CREDIT RATING AGENCIES

MEANING OF CREDIT
RATING
The credit rating is a symbolic indicator of the
current opinion of the relative capability of the
issuer to service its obligation to pay its dues in
due course of time, with the particular type of
instrument to be rated by the agency.

"Thus, a credit rating is neither a general
purpose evaluation of the issuer, nor an overall
assessment of the credit risk likely to be
involved in all the debts contracted or to be
contracted by such entity".
Definition Of Credit Rating
" A rating is an opinion on the future ability and
legal obligation of the issuer to make timely
payments of principal and interest on a specific
fixed income security. The rating measures the
probability that the issuer will default on the
security over its life, which depending on the
instrument , may be a matter of days to 30
years or more. In addition , long term ratings
incorporate an assessment of the expected
monetary loss should a default occur."
Moodys
"Credit ratings help investors by providing an
easily recognizable , simple tool that couples a
possibly unknown issuer with an informative
and meaningful symbol of credit quality."
Standard & Poors
WHAT CREDIT RATING IS
NOT?
Credit rating is not a sort of recommendation to
buy, hold or sell the instruments because it does
not take into consideration factors like the
market prices, preferences to the personal risks,
market trend and certain other considerations
which may influence an investor's decision while
investing. The whole process has to depend
upon whatever is being provided by the issuer.
FACTORS LEADING TO
GROWING IMPORTANCE OF
CREDIT RATING
1. The increasing role of money and capital markets
consequent to dis-intermediation.
2. Increased securitization of borrowing and lending
consequent to disintermediation.
3. Globalization of the capital market.
4. The continuing growth of information technology.
5. The growth of confidence in the efficiency of the
market mechanism.
6. The withdrawal of Govt. safety nets and the trend
towards the privatization.
CREDIT RATING AGENCY
DEFINED
"Credit rating agency" is a commercial concern
engaged in the business of credit rating of any
debt obligation or of any project or program
requiring finance, whether in the form of debt or
otherwise, and includes credit rating of any
financial obligation, instrument or security, which
has the purpose of providing a potential investor
or any other person any information pertaining to
the relative safety to timely payment of interest
or principal.
Ministry of Finance, GOI
OBJECTIVE OF CREDIT RATING
AGENCY
The primary objective of credit rating
agency is to communicate the investor
about the present state of the instrument,
what are the probabilities of the issuer
company of repayment of loan or the
interest at the time of its discharge in
comparison to other related instruments.
CREDIT RATING SYSTEM IN
INDIA
1980's - The concept of credit rating in India was
emerging in mid 1980's.
1987- Credit Rating Information Services of India
Ltd. (CRISIL) was established.
1991- Investment Information & Credit Rating
Agency of India Ltd. ( ICRA)
1994- Credit Analysis & Research Ltd. ( CARE )
1996- Duff & Phelph Credit Rating India (Pvt.)
Ltd. (DCR) now known as Fitch ratings.
Why bother a rating/rating agency:

Increase investor acceptance.

Current economic environment.

Current capital market environment.

BOTTOM LINE: Lower Interest Cost.


Types of Credit Ratings:
Issuer Ratings
Long Term debt issuance
Short Term Debt Issuance
Commercial Paper
Loans
Credit Assessments
PTCs

Corporates
Banks and Financial Institutions
Finance Companies
Asset Managers
Insurance Companies
Securitization
ABS
MBS
CDOs/CLOs
Distress Debt
SME
Project Finance
Public Finance

Rating Terminologies Long Term :

AAA
AA+
AA
AA-
A+
A
A-
BBB+
BBB
BBB- etc (Please refer to notes)



Rating Terminologies Short Term:
A1+: Obligations supported by the highest capacity for timely repayment.
A1: Obligations supported by a strong capacity for timely
repayment.
A2: Obligations supported by a satisfactory capacity for timely
repayment, although such capacity may be susceptible to
adverse changes in business, economic, or financial conditions.
A3: Obligations supported by an adequate capacity for timely
repayment. Such capacity is more susceptible to adverse
changes in business, economic, or financial conditions than for
obligations in higher categories.
B: Obligations for which the capacity for timely repayment is
susceptible to adverse changes in business, economic, or
financial conditions.
C: Obligations for which there is an inadequate capacity to
ensure timely repayment.
D : Obligations which have a high risk of default or which are
currently in default.


Sectors where Credit Rating Plays a Vital Role:

Commercial Banks:

Mutual Funds:

Investment Banks:

Leasing Companies:

Insurance Companies:

Bonds & Securitization etc.



