The 'D' rating also will be used upon the filing of a bankruptcy petition or the taking of a similar action if payments on an obligation are jeopardized.

Life insurance companies rating criteria:


CRABs analysis incorporates an evaluation of financial strength of the life insurer to meet all of its obligations. A logical starting point is to consider the various interests of the three stakeholders, namely, the policyholders, the shareholders and the regulators. To safeguard the interests of all the stakeholders, a life insurer must manage the collective risks passed on to it by its policyholders. The risks associated with the management of a life insurer arise from three main sources: insurance risk, investment risk, and business risk. Consequently CRABs rating methodology includes primarily an assessment of how prudently a life insurer manages its risks to meet all of its obligations. Our methodology makes an in-depth analysis of various risks undertaken by the life insurer. Our experienced analysts make detailed analysis of both quantitative and qualitative factors based on in-depth discussions with the key management personnel of the life insurer. CRABs methodology incorporates a review of the life insurance industry as well as the macroeconomic trends affecting the industry in general. The nature of insurance regulation and the life insurers performance with regard to the compliance of the various provisions of the Insurance Act 1938, the Insurance Rules 1958 and the related circulars and guidelines issued by the Department of Insurance are also examined. The competitive position of the life insurer in relation to other life insurers within the industry is evaluated. CRAB then applies CARAMELS framework to assess the financial strength of the life insurer. Both the quantitative and qualitative factors are considered together before assigning a rating. C : Capital Adequacy A : Asset Quality R : Risks Underwritten A : Actuarial Liability M : Management E : Earnings L : Liquidity S : Solvency Margin

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Capital adequacy : CAPITAL ADEQUACY Capital adequacy in the context of Bangladesh is judged as to whether a life insurer has complied with the requirement of paid-up capital as per Section 6 of the Insurance Act 1938. The minimum paid-up capital as specified by the Regulatory Authority under the Insurance Act 1938 is not a good indicator on the level and quality of a life insurers capital position. It is reported that the Regulatory Authority in Bangladesh starting from imposition of solvency margin requirement would gradually move towards risk based capital requirement. CRAB evaluates risk based capital requirement although no rule, regulation or guideline has yet been issued by the Regulatory Authority with regard to the methodology to be adopted by the insurers for calculation of risk based capital requirement. However, the Regulatory Authority must be concerned that the insurers honour its obligations to the policyholders while not putting at risk the solvency of the insurers. The risk based capital is a good measure of the insurers solvency assessment. CRAB evaluates the level of capital in relation to profitability and the insurers exposures to different kinds of risks. In the absence of any regulation relating to calculation of risk based capital requirement, CRAB has developed a formula for calculation of risk based capital for the particular insurer based on the particular risk characters the insurer has. Subject to the availability of data, the different sources of risk, namely asset default risk, insurance risk, asset liability mismatching risk and business risk are explicitly taken into account. However, rating is based on the current regulatory requirement of capital adequacy. CRAB provides additional information on the requirement of risk based capital but it does not affect the current rating process. Asset quality: ASSET QUALITY Rate of return is an important indicator of the insurers financial performance. Quality of assets has to be of excellent standing to ensure high rate of return on investment. Rate of return on each class of asset and the risks associated with each class and liquidity are evaluated by CRAB. Understanding the structure and composition of asset portfolio is very critical for analysis of asset quality. CRAB considers the following factors while analyzing the asset quality. Investment strategy Diversification Credit risk Market risk Liquidity Provisioning against loss on investment Investment risk is determined by the risk that liabilities cannot be met. It is, therefore, important that investments are appropriate to the nature of liabilities. It is desirable to reduce risk of investment by diversification, which helps reduce the risk of major default and reduce volatility of asset value. Section 27 of the Insurance Act 1938 and the Rule made there under prescribes

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investment rule to be followed by insurers for investment of its funds. CRAB examines whether the insurer while making investment has complied with statutory obligation. CRAB makes assessment of overall diversification of investment portfolio by asset class and industry sector to identify any concentration of risk. Credit risk is evaluated by examining the insurers exposure to high-risk investment relative to the total investment portfolio and capital base. CRAB also evaluates market risk to identify potential changes in asset valuation due to change in market conditions. CRAB examines the marketability of investment and cash assets to meet the potential management expense, claims on the death of the policyholders, claims on surrenders and at maturities of the policies. Method of valuation of assets as at the balance sheet date is also examined. CRAB also examines the insurers policy of provisioning against loss on investment including default on loans to policyholders. Risks underwritten: RISKS UNDERWRITTEN CRAB examines the nature of risks underwritten by the life insurer. CRAB considers the following factors while analyzing the nature of risks Pricing of insurance products Underwriting standard Reinsurance arrangements Business risk Pricing of insurance products is done by the actuary of the life insurer, which is based on, among others, assumptions of the expected mortality. Every insurer in Bangladesh is required to determine premium rates using the mortality table to be prepared by the Chief Controller of Insurance as stipulated in Section 3BB of the Insurance Act 1938. However, no such mortality has yet been prepared. In the absence of mortality table representing the mortality of assured lives in Bangladesh, the actuaries in Bangladesh have been using mortality tables prepared by other countries. There is a risk that the actual death claims may be significantly different from the expected death claims. CRAB, subject to availability of relevant data and information, evaluates whether there is any significant difference between the assumed mortality rates used in the determination of premium rates and the actual mortality experienced by assured lives of the life insurer. The main objective of underwriting is to charge a premium rate to each individual at the rate, which is broadly commensurate with the risk associated with each case. There may be a number of applicants who may be currently uninsurable because of uncertainty regarding the level of risk involved. A small number of impaired lives may be insured at rates higher than the standard rates. Moral hazard is eliminated through the process of underwriting. CRAB evaluates the process of underwriting of the life insurer. CRAB looks at the educational background and experience of key persons who are involved in the process of underwriting. Reinsurance is one of the key elements for a life insurer for reducing the risk caused by concentration of sum assured under individual policyholders.

