Credit Rating

Credit rating services, types of rating, advantages and disadvantages, credit raging agencies and their methodology.

Introduction
Credit rating: symbolic indicator of the current opinion of a rating agency.
Capability and willingness of an issuer of a debt program to serve the debt obligations as per terms of the contract. A rating is a specific to a debt instrument: an analysis of credit risk associated with it. Rating is not a general purpose, nor entity rating

 It is not a recommendation to buy, sell or hold Objective of rating s to provide guidance to investors in determining a credit risk. It is not going to consider market price personal risk references. It does not perform audits, it relays on information provided by the issuer, and the information collected by the analysts. Agency is not guarantee the completeness and accuracy on which the rating is based.

Types of credit rating

Bond Rating: Equity rating: Commercial paper rating: P1 in India Sovereign rating

Credit rating Vs financial analysis

Financial analysis based on the figures Credit rating is based on unpublished and corporate plan and strategies.

Factors contributing to the success of the rating system

Credible and independent structure and procedure Reliance on the market mechanism : perceived default risk. Regulatory guidelines for mandatory disclosure of the rating Creation of active debt market: an active primary and secondary debt markets are crucial for rating agencies.

Benefits of Credit Rating

INDIVIDUALS:
It enables investor to get superior information at low cost It enables the investor to take calculated risk in their investment decisions It encourages the investor to invest his savings.

 Corporate borrowers:
With good rating they can enter into the market with confidence to raise funds It can use as a marketing tool It facilitates foreign collaborations It encourages discipline against corporate borrowers

Credit rating companies:

Development and exsistance

 Government:
Good rating motivates public to invest It facilitates the formulation of public policy guidelines CR system play a vital role in investors protection without casting burden on Govt.

Methodology
Business Analysis:
Industry risk:
nature and basis of competition, key success factors, demand-supply position, structure of industry , cyclical seasonal factors, govt. policies

 Market position of the company within the industry:

Market share Competitive advantage Selling and distribution arrangement Product and customer diversity Locational advantages Labor relations Cost structure Technological advantages Manufacturing efficiency

Operating efficiency of the company:

Legal position:
Terms of prospectus Trustee and their responsibilities System for timely payment

 Financial analysis:
Accounting quality:
Over statement/under statement profit, auditors qualifications, method of income recognition, Inventory valuation Depreciation policies Off balance sheet liability.

Earning protection:
Source of future earnings growth Profitability ratios Earning in relation to fixed income charges

 Adequacy of cash flows:

Debt, fixed and working capital needs Sustainability of cash flows Capital spending flexibility Working capital management.

Financial flexibility
Alternative financial plan Ability to raise funds Asset re-development potential

Management evaluation:
Track record of management Planning for control system Depth of managerial talents Succession plans

 Evaluation of capacity to overcome adverse situations

Regulatory and competitive environment

Structure and regulatory framework of the financial system. Trends in regulation/deregulation and their impact on the company.

Fundamental Analysis:
Capital adequacy
Assessment of true net worth of the company, Its adequacy in relation to the volume of business and the risk profile of the asset

 Asset quality:
Quality of the companys credit-risk management System for monitoring credit Sector risk Exposure to individual borrowers Management of problem credit

Liquidity management Profitability and financial position Interest and tax sensitivity

Ratings
Securities are complex instruments Banks
Renewal above 50cr New loan above 10 cr

The ratings
Ratings can bn classified into four main categories
High investment grade Investment grade Speculative grade Poor grade

Credit rating agencies

CRISL ICRA CARE

CRISL
Credit Rating Information Services of India Ltd
Was promoted in 1987 by ICICIC and UTI Bank loan ratings SME ratings NSIC ratings Real estate ratings Other ratings
Banker quality grade (http://www.crisil.com/ratings/bankloan-rating-scale.html) Financial strength rating Fund rating GVC ratings

Rating scales
Credit rating long term scale Credit rating short term scale Credit rating- fixed deposit scale Credit rating- corporate credit scale http://crisil.com/pdf/ratings/standardisationrating-symbols-definitions.pdf

ICRA
Investment information and credit rating agency of India limited

Sample grading
ICRA's MFI Grading Scale M1 Indicates that in ICRA's current opinion, the Graded MFI's ability to manage its microfinance activities in a sustainable manner is the highest. M2 Indicates that in ICRA's current opinion, the Graded MFI's ability to manage its microfinance activities in a sustainable manner is high. M3 Indicates that in ICRA's current opinion, the Graded MFI's ability to manage its microfinance activities in a sustainable manner is moderate. M4 Indicates that in ICRA's current opinion, the Graded MFI's ability to manage its microfinance activities in a sustainable manner is below average. M5 Indicates that in ICRA's current opinion, the Graded MFI's ability to manage its microfinance activities in a sustainable manner is weak. Note: For the Grading categories M2, M3 and M4, the sign of + (plus) may be appended to the Grading symbols to indicate their relative position within the Grading categories concerned. Thus, the Gradings of M2+, M3+ and M4+ are one notch higher than M2, M3, and M4, respectively.

CARE
Credit analysis and research institute promoted by IDBI, UTI AND CANARA BANK http://www.careratings.com/Content/CreditR atings/RatingSymbolAndDefinition.aspx

Credit rating mandate in India

Public issue debentures and bonds with conversion period more than 18 months Commercial papers can be issued in India it the program has rated above A2 Fixed deposit programs by NBFC

Use of ratings by regulators in India

NBFC must have min investment grade credit rating. Unrated NBFC required to disclose the fact of being unrated CP should get rated. Collective investment schemes should get rated (> 100 cr) Pension funds can invest in debt securities that have two ratings.

Risk of use of ratings by regulators

Issuer will be inclined to seek the cheapest and least demanding credit rating agency It create continuous revenue sources for rating agencies Regulatory requirement could induce ritualism and even enhance risk. Official sanction for rating agency assumptions : ex