1. Chapter 6 CREDIT RATING “Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

2. Learning Goals:
Introduce rating services offered by the rating agencies.
Explain the concept of credit rating and its uses to various stake holders
Discuss the methodology of rating
Explain the significance of credit rating symbols
Contd…
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

3. Define the concept of equity grading.
Provide an overview of the rating industry
Discuss the Regulatory issues
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

4. MEANING
It’s an opinion on credit quality of a debt instrument offered by a credit rating company.
It is a symbolic indicator regarding the capability of an issuer of debt.
It serves as a tool to guage the risk level of an instrument.
It provides a yardstick with which the risk of an instrument can be measured.
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

5. FEATURES OF CREDIT RATING
Expression of opinion
Grading of risk
Symbols
Instrument specific
Difference in the ratings
It is not an investment recommendation
It is a continuous process and it may be revised.
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

6. RATING SERVICES
The services offered are rating of corporate debt, Fixed deposits, preference shares, CPs, structured finance arrangements, securitised papers, IPO grading etc..
International rating agencies like Moody’s and S&P offer country rating or soverign rating.
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

7. IS CREDIT RATING MANDATORY?
It is not mandatory in countries like US.
In India it is compulsory in few cases.
According to SEBI, if the issue of debentures and bonds, exceeds the maturity period of 18 months, then it must be rated.
It is mandatory for mutual funds to get capital protection scheme rated.
Medium term debt instrument such as fixed deposits and short term instruments such as CPs are to be rated.
Contd…
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

8. RBI has made compulsory for all the NBFCs to get themselves rated.
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

9. NEED FOR CREDIT RATING To avoid information asymmetry
To help market participants to know about issuers and the risk levels.
For institutional investors it serves as a second check.
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

10. USES OF CREDIT RATING To the Issuers To the Investors
To the intermediaries and regulators
To the Economy
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

11. CREDIT RATING PROCESS
Involves analysis of qualitative and quantitative information
Plant visits
Rating Committee
Mandate from the client
Extensive analysis of documents
Discussions with management
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

12. “Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

13. Operational efficiency Project risks Management quality
RATING METHODOLOGY
Industry analysis
Market position
Operational efficiency
Project risks
Management quality
Financing policies
Financial flexibility
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

14. INDICATORS OF RATING METHODOLOGY
Past financial performance
Accounting quality
Financial performance indicators
Profitability
Leverage
Coverage
Liquidity and cash flow adequacy
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

15. CREDIT RATING SYMBOLS OF CRISIl, ICRA and CARE
Debt Category
Debt Instruments
CRISIL
ICRA
CARE
Remarks
Long
Term Instrument
Debentures
Bonds
Preference shares
AAA
*AA *A
*BBB *BB *B *C D
LAAA
*LAA *LA
*LBBB *LBB *LB *LC LD
CARE AAA
*CARE AA
*CARE A
*CARE BBB
*CARE BB
*CARE B
*CARE C
CARE D
Highest Safety
High safety
Adequate safety
Moderate safety
Inadequate safety
Risk prone
Substantial risk
Default
Medium
Fixed deposits
FAAA *FAA *FA *FB
*FC FD
MAAA
*MAA *MA *MB
*MC MD
CARE AAA *CARE AA
*CARE A
*CARE BBB
*CARE BB
*CARE B
*CARE C
CARE D
--do—
--do---
Short
Term instrument
Commercial Paper
*P1
*P2
*P3
*P4 P5
*A1
*A2
*A3
*A4 A5
*PR-1
*PR-2
*PR-3
*PR-4
PR-5
Highest safety
Note : * The suffix of”+” (plus) or “—“(minus) signs are added with the rating symbols to indicate the comparative positions of the instrument within the group covered by the symbol
SOURCE : Brochures of Various Credit Rating Agencies.
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

16. RATING REVISIONS
Ratings assigned are subject to surveillance by the agency.
Seeing the conditions in the post-issue period, the ratings may be upgraded or downgraded.
The rating revisions are common because financial conditions might change affecting the cash generating capacity of the issuers.
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

17. EQUITY GRADING It is focused on fundamentals of the issuing company.
It is a the risk associated with the expected net incomes.
A five point grading is adopted. A grade of 5 indicates highest grading and 1 indicates lowest grading.
Contd…
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

18. Highest grading indicates strong fundamentals and lowest grade indicates weak fundamentals of the issuer.
In case of new projects and expansion projects, the risk inherent in them are evaluated.
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

19. CREDIT RATING INDUSTRY: OVERVIEW
1. US INDUSTRY:
It is a 150 year old industry.
Moody’s, S&P and Fitch are three international credit rating agencies in US.
Moody’s Investor Services cover more than 100 nations, corporates, public finance institutions, and structured finance obligations. It has more than 1000 analyst and it is engaged in credit research and industry studies.
Contd…
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

20. S&P is a global leader in credit rating
S&P is a global leader in credit rating. It has a major stake in the Indian credit rating company, CRISIL.
Fitch Ratings Services cover more than 150 countries. Fitch India is a subsidary of Fitch Ratings.
Contd…
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

21. 2. INDIAN INDUSTRY: It is a 20 year old industry in India.
CRISIL, ICRA, CARE and Fitch India are four leading rating agencies.
SMERA is the country’s first credit rating agency dedicated to the rating of SMEs.
ONICARA agency promoted by ONIDA specialises in rating of individuals.
Contd…
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

22. LIMITATIONS OF CREDIT RATING
Lack of standardised symbols
Rating shopping
Issuer-rater relationship
Opinion of acceptance
Accountability
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

23. SEBI AND CREDIT RATING
SEBI (Credit Rating Agencies) Regulation came into effect from July 1999.
It provides for registration of credit rating agencies operating in India.
The procedure for registration, general obligation and code of conduct are mentioned in regulation.
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.

24. CONCLUSION
Credit rating agencies serve as the information intermediaries between the issuers and investors.
This helps to reduce the information asymmetry in the market.
The global financial crisis has resulted in tight supervision and control in rating industry.
It has to follow the code of conduct to ensure the delivery of efficient service to client.
“Financial Services” by R Shanmugham
Copyright  2009 Wiley India Pvt. Ltd. All rights reserved.