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Reinsurance allows each life insurer to keep the benefits insured at any one time for any individual policyholder below a certain maximum level and thereby help reduce the probability of insolvency of a life insurer. CRAB examines the reinsurance policy of the life insurer, which determines both the method and terms under which reinsurance is arranged, credit worthiness of the reinsurer and the administration of reinsurance of the lives insured relating, in particular, to timely payment of reinsurance premiums, determination of reinsurance sums assured and settlement of outstanding reinsurance receivables. Business risk: BUSINESS RISK Business risk is usually considered as the contribution to a life insurers risk caused by its business activities. These primarily arise from the following elements: expense risk, discontinuance risk and distribution risk. A life insurer incurs expenses of management for its business operations. Rule 39 of the Insurance Rule 1958 has prescribed maximum allowable expenses of management for business operations of a life insurer. Expense risk is essentially the risk that the total expenses incurred by a life insurer are more than the allowable expenses as per the Insurance Rule. CRAB examines actual management expenses in relation to the maximum allowable management expenses to evaluate the longterm sustainability of its business operations. Section 40A of the Insurance Act 1938 provides for limitation of expenditure on commission. CRAB also evaluates whether the commission rates payable by the life insurer for procuration of insurance business are consistent with the commission rates allowed under the Insurance Act 1938. Voluntary discontinuance is a very important aspect of life insurance funds. There are essentially three modes of discontinuance: lapse surrenders and policies becoming paid-up. Sub-section 1 of Section 113 of the Insurance Act 1938 provides that a policy shall acquire surrender value if at least two consecutive years premiums have been paid. Therefore if a policyholder discontinues payment of premiums before payment of two consecutive years premium the policy does not acquire surrender value, and hence the policy becomes lapsed. First years expense of a policy are usually very high, often more than the first years premium, and, therefore with the lapsation of a policy the insurer incurs loss. Moreover high lapse ratio discourages the prospective policyholders to buy life insurance policies, which affect adversely the growth of life insurance business and could lead to ultimate insolvency. CRAB examines the actual lapse ratio of the insurer as well as the first year expenses incurred by the insurer for selling a policy and evaluates the impact of lapse ratio on the insurers financial position. As per sub-section 1A of Section 113 of the Insurance Act 1938, every insurer is required to submit to Chief Controller of Insurance for his approval a statement showing the bases and formulae on which guaranteed surrender values of the policies issued by such insurer are determined. CRAB examines whether the insurer has complied with the requirement of the Act. Surrender values may easily exceed asset shares on the surrender of certain long-term contracts at early policy durations, as with high initial costs relative to the low annual premiums may be very small relative to early years of policy durations. There are other implications of minimum surrender values. CRAB makes an in-depth analysis of the insurers policy of guaranteeing minimum surrender values of policies issued under different plans and terms. CRAB also

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examines the ratio of paid-up policies to the total number of valued policies to evaluate the life insurers efforts to keep the policies in-force. Distribution risk is the risk of distributing too much surplus to the shareholders and/or to the policyholders and becoming insolvent as a result. Surplus distribution is made by the payment of bonuses to the with-profit policyholders and by the payment of dividends to the shareholders. One of the main responsibilities of the life insurers actuary is to recommend distribution of surplus within the framework of the relevant provision of the Insurance Act keeping in view the long-term solvency and profitability of the life insurer. CRAB reviews the life insurers distribution policy in relation to that of life insurance industry. Actuarial Valuation of liabilities: ACTUARIAL VALUATION OF LIABILITIES Section 13 of the Insurance Act 1938 stipulates that every insurer shall cause an investigation to be made by an actuary into the financial condition of the life insurer. CRAB reviews valuation results. CRAB does not carry out actuarial valuation of liabilities; rather it uses the results of the valuation made by the life insurers actuary. Actuarys management report, if available, is also used to evaluate the insurers current financial position and likely scenarios that may emerge under different set of assumptions. MANAGEMENT Management quality is a very important factor, which can make substantial difference to the life insurers performance. CRAB evaluates the performance of the management team by focusing on policy administration, actuarial management, data management and compliance of statutory obligations. Each of the factors can be subdivided as follows. Corporate Governance Ownership pattern Board of Directors Regulatory compliance Internal control Management Information System Policy administration Method of premium collection Policy servicing Claims settlement Marketing Actuarial management Product design Reinsurance policy Risk assessment Expenses monitoring Investment policy

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Statutory obligations Actuarial reports and abstracts Other statutory reports Data management Quality of management information system Level and quality of computerization of accounting and valuation data Level and quality of computerization of business operations Some of the above factors have been covered elsewhere. CRAB also looks at academic and professional qualifications in respective fields of key executives, management succession plan, business plan and performance in relation to stated objectives and plans. Earnings: The actual investment yield as against the assumptions made in the pricing of products, actual management expense compared to expenses loaded in the premium formulae and actual mortality experience as against mortality rates assumed in the determination of premium rates have an important bearing on the profitability of a life insurer. The excess of life fund over the net liability (reserves) as valued by the actuary is the surplus generated as at the balance sheet date. The surplus after provision for taxes is distributed among the shareholders and policyholders on the recommendation of the actuary. CRAB examines the trend of surplus emerges during the inter-valuation period. CRAB also looks at the proportion of the annual premium reserved as a provision for future expense and profits to the total of annual premiums. Gross and net yields are also examined. CRABs review includes calculation of numerous financial ratios and other qualitative measurements. The review is based on audited financial statements, statutory reports submitted to the Chief Controller of Insurance, insurers annual reports, actuarial reports and abstracts. In case detailed actuarial reports are not made available, valuation results in a summary form as prescribed by CRAB are used instead of detailed report on actuarial valuation. Solvency Margin: SOLVENCY MARGIN Solvency margin is a kind of risk-based capital assessment of a life insurers risk. Adequacy of solvency margin is the basic test to assess the long-term financial viability of a life insurer. Insurance companies are required either to comply with the statutory solvency margin requirement in addition to having minimum paid-up capital as per provision of the law or to comply with a more formal risk-based capital requirement. In Bangladesh, there is no statutory requirement for solvency margin nor has any requirement of risk-based capital for carrying on insurance business. CRAB has developed a formula for calculation of solvency margin, which is used to test the solvency of the life insurer. As soon as the Regulatory Authority of the insurance sector in Bangladesh requires insurers to comply with the solvency margin requirement CRAB shall adopt the formula as specified by the Regulatory Authority. CRAB RATING SCALES AND DEFINITIONS

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LONGTERM LIFE INSURANCE COMPANIES ENTITY RATING AAA (Triple A): Have EXTREMELY STRONG financial security characteristics. AAA is the highest Insurer Financial Strength Rating assigned by CRAB. AA1, AA2, AA3* (Double A): Have VERY STRONG financial security characteristics, differing onlyslightly from those rated higher. A1, A2, A3 (Single A): Have STRONG financial security characteristics, but are somewhat more likely to be affected by adverse business conditions than Insurers with higher ratings. BBB1, BBB2, BBB3 (Triple B): Have GOOD financial security characteristics, but are more likelyto be affected by adverse business conditions than higher rated insurers. BB1, BB2, BB3 (Double B): Have MARGINAL financial security characteristics. Positive attributesexist, but adverse business conditions could lead to insufficient ability to meet financial commitments. B1, B2, B3 (Single B): Have WEAK financial security characteristics. Adverse business conditionsare likely to impair their ability to meet financial commitments. CCC1, CCC2, CCC3 (Triple C): Have VERY WEAK financial security characteristics, and are dependent on favorable business conditions to meet financial commitments.. CC (Double C): Have EXTREMELY WEAK financial security characteristics and are likely not tomeet some of their financial commitments. C (Single C): Currently highly vulnerable to non-payment, having obligations with payment arrearages allowed by the terms of the documents, or have obligations subject of a bankruptcy petition or similar action though have not experienced a payment default. C is typically in default, with little prospect for meeting its financial commitments. D (Default): 'D' is assigned to insurance companies which are in DEFAULT. The 'D' rating also will be used upon the filing of a bankruptcy petition or the taking of a similar action if payments on an obligation are jeopardized.

Manufacturing Companies rating criteria:

CRAB uses a comprehensive methodology for credit rating of manufacturing companies developed in collaboration with its technical collaboration partner ICRA Ltd of India. The methodology addresses the international standards for credit rating of manufacturing companies and incorporates the regulatory framework in Bangladesh.