The Rating Process:

Step I: Decision and documents

Step II: Rating Presentations meetings, conference
calls, and /or site visits

Step III: Rating Committee, communication, press
release, report

Appeal process, if necessary

Surveillance


Rating Methodology
Following major factors are assessed in the Credit Rating
Process:

Industry Risk
Market Position
Ownership & Support
Earning & Performance
Cash Flows
Management Evaluation
Capital & Debt Structure
Funding & Flexibility
Corporate Governance
Additional Factors for Financial Institutions
I - Industry Risk

Economic importance of the industry to the country.
Potential for support.
Employment significance.
Industrial relations record.
Significance of legislation: protective and harmful, relationship with
government.
Maturity of the industry.
International competition.
Barriers to entry.
Competitive situation domestically: monopoly, oligopoly, fragmentation.
Nature of the industry: capital intensity, product lifespan, marketing
.requirements.
Cyclic factors: demand, supply, implications for price volatility.
Industry cost and revenue structure: susceptibility to energy prices,
interest rate levels, government policies.
Important developments and trends in the industry


II - Market Position:

Competitive position within the industry: size, market share &
trend, price-setting ability.
Major product importance.
Product lives and competition.
Degree of product diversification.
Significance of R&D expenditure and of new product
development.
Geographic diversity of sales and production.
Significance of major customers.
Dependence on major suppliers and access to alternatives.
Marketing needs.
Distribution network, control and susceptibility to external
factors.
What are the growth trends, and sources of growth?
III Ownership & Support
The specific issues include:

Ownership of the entity.

Relationship with owners, autonomy, control.

Financial strength of owner (s).

Potential for support or for funds withdrawals.

Structure of ownership.

Other benefits: access to technology, products.

Access to capital markets.

IV- Earnings & Performance

The specific issues include:

Consistency and trend of core earnings.

Earnings mix by activity and geography.

Exceptional and extraordinary items: non-recurring impacts on
past earnings levels.

True earnings levels available for cash flow: equity accounting,
restrictions on profit repatriation.

Internal growth versus acquired earnings.
Contd




IV- Earnings & Performance

Profitability and protection measures.

Profit margins.

Interest & pre-tax coverage measures.

Dividend cover, payment levels and future policy.

Taxation situation: effective tax rate, specific relief.

Sufficiency of retained earnings to finance growth internally.




V Cash Flows

Relationship of cash flow to leverage and ability to internally meet
all cash requirements is evaluated. The volatility of cash flow
over time and the impact of seasonality on cash flow is also
assessed.

The specific issues include :
Adequacy of cash flow to maintain the operating capacity of the
business: working capital levels, replacement of fixed assets.

Contribution from cash flow towards expansion: major capital
spending projects, acquisitions.

Discretionary spending included in cash flow including
advertising, exploration, research & development expenditure.
contd




V Cash Flows


Volatility of cash flow over time.

Relationship between cash flow and total debt.

Restrictions on cash flow : limits on repatriation, potential
taxation effects, access to dividends from subsidiaries.

Liquidity levels and fluctuations: seasonality, sensitivities.

Working capital management and measurements. .






VI Management Evaluation

The specific issues include:

Record to date in financial terms.

Corporate goals and outlook: aggressive stance, attitude to risk.

Experience, background, credibility.

Depth of management: key individuals, succession.

Record compared with peers.








VII Capital & Debt Structure

Te specific issues include:

Debt/Equity measures: historic, present and projected.
Leverage (total liabilities/equity) measures: historic, present and
projected
Sensitivity Analysis on projected levels
Seasonal variations
Coverage measures on interest & leasing
Adjustmenths for off-balance sheet items.
Appropriateness of capital structure for the business: over-
reliance on short term funding, sensitivity to interest rate
changes.
Debt Structure: Type, maturity, currency, service schedule,
covenants, security, default clause.








VIII Funding & Flexibility
specific issues include:The

Flexibility of planned financial needs : capital spending, dividend
levels, acquisitions.

Ability to raise additional financing under stress.

Back-up and standby lines of credit : periods and covenants of
underwriting facilities and committed lines, bank relationships
generally.

Ability to attract capital : shareholder make-up, access to equity
markets.
Capital commitments. Cont..








VIII Funding & Flexibility
The specific issues include:

Flexibility of planned financial needs : capital spending, dividend
levels, acquisitions.

Ability to raise additional financing under stress.

Back-up and standby lines of credit : periods and covenants of
underwriting facilities and committed lines, bank relationships
generally.

Ability to attract capital : shareholder make-up, access to equity
markets.
Capital commitments. Cont..








VIII Funding & Flexibility

Margin of safety in present and planned gearing/leverage levels.

Asset make-up : nature of assets and potential for reductions or
disposals under stress, scalable units.

Off-balance sheet assets and liabilities : goodwill or other
intangibles written off, undervalued assets, pension under
funding.







IX Corporate Governance

The independence and effectiveness of the board of directors

Oversight of related party transactions that may lead to conflicts of
interest.

Board oversight of the audit function.

Executive and director remuneration.

Complex holding company structures.

Ownership by private individuals and families.

Also examine other aspects of corporate governance whose impact on
bondholders is less clear cut; these include equity ownership by
executives and directors






X Additional Factors for Financial Institutions

Quality of the asset portfolio

Stability of earning

Sources and cost of funds

Asset / liability structure

Capital adequacy and liquidity

Market environment and strategy

Prospects






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