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The major factors considered in CRABs rating analysis are described below: Industry Risk Analysis Analysis of industry risk focuses on the prospects of the industry and the competitive factors influencing it. The industry environment is assessed to determine the degree of operating risk faced by the company in a given business. Investment plans of the major players in the industry, demand supply factors, price trends, changes in technology, international/domestic competitive factors, entry barriers, capital intensity, business cycles etc. are key ingredients of industry risk. Rating also takes into account economy wide factors which have a bearing on the industry under consideration. The strategic nature of the industry in the prevailing policy environment, regulatory oversight governing industries etc are also analysed. Business Risk Analysis The position of the Company within the industry is then analysed. The key areas considered in assessment of business risk are as follows: Diversification For companies that operate in several industries, each major business segment is analysed separately. The contribution of each business segment to the companys overall profitability is assessed. While diversification results in better sustainability in cash flows, the analysis specifically looks into the suitability and adequacy of management structure to operate the diversification. Analysis also considers the forward and backward linkages required for the diversified operations. Seasonality and Cyclicality Some industries are cyclical in nature with their performance varying through the economic cycle. Some industries are seen to exhibit seasonality in sales or production. The analysis aims to be stable across seasons and economic cycles and are adjusted considering the long term fundamentals. Scale of Operation Small size presents a significant hurdle in getting higher ratings commensurate with a companys financials. Presence in selected market segments, limited access to funds leading to lack of financial flexibility etc., result in lower protection of margins when faced with adverse developments in business areas. Large firms, on the other hand, have higher susteinance power, even during troubled times.

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Cost Structure The cost factors and efficiency parameters of existing operations are assessed in respect of expenditure levels required to maintain its existing operating efficiencies as well as to improve its efficiency parameters in a competitive scenario. Nature of technology may also influence the cost structure. Market share A companys current market share and the trends in market share in the past are important indicators of the competitive strengths of the company. A sustained leadership position leads to ability to generate cash over the long term. A market leader generally has financial resources to meet competitive pricing challenges. Marketing and distribution arrangements Depending on the nature of the product, the rating analyses the depth and importance of the marketing and distribution of the company. For example, companies in FMCG sector require an extensive marketing and distribution network and rating gives high importance to the same when analyzing companies in those industries. Strategy & Financial Policies The companys business plans, mission, policies and future strategies in relation to the general industry scenario are assessed. An important factor is assessment of the managements ability to look into the future and its strategies and policies to tackle emerging challenges. The financial policies of the sponsors and management regarding financing its capital expenditure and working capital requirement is analysed. Operating Efficiency In a competitive market, it is critical for any business unit to control its costs at all levels. This assumes greater importance in commodity or me-too businesses, where low cost producers almost always have an edge. Cost of production to a large extent is influenced by: Location of the production unit(s) Access to raw materials Scale of operations State of technology Level of integration Experience of operating personnel And last but not the least, the ability of the unit to efficiently use its resources.

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A comparison with the peers is done to determine the relative efficiency of the unit. Some of the indicators for measuring production efficiency are: resource productivity (both assets and manpower), material usage (or input-output ratios) and energy consumption. Collection efficiency and inventory levels are important indicators of both the market position and operational efficiency. State of technology is a key to operational efficiency and lower production costs. Analysis of technology will also cover probability of obsolescence and threat of new technology. Market position All the factors influencing the relative competitive position of the Issuer are examined in detail. Some of these factors include positioning of the products, perceived quality of the products or brand equity, proximity to the markets and distribution network as well as relationship with the customers. Competitiveness is largely determined by costs. The market position is reflected in the ability of the Issuer to maintain / improve its market share and command differential in pricing. It may be mentioned that the Issuers whose market share is declining or expected to decline generally do not get favourable long term Ratings. Financial Strength Financial strength analysis involves evaluation of past and expected future financial performance with emphasis on assessment of adequacy of cash flows towards debt servicing. The analysis is mainly based on audited accounts of the company although unaudited accounts are noted. A review of accounting quality and adherence to prudential accounting norms are examined for measuring the companys performance. Accounting policies relating to depreciation, inventory valuation, income recognition, valuation of investments, provisioning/ write off etc. are given special attention. Prudent disclosures of material events affecting the company are reviewed. Impact of the auditors qualifications and comments are quantified and analytical adjustments are made to the accounts, if they are material. The rating team may meet the auditor to understand his comfort level with the accounting records, systems and policies of the company and his assessment of the management of the company. In the process, the rating group also forms an opinion on the quality of the auditor and his firms reputation in the market. Off-balance sheet items are factored into the financial analysis and adjustments made to the accounts, wherever necessary. Change of accounting policy in a particular year which results in improved reported performance is analysed more closely. Financial Ratios Financial ratios are used to make a holistic assessment of financial performance of the company, as also to see the companys performance compared to its peers within the industry. (i) Growth Ratios:

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Trends in the growth rates of a company vis--vis the industry reflect the companys ability to sustain its market share, profitability and operating efficiency. In this regard, focus is drawn to growth in income, PBIDT, PAT and assets. (ii) Profitability Ratios: Capacity of a company to earn profits determines the protection available to the company. Profitability reflects the final result of business operations. Important measures of profitability are PBIDT, Operating and PAT margins, ROAE and ROAA. Profitability ratios are not regarded in isolation but are seen in comparison with those of the competitors and the industry segments in which the company operates. (iii) Leverage and Coverage Ratios:

Financial leverage refers to the use of debt finance. While leverage ratios help in assessing the risk arising from the use of debt capital, coverage ratios show the relationship between debt servicing commitments and the cash flow sources available for meeting these obligations. The ratios considered are: Debt/Equity Ratio, Overall gearing ratio, Interest Coverage, Net cash accruals / Debt and Debt Service Coverage Ratio to measure the degree of leverage used vis-vis level of coverage available with the company. (iv)Turnover Ratios: Turnover ratios, also referred to as activity ratios or asset management ratios, measure how efficiently the assets are employed by the firm. These ratios are based on the relationship between the level of activity, represented by sales or cost of goods sold, and level of various assets, including inventories and fixed assets. (v) Liquidity Ratios: Liquidity ratios such as current ratio, quick ratio etc. are broad indicators of liquidity level and are important ratios for rating short term instruments. Cash flow statements are also important for liquidity analysis. Cash flows Interest and principal obligations are required to be met by cash and hence only a thorough analysis of cash flow statements would reveal the level of debt servicing capability of a company. Cash flow analysis forms an important part of credit rating decisions. Availability of internally generated cash for servicing debt is the most comforting factor for rating decisions as compared to dependence on external sources of cash to cover temporary shortfalls. Cash flow adequacy is viewed by the capability of a company to finance normal capital expenditure, as well as its ability to manage capital expenditure programmes as per envisaged plans apart from meeting debt servicing requirements. Financial flexibility

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Financial flexibility refers to alternative sources of liquidity available to the company as and when required. Companys contingency plans under various stress scenarios are considered and examined. Ability to access capital markets and other sources of funds whenever a company faces financial crunch is reviewed. Existence of liquid investments, access to lines of credits from strong group concerns to tide over stress situations, ability to sell assets quickly, defer capex etc. are favourably considered. Validation of projections and sensitivity analysis The projected performance of the company over the life of the instrument is critically examined and assumptions underlying the projections are validated. The critical parameters affecting the industry and the anticipated performance of the industry are identified. Each critical parameter is then stress tested to arrive at the performance of the company in a stress situation. Debt service coverage for each of the scenarios would indicate the capability of the company to service its debt, under each scenario. Management Evaluation

Management evaluation is one of the most important factors supporting a companys credit standing. An assessment of the managements plan in comparison to those of their industry peers can provide important insights into the companys ability to sustain its business. Capability of the management to perform under stress provides an added level of comfort. Meetings with the top management of the company are an essential part of the rating process. Track record The track record of the management team is a good indicator for evaluating the performance of the management. Managements response to key issues/events in the past like liquidity problems, competitive pressures, new project implementation, expansions and diversifications, etc. are assessed. Performance of group companies Interests and capabilities of the group companies belonging to the same management/sponsors give important insights into the managements capabilities and performance in general. Organisational structure Assessment of the organizational structure would indicate the adequacy of the same in relation to the size of the company and also give an insight on the levels of authority and extent of its delegation to lower levels in the organization. The extent to which the current organizational structure is attuned to management strategy is assessed carefully. Control systems

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Adequacy of the internal control systems to the size of business is closely examined. Existence of proper accounting records and control systems adds credence to the accounting numbers. Management information systems commensurate with the size and nature of business enables the management to stay tuned to the current business environment and take judicious decisions. Personnel policies Personnel policies laid down by the company would critically determine its ability to attract and retain human resources. Incidence of labour strikes/unrest, attrition rates etc., are seen in perspective of nature of business and relative importance of human capital. Corporate Governance

The corporate governance practices prevalent in a company reflect the distribution of rights and responsibilities among different participants in the organisation such as the Board, management, shareholders and other financial stakeholders, and the rules and procedures laid down and followed for making decisions on corporate affairs. The emphasis is on companys business practices and quality of disclosure standards that address the requirements of the regulators and are fair and transparent for its financial stakeholders. Security & Relationship Risk Analysis

This part is included to identify and assess the relationship history with the financers in term of credit sanctions, limit utilization, repayments, securities etc. CRAB RATING SCALES AND DEFINITIONS LONGTERM CORPORATE ENTITY RATING AAA (Triple A) Companies rated in this category have extremely strong capacity to meet financial commitments. These are judged to be of the highest quality, with minimal credit risk. AA1, AA2, AA3 (Double A)* Companies rated in this category have very strong capacity to meet financial commitments. These are judged to be of very high quality, subject to very low credit risk. A1, A2, A3 (Single A) Companies rated in this category have strong capacity to meet financial commitments, but susceptible to the adverse effects of changes in circumstances and economic conditions. These are judged to be of high quality , subject to low credit risk. BBB1, BBB2, BBB3 (Triple B) Companies rated in this category have adequate capacity to meet financial commitments but more susceptible to adverse economic conditions or changing circumstances. These are subject to moderate credit risk. Possess certain speculative characteristics.

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BB1, BB2, BB3 (Double B) Companies rated in this category have inadequate capacity to meet financial commitments. Have major ongoing uncertainties and exposure to adverse business, financial, or economic conditions. Have speculative elements, subject to substantial credit risk. B1, B2, B3 (Single B) Companies rated in this category have weak capacity to meet financial commitments. Have speculative elements, subject to high credit risk. CCC1, CCC2, CCC3 (Triple C) Companies rated in this category have very weak capacity to meet financial obligations. Have very weak standing and are subject to very high credit risk. CC (Double C) Companies rated in this category have extremely weak capacity to meet financial obligations. Highly speculative and are likely in, or very near, default, with some prospect of recovery of principal and interest. C (Single C) Companies rated in this category are highly vulnerable to non-payment, have payment arrearages allowed by the terms of the documents, or subject of bankruptcy petition, but have not experienced a payment default. Payments may have been suspended in accordance with the instrument's terms. Typically in default, with little prospect for recovery of principal or interest. D Default. Will also be used upon the filing of a bankruptcy petition or similar action if payments on an obligation are jeopardized.

Mobile Telecom service providers rating criteria:


CRAB has developed its rating methodology for mobile service providers in collaboration with its technical partner ICRA Ltd., Indias leading rating agency. The methodology focuses on evaluating the regulatory trends impacting the sector, the business position or profile of the service provider, the management strategy, and the risks associated with further investments. CRAB evaluates the financial risk profile of company by analysing the sponsors strength and commitment to the business, besides the companys capital structure, profitability, free cash flows, and coverage indicators. Additionally, CRAB assesses the credit risks arising out of expansions, restructuring, and strategic alliances to determine their likely impact on the companys ability to repay its financial obligations. Regulatory Risks The telecommunications industry in Bangladesh is highly regulated and in CRABs view, the regulatory environment has a critical bearing on a mobile service companys rating since it determines the intensity of competition for incumbents and delineates the opportunities for new

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entrants. CRAB assesses the regulatory regime for the mobile phone operators and the impacts of the likely changes in their businesses. Issuers Business Position The main factors that determine an issuers business position are attractiveness of its area of operation, its operating strengths, economies of scale drawn from presence across zones, and its cost structure. Market Potential of the of the Issuer The operating and financial viability of a mobile service provider depends on factors like addition to subscriber base, average revenue per user, and potential for growth, all of which are driven by the economic prospects of the country. CRAB therefore, analyses the market potential taking into account, among others, the following relevant macro indicators: Gross and Net Domestic Product, GDP per capita/households, past growth rates in these indicators, and the expected future trends of these parameters for the various markets the operator is present or aims to be present. Contribution of the secondary and tertiary sectors to total NDP: Higher the contribution of manufacturing industry and services NDP, higher the potential for telecom services. A high level of industrialization and a strong presence of service sector such as hotel, tourism, hospital, trading and finance are positive factors for the operator. Income distribution and other proxy indicators: CRAB assesses this aspect to determine the size of the future addressable market for mobile services. For instance, CRAB considers the addressable market as the total number of households above a particular income level. For this market CRAB analyses the expected penetration of mobile services and the growth rate of such households. Alternatively, CRAB evaluates other proxy indicators such as the penetration of two-wheelers, durable consumer goods, and cable television in the markets for use as reference checks to estimate subscriber growth. Existing Subscriber Base and Composition For rating an incumbent mobile service provider, CRAB looks at the attractiveness of its existing subscriber base as reflected by: Size Net month-on-month additions, and Prepaid/post-paid mix. The existing subscriber size and net month-on-month additions determine the market share of the operator on both a static and dynamic basis. The mix of postpaid-prepaid customers and the trends in the same are important since postpaid subscribers on an average generate higher

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average revenue per user (ARPU) and demonstrate higher loyalty towards the service provider as compared with prepaid subscribers. Also, with the decline in activation and upfront charges, an unfavourable postpaid-prepaid mix of subscribers increases subscriber churn since prepaid subscribers (especially marginal subscribers) are heavily influenced by costs and can be easily poached by competitive predatory pricing strategies. However, some of the retention barriers for postpaid subscribers could also get lowered once number portability is introduced and activation charges decline because of competitive pressures. Intensity of Competition With the entry of the fifth mobile service provider and the private fixed phone operators intensity increased significantly, leading to operators significantly lowering rentals and tariffs to maintain/increase market share. Initially, these measures affected the incumbent operators revenues and profitability, but over a period of time, the operators found themselves largely compensated by the significant growth in domestic mobile subscriber base and increase in minutes of usage. However, going forward, further reductions in tariff may not get adequately compensated by an increase in minutes of usage or subscriber growth. In the case of new entrants, garnering market share in the growing mobile market is important for their viability in the long run. Thus, understanding the strengths of various players and the strategies adopted by them to counter competition is important to estimate their future market shares and profitability. Therefore, to arrive at a rating decision, CRAB evaluates the competitiveness of the players by assessing their network coverage and quality, brand development efforts, customer service standards, sales and distribution network, cost structure and financial strength. Network Coverage and Quality As mobile subscribers want to be able to use their phones everywhere, the operator who offers seamless coverage, better voice quality and lower congestion has a competitive advantage. Coverage is even more relevant in the case of non-metropolitan areas, where people attach significant importance to inter zonal roaming. Inter zonal roaming allows higher mobility and that too at no extra cost to the subscriber (as such calls usually do not invite long-distance charges). CRAB has observed that mobile service providers who have lower coverage usually have a lower market share. Thus, to determine the potential for subscriber growth and penetration of mobile operators, CRAB evaluates their current coverage and network rollout plans, which, among others, include the current and planned number of cities/highways covered and number of interconnection points. Besides, CRAB assesses the adequacy of the spectrum available to the operator to service its current and expected growth in subscriber base over the long term and its capability to support higher capital expenditure if the current spectrum allocation is inadequate. Brand Image CRAB has observed that in a competitive environment, any reduction in tariffs can be matched by competitors. Thus plain vanilla price planks have given way to building up brand image among subscribers. In choosing an operator, customers usually go by their own brand evaluation

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and also rely on word of mouth publicity. With increasing price competition, product comparisons are becoming more difficult and branding and quality of service more important. Thus CRAB believes that players with a strong brand presence across zones would enjoy higher consumer awareness, and this in turn would reduce advertising costs. Customer Care and Retention Mobile operators spend substantial resources to add customers and thus customer retention is critical for them. The loss of subscribers is measured by churn, which is the ratio of subscribers leaving the network to the present subscriber base. Churn can either be voluntary (subscribers opting for a better package offered by a competitor, citing low service quality to move over to another service provider, deciding to discontinue with mobile services altogether, etc.) or involuntary (subscribers disconnected by the operator because of credit problem, for instance). High voluntary churn can have a large impact on an operators profitability, since higher the number of subscriber an operator loses, more it has to add to sustain growth in its total subscriber base. Thus, CRAB evaluates the customer care and retention strategies of operators while arriving at a rating opinion. The evaluation involves an assessment of the entire chain, beginning with initial customer contact, through problem solving and ongoing support, to monitoring the reasons for exit. Providing another dimension to the assessment of customer care and retention is the pyramidal structure of mobile revenues, wherein a small proportion of subscribers accounts for a significant portion of revenues. Usually, new entrants devote considerable resources in luring away these highuse subscribers from incumbents. Therefore, while assessing an operators customer care and retention strategies, CRAB also evaluates an incumbents systems that seek to identify such customers and retain them. Sales and Distribution CRAB believes that in the mobile service business, an operators sales and distribution network is of considerable importance since this network allows the operator to respond effectively to changing market and consumer needs, and attract new customers as well. Thus, CRAB evaluates the current and proposed distribution strategies of mobile service providers while arriving at a rating decision. The evaluation involves an assessment of the direct and indirect distribution channels of the operator, and the operating, technical and financial support that the operator extends to the channel partners. Operating Costs The operating costs of a mobile service provider have three principal components: Network related costs

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Customer acquisition costs Collection and administrative costs Network Related Costs: For a mobile operator, the main cell site/network related costs are cell site rentals, transmission costs, and maintenance costs. CRAB evaluates the operators strategy to lower these costs, for instance, by entering into long-term contracts for site rentals, or sharing cell sites with other operators. Transmission costs are dependent on both the choice of the connecting media (fibre optics or microwave links) and on whether such media are owned by the company or are rented. Customer Acquisition Costs: Customer acquisition costs include sales and distribution expenses and means for lowering subscribers entry costs such as subsidies on handsets and bundled packages. In a competitive environment, it is becoming increasingly difficult to reduce customer acquisition costs. Therefore, CRAB analyses the strategies adopted by mobile service operators to utilise their distribution channels effectively. CRAB also assesses the initiatives taken by operators to lower distribution costs by adopting new channels for mass marketing such as providing online web registration facilities, and forging alliances with companies with established customer links (credit card issuers, retail chain outlets and consumer durable financing companies). Collection and Administrative Costs: CRAB evaluates the mobile service operators bad debt levels, collection expenses, and other customer and company related costs under this parameter. The bad debt levels depend on the credit systems in place and the proportion of postpaid customers in the subscriber mix. Although like most other operating costs, these costs are largely influenced by market dynamics, operators can control them to an extent by superior management. Therefore, CRAB analyses the operators credit system in detail, covering the entire range of operations including verification of new customers, assigning of credit levels, monitoring of usage pattern, and assessing of billing and collection mechanisms. CRAB measures credit norms in terms of monthly collection efficiencies, the collection cycle (the number of days in which an operator collects 95% billing for a particular month), the ageing profile of receivables, and collection costs as percentage of postpaid revenue. Good credit evaluation systems mitigate the chances of fraud and bad debts. Overall, a good indicator of an operators cost competitiveness is its collection and administration expenses per subscriber. Economies of Scale One of the main operating costs for mobile service operators is interconnect costs. Interconnect costs refer to the costs of interconnecting with other networks in the same telecom zone (e.g. a landline to a mobile network) and linking operators in different telecom zones. The interconnect

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arrangements and rates charged for carrying traffic through interconnecting networks can have an impact on the costs, profits and business strategies of operators. Mobile service companies having operations with bigger area of coverage can have better bargaining power with other operators and long distance carriers, which in turn can provide them with a competitive edge against players operating with smaller coverage. In addition, large operators can negotiate better terms with vendors for capital equipment as well as consumer equipment, repairs and maintenance, and can distribute their marketing and operating costs over a larger base of subscribers. Moreover, players with a higher coverage enjoy higher consumer awareness and benefits of lower advertising costs. Thus, CRAB associates lower risk with players having higher coverage. Management Quality and Strategy A rating decision is significantly influenced by a mobile operators management strategy for future growth and profitability, and its ability to execute such strategies. This is particularly important in an industry that is characterised by rapid changes. CRAB, while evaluating a mobile service providers management quality and strategy, specifically examines the following aspects: Strategy to maintain market position: This is important while rating an incumbent mobile service provider since the competitive scenario is changing continually and significantly. Strategy to build up new areas of expertise and new sources of revenues: With voice becoming increasingly commoditised and therefore vulnerable to price risks, CRAB evaluates mobile operators strategy for introduction of new higher-margin data and video services. Acquisitions and venturing into related or unrelated businesses: CRAB evaluates the mobile operators risk appetite for acquisitions and for related or unrelated diversification. This can become a rating concern if the acquisition or diversification has a long gestation period or is funded mainly through debt, which can affect the operators capital structure and profitability. Besides the specific issues discussed, CRAB seeks to gain an understanding of the mobile service providers risk philosophy, particularly in the context of adopting new technologies, and its financial policies. Foreign Promoters CRAB evaluates the operational and financial strengths of the foreign promoter of a cellular service provider while arriving at a rating decision. The foreign promoters experience in working in multiple-operator

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Sponsors Strength and Financial Flexibility The mobile service industry has been witnessing healthy growth rate in the recent periods. As a result, most operators have large funding requirements, and the ability to raise funds through alternative sources is an important credit determinant. Apart from the financial strength of the operator being rated, an assessment of the financial strength of the sponsors also becomes important. CRAB therefore assesses the ability and willingness of the sponsors to inject additional funds in the mobile venture by looking at their financial strength and the importance of the mobile service venture in the sponsors overall business plans. In case the mobile venture has foreign promoters, CRAB examines the regulatory requirements that the foreign promoter must comply with to inject additional funds into the Bangladeshi company. The mobile ventures capacity to raise debt, besides its financial soundness, is also determined by sponsors relationship with the lending institutions and credit enhancements from sponsors in the form of guarantees and comfort letters. CRAB would also evaluate the financial flexibility available to service providers in case the gestation period is longer than initially expected. An important source of financial flexibility could be moderate gearing or the option to issue equity to other strategic investors. New Project Risks From a rating perspective, CRAB would look more favourably at mobile service providers who have a good track record in setting up cellular networks in an efficient and timely manner. CRAB would also evaluate the status of all approvals and clearances as required under the cellular licensing agreement. Such approvals and clearances may pertain to operational aspects such as frequency allocation from the regulators or changes in the capital structure (e.g. foreign holdings) that in turn may necessitate regulatory permissions/approvals. Delays in obtaining such clearances may cause delays in rolling out the network and in commencing commercial operations. CRAB would also assess the status of funding tie-ups of the mobile operator to meet the proposed capital expenditure. This would involve evaluation of the promoters ability to meet the equity requirements and the status of loan agreements with suppliers and financial institutions. Financial Evaluation CRAB evaluates mobile service providers past financial performance and draws up cash flow projections to assess the adequacy of their cash flows in relation to their debt repayment

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obligations. The process also involves a comparison of the service providers key financial parameters and ratios with those of the others in the industry. The key parameters include capital cost per subscriber, average revenue per user (ARPU), operating cost per subscriber, earning before interest, taxes, depreciation and amortisation margin (EBITDA), and collection efficiency. The other key financial ratios that CRAB examines while rating a mobile service provider include: Total Debt/EBITDA Retained Cash Flow (Net Cash Accruals)/Debt Retained Cash Flow/Capital Expenditure Free Cash Flows/Debt EBITDA/Interest EBIT/Interest Debt/Tangible Net Worth Debt Service Coverage Ratio The ratio analysis is done taking into consideration the characteristics of the mobile service industry. For instance, it is typical for a mobile service operator to have a high gearing as it invests heavily in setting up networks in new areas, or upgrades its network. Thus this gearing is viewed against the prospects of increase in internal cash accruals in future. If the prospects are positive, there are chances that the gearing would decline to better levels in future. While assessing the adequacy of future cash flow to meet debt servicing obligations, apart from conventional debt servicing indicators, the issues looked at include peak funding requirements, means of funding the deficits, and status of funding tie-ups. In conclusion, CRABs rating decision on a mobile service provider is influenced by various factors, which have varying degrees of importance. CRAB remains open to incorporating changes in its rating methodology either in response to or in anticipation of changes impacting the dynamics of the Bangladesh mobile service sector. Such changes could be prompted by the evolving regulatory framework, technological advancement, media convergence, and declining costs, amongst other factors. CRAB RATING SCALES AND DEFINITIONS LONGTERM CORPORATE ENTITY RATING AAA (Triple A) Companies rated in this category have extremely strong capacity to meet financial commitments. These are judged to be of the highest quality, with minimal credit risk. AA1, AA2, AA3 (Double A)* Companies rated in this category have very strong capacity to meet financial commitments. These are judged to be of very high quality, subject to very low credit risk. A1, A2, A3 (Single A) Companies rated in this category have strong capacity to meet financial commitments, but susceptible to the adverse effects of changes in circumstances and economic conditions. These are judged to be of high quality , subject to low credit risk.

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BBB1, BBB2, BBB3 (Triple B) Companies rated in this category have adequate capacity to meet financial commitments but more susceptible to adverse economic conditions or changing circumstances. These are subject to moderate credit risk. Possess certain speculative characteristics. BB1, BB2, BB3 (Double B) Companies rated in this category have inadequate capacity to meet financial commitments. Have major ongoing uncertainties and exposure to adverse business, financial, or economic conditions. Have speculative elements, subject to substantial credit risk. B1, B2, B3 (Single B) Companies rated in this category have weak capacity to meet financial commitments. Have speculative elements, subject to high credit risk. CCC1, CCC2, CCC3 (Triple C) Companies rated in this category have very weak capacity to meet financial obligations. Have very weak standing and are subject to very high credit risk. CC (Double C) Companies rated in this category have extremely weak capacity to meet financial obligations. Highly speculative and are likely in, or very near, default, with some prospect of recovery of principal and interest. C (Single C) Companies rated in this category are highly vulnerable to non-payment, have payment arrearages allowed by the terms of the documents, or subject of bankruptcy petition, but have not experienced a payment default. Payments may have been suspended in accordance with the instrument's terms. Typically in default, with little prospect for recovery of principal or interest. D Default. Will also be used upon the filing of a bankruptcy petition or similar action if payments on an obligation are jeopardized.

Commercial Baks rating Criteria:


CRAB uses a comprehensive methodology for credit rating of commercial banks developed in collaboration with its technical collaboration partner ICRA Ltd of India. The methodology addresses the international standards for credit rating of Commercial banks and incorporates the regulatory framework in Bangladesh. The major factors considered in CRABs rating analysis are described below: QUANTITATIVE FACTORS The starting point in reaching a rating decision is a detailed review of key measures of financial performance and stability:

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Capital Adequacy Capital Adequacy is a measure of the degree to which the banks capital is available to mitigate the stress of possible losses. CRAB examines the conformity of the bank to the Bangladesh Bank guidelines on Capital Adequacy ratio. Asset Quality Asset Quality review assesses the quality of the banks overall investment portfolio and includes a sector by sector analysis of the investment and guarantee portfolio, as well as inter-bank exposures. The historical recovery rate of annual demands of principal and profit and the banks experience of investment losses and writeoff/ provisions are studied. The percentage of assets classified into standard, substandard, doubtful or loss is examined closely. The portfolio diversification and exposure to troubled industries/areas is evaluated to determine the extent of potential losses. In addition, the banks own credit risk norms are examined. Funding and leverage The funding mix determines the leverage and the cost of capital. One of CRABs principal aims in bank analysis is to assess the institutions ability to finance itself in times of stress. CRAB examines the composition of deposits in terms of short term or long term, domestic or foreign currency and also the composition of currencies. The volatility, growth and shift in the composition of the funding pattern are also studied. Overall gearing, profit coverage and their trends are taken as measures of financial risk arising as a result of funding decision. Liquidity Liquidity is often the proximate cause of bank failure, while, strong liquidity can help even an otherwise weak institution to remain adequately funded during difficult times. CRAB determines the maximum stress which the bank is likely to face and evaluates the internal and external sources available to meet this. Factors examined are the credit deposit ratio, the maturity matching of assets and liabilities, proportion of liquid assets to total assets and the degree to which core assets that are illiquid are funded by core liabilities. The short term external funding sources in the form of refinance facilities from Bangladesh Bank and the inter-bank borrowing limits available are considered. The banks CRR and SLR investments are important sources of reserve liquidity. Earnings quality Earnings quality reviews cover the performance and risk assessment of each business area- the investment portfolio, guarantees and forex & treasury operations and non fund based activities.

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CRAB focuses on the strength of each major business and its earnings prospects. The main indicators used to measure profitability are return on assets, spreads, the expense ratios and the earnings growth rate. Evaluation of quantitative factors is done, not only of the absolute numbers and ratios, but their volatility and trends as well. The attempt is to determine core, recurring measures of performance. CRAB also examines how the banks performance on each of the above discussed parameters is, compared to its peers. Detailed inter-firm analysis is done to determine the relative strengths and weaknesses of the bank in its present operating environment and any impact on it, in future. Sensitivity to Market Risk The sensitivity test of a bank addresses the degree to which changes in profit rates, foreign exchange rates, commodity prices or equity prices can adversely affect a financial institution's earnings or capital. For most institutions, market risk primarily reflects exposures to changes in profit rates. (An institution's ability to monitor and manage its market risk is also assessed in the qualitative risk management area) Qualitative factors QUALITATIVE FACTORS Some of the qualitative factors that are deemed critical in the rating process are: Ownership An assessment of ownership pattern and shareholder support in a crisis is significant. In case of public sector banks, the willingness of the government to support the bank is an important consideration. Management quality The composition of the board, top management and the organizational structure of the bank are considered. The banks strategic objectives and initiatives in the context of resources available, its ability to identify opportunities and track record in managing stress situations are taken as indicators of managerial competence. CRAB analyses the banks budgeting process and cost control in terms of their effectiveness. The adequacy of the information systems used by the management is evaluated in terms of quality and timeliness of the information made available to bank managers. CRAB focuses on the modern banking practices and systems, degree of computerization, capabilities of senior management, personnel policies and extent of delegation of powers. Risk Management Credit risk management is evaluated through the appraisal, monitoring and recovery systems and the internal prudential lending norms of the bank. The banks balance sheet is examined from the perspective of profit rate sensitivity and foreign exchange rate risk. Liquidity risk arises due to differing maturity of assets and liabilities and profit rate risk appears because of mismatch

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between the floating and fixed rate assets and liabilities. CRAB also assesses the extent to which the bank has assets denominated in one currency with liabilities denominated in another currency. Compliance with statutory requirements CRAB examines the track record of the bank in complying with SLR/CRR and priority sector lending norms as specified by Bangladesh Bank. Accounting Quality Rating relies heavily on audited data. Policies for income recognition, provisioning and valuation of investments are examined. Suitable adjustments to reported figures are made for consistency of evaluation and meaningful interpretation. Size and Market Presence The fund base and branch network of the bank are taken as important indicators of strength. In a fast changing environment, a large bank can meet the competitive challenges from other financial intermediaries due to its economies of scale and wider reach. Also if the bank represents a substantial percentage of the banking sector, its failure would cause severe disruptions for the country as a whole and it is thus likely to obtain government support in times of distress. Long-term and Short-term rating: Long Term and Short Term Rating All relevant quantitative and qualitative factors are considered together, as relative weakness in one area of the banks performance may be more than adequately compensated for by strengths elsewhere. However, the weights assigned to the factors are different for Short Term Ratings and Long Term Ratings. The intention of long term ratings is to look over a business cycle and not adjust ratings frequently for what appear to be short term performance aberration. The quality of the management and the competitiveness of the bank are of greater importance in long term rating decisions. The rating process is ultimately a search for the fundamentals and the probabilities for change in the fundamentals. The assessment of management quality, the banks operating environment and its role in the nations financial system is used to interpret current data and to forecast how well the bank is positioned in the future. The final rating decision is made by the Rating Committee after a thorough analysis of the banks position over the time with regard to business fundamentals.

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LONGTERM COMMERCIAL BANKS ENTITY RATING AAA (Triple A): Have extremely strong capacity to meet financial commitments, maintains highest quality, with minimal credit risk. AA1, AA2, AA3* (Double A): Have very strong capacity to meet financial commitments, maintains very high quality, with very low credit risk. A1, A2, A3 (Single A): Have strong capacity to meet financial commitments, maintains high quality, with low credit risk, but susceptible to adverse changes in circumstances and economic conditions. BBB1, BBB2, BBB3 (Triple B): Have adequate capacity to meet financial commitments but are susceptible to moderate credit risk. Adverse changes in circumstances and economic conditions are more likely to impact capacity to meet financial commitments. BB1, BB2, BB3 (Double B): Have inadequate capacity to meet financial commitments and possess substantial credit risk, with major ongoing uncertainties and exposure to adverse business, financial, or economic conditions. B1, B2, B3 (Single B): Have weak capacity to meet financial commitments and are subject to high credit risk. Currently meeting the financial commitments, but adverse business, financial, or economic conditions are likely to impair capacity to meet obligations. CCC1, CCC2, CCC3 (Triple C): Currently vulnerable, and are dependent upon favourable business, financial, and economic conditions to meet financial commitments. Have very weak standing and are subject to very high credit risk. CC (Double C): Currently highly vulnerable, highly speculative and are very near to default, with some prospect of recovery. C (Single C): Currently very highly vulnerable to non-payment, may be subject of bankruptcy petition or similar action, though have not experienced payment default. C is typically in default, with little prospect for recovery. D Default. 'D' rating also will be used upon the filing of bankruptcy petition or similar action if payments on an obligation are jeopardized.

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Rating criteria securitizations and structured finance obligations


The method of conversion of financial assets into tradable assets is known as securitization. Structured finance or securitized finance are a wide variety of debts, and related to securities whose promise to repay is backed by (a) the value of some financial assets or (b) the credit support from a third party to the transaction - securities supported wholly or mainly by pool of assets are generally referred to as either Mortgaged Backed Securities or Asset Backed Securities. In the transactions supported by assets, some or all of the cash flows from these assets are dedicated to the payment of principal and interest. There could be two types of cash flow structures, i.e. Pass-Through or Pay-Through. Pass Through securities are equity instruments, in which assets are typically sold to a Trust and investor buy shares of the Trust. Pay- Through securities are debt obligations and raiser of funds pledges or sells the assets to a Special Purpose Vehicle (SPV). Common participants in the asset backed securities market: A. Sellers i. Banks ii. Financial Institutions iii. Pension Funds iv. Corporate Entities v. Mutual Funds B. Intermediaries i. Trust ii. Credit Rating Agency iii. Servicer (more often than not the Seller acts as the servicer) Asset Backed Securitization Asset Types: Securitisation essentially requires a steady and predictable cash flow stream and an underlying asset (which may be absent at that point of time in certain deals like future flows). Categorization is, therefore, possible based on the type of asset securitised. A. Mortgage Backed: Mortgage backed securitization involves conversion of pools of mortgage backed housing loans into tradable debt securities. Such securities are termed Mortgage Backed Securities. The market for housing loans involving a housing finance company (HFC) and the borrower is referred to as the primary market. The market for securitised paper backed by such mortgage loans is the secondary market.

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B. Fixed Asset Receivables: Finance companies provide financing in the form of leases and hire purchase (typically 3 to 5 year assets). Pools of receivables from these assets may be securitised with the underlying asset providing the collateral security. C. Bills / Trade Receivables: Short term cash flows like trade receivables or external trade bills purchased by companies are also assets, which may be securitized. Typically, credit enhancement for such securities may be through Letters of Credit (LC), irrevocable guarantees or even over collateralisation. One of the transaction structures may operate as follows: D. Non-Asset Backed Securitisation Future Flows: Unlike traditional Asset Backed transactions, future flow securitization utilises the cash receivables of a corporate, based on its future performance. The sale here is of a particular stream of future cash receivables and no asset is sold or removed from the books of the entity. This form of structured offering has been particularly popular with the corporate entities while issuing international debt, whereby expected cash inflows ensure an instrument Rating superior to the sovereign Rating by mitigating some of the currency related risks involved. International future flow securitisations are structured debt offering of the corporate secured by receivables due from international obligors. The originating company that issues certificates or notes generally sells the future receivables to an offshore Trust. In addition, receivable obligors are directed to make payments directly to the offshore Trust. Advantages of Securitisation: The main advantages of securitisation for entities holding financial assets are listed below: (a) Increased liquidity as relatively illiquid assets are converted into tradable securities; (b) Risk diversification; (c) Better asset liability management because securities offer an efficient way of tenure for matching of assets and liabilities; (d) Funding sources securitisation allows the issuers to find alternate sources of funding and also raise funds at low costs with improved Credit Rating. Rating Framework: Credit Ratings play a very important role in the issuance of structured debt instruments. The process of structuring of the instruments is generally quite complex which makes the task of assessing the credit risk extremely difficult for lay investors. Credit Ratings provide a simple and objective assessment of default risk in the form of symbolic indicators, which are easy to comprehend. The framework used for assessing the risk of default involves assessment of three types of risk i.e. credit risk, structural risk, and legal risk. (a) Credit Risk: It is the risk of default by the borrowers. It refers to the uncertainty

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regarding the extent to which the borrowers of underlying assets backing the security will pay as per the terms of contract. (b) Structural Risk: It refers to the manner in which the transaction is structured to direct the payment stream (along with the collateral or support provider) to the investors. (c) Legal risk: It refers to the risk of potential insolvency of the issuer or other parties involved in the transaction. The methodology for Rating Asset Backed Securities would cover: 1. The originator: Its current Credit Rating, underwriting standards, appraisal, monitoring and collection systems, financial performance, competitive position and strategy, experience and competence of management. 2. Asset quality: Loan to value ratio, EMI cover, historical repayment, delinquency and loss statistics, history of repossessions, ageing analysis of overdue, prepayments, losses on foreclosure, resale price and value of the underlying asset, availability of a resale market, presence or absence of recourse to originator and maturity profile of contracts. 3. Portfolio characteristic: Including pool size, customer or geographic concentrations, average seasoning; nature of asset composition of new or old assets (in vehicles and lease assets), loan size of contracts; difference with total pool characteristics (left-over pool may not be securitized) when selecting from large portfolio; the receivables should be chosen randomly selecting receivables that represent new property (i.e. Assets that have not been previously owned), are at least six months seasoned, have no current delinquencies, and are geographically dispersed. 4. Credit enhancement structure: The level of credit enhancement is usually based upon the selection of a prime pool that would have the lowest risk profile. Credit enhancement required for the prime pool to achieve a particular Rating is first determined. Other pools may achieve similar Ratings based on differing levels of credit enhancement. 5. Structure: Refers to allocation of cash flows to investors, recourse provision, combining of cash flows and reinvestment in certain structures. 6. Service provider, Trustee / Administrator / Receiving and Paying Agent: The ability, willingness, reputation and market standing of the third parties involved, power and authority bestowed on them and provision for appointment of successor. 7. Legal issues: include true sale characteristics of the transactions and building a bankruptcy remote structure bankruptcy of originator should not hinder timely payment on the instrument and legal enforceability of the structure as a whole. Some of the criteria considered for determining bankruptcy remoteness are: Collections of the receivables securitised;

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Assets should not be co-mingled with the funds of the seller as far as possible; There should be no recourse against the seller for defaulted receivables beyond a reasonable anticipated default rate based on historical analysis; The transfer of the receivables should be accounted for as a sale on the sellers financial statements. Crab rating scales and definitions:

CRAB RATING SCALES AND DEFINITIONS LONGTERM DEBT INSTRUMENTS AAA (Triple A) Debt instruments rated AAA have extremely strong capacity to meet financial commitments. These are judged to be of the highest quality, with minimal credit risk. AA1, AA2, AA3 (Double A)* Debt instruments rated AA have very strong capacity to meet financial commitments. These are judged to be of very high quality, subject to very low credit risk. A1, A2, A3 (Single A) Debt instruments rated A have strong capacity to meet financial commitments, but susceptible to the adverse effects of changes in circumstances and economic conditions. These are judged to be of high quality, subject to low credit risk. BBB1, BBB2, BBB3 (Triple B) Debt instruments rated BBB have adequate capacity to meet financial commitments but more susceptible to adverse economic conditions or changing circumstances. They are subject to moderate credit risk. Such rated projects possess certain speculative characteristics. BB1, BB2, BB3 (Double B) Debt instruments rated BB have inadequate capacity to meet financial commitments. They have major ongoing uncertainties and exposure to adverse business, financial, or economic conditions. Such projects have speculative elements, and are subject to substantial credit risk. B1, B2, B3 (Single B) Debt instruments rated B have weak capacity to meet financial commitments. They have speculative elements and are subject to high credit risk. CCC1, CCC2, CCC3 (Triple C) Debt instruments rated CCC have very weak capacity to meet financial obligations. They have very weak standing and are subject to very high credit risk. CC (Double C) Debt instruments rated CC have extremely weak capacity to meet financial obligations. They are highly speculative and are likely in, or very near, default, with some prospect of recovery of principal and interest. C (Single C) Debt instruments rated C are highly vulnerable to non-payment, have payment arrearages allowed by the terms of the documents, or subject of bankruptcy petition, but have not experienced a payment default. Payments may

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have been suspended in accordance with the instrument's terms. They are typically in default, with little prospect for recovery of principal or interest. D (Default) D rating will also be used upon the filing of a bankruptcy petition or similar action if payments on an obligation are jeopardized. RATING CRITERIA SECURITIZATIONS & STRUCTURED FINANCE OBLIGAT

RATING CRITERIA SECURITIZATIONS & STRUCTURED FINANCE OBLIGATIONS