All about Credit Rating

Credit Rating has assumed an important place in the modern and developed financial markets. It facilitates the company in raising funds in the capital market and helps the investors to select their risk-return trade off. Fund procurement is one of the key functions of a business undertaking. Among the various sources of fund, long term debt, debenture, bonds, fixed deposit and commercial papers, besides share capital are worth mentioning. The issuer of these instruments approaches capital market, financial institutions and various agencies o raise necessary finance at certain terms and conditions. As investors are concerned with the timely payment of interest and principal, credit rating indicates the creditworthiness of a borrower. Credit rating essentially indicates the risk involved in a debt instrument as well as its qualities. Higher the credit rating greater is the probability that the borrower will make timely payment of principal and interest and vice versa. Thus, a credit rating is not a general evaluation of the issuing organization. It essentially reflects the probability of timely repayment of principal and interest by a borrower company. The credit rating is not a onetime evaluation of credit risk of a security. The rating agency may change the rating considering the changes periodically.
CREDIT RATING AGENCIES:
The important credit rating agencies in India are given below:

Credit Rating and Information Services of India Ltd(CRISIL): CRISIL was jointly promoted, in 1988, by India’s leading financial institutions, ICICI and UTI. Its other shareholders include LIC, SBI, HDFC, GIC, Standard Chartered Bank, Bank of Tokyo, Banque Indo shez, Sakura Bank, UCO Bank, Canara Bank, Central Bank of India, IOB, Vysya Bank Ltd, and Bank of Madura Ltd. CRISIL went public vto extend its credit rating services to borrowers from the overseas market.
Investment Information and Credit Rating Agency of India Ltd.(ICRA): ICRA has promoted by IFCI and 21 other shareholders comprising foreign and nationalized banks and Indian insurance companies. Established in 1991, ICRA is the second rating agency in India. In 1996, ICRA entered into a strategic alliance with Financial Proforma Inc., a Moody’s subsidiary to offer services on Risk Management Training and Software. Moody’s and ICRA have entered into a memorandum of understanding to support these efforts.  
Credit Analysis and Research (CARE): CARE has promoted in 1992, by IDBI jointly with Canara Bank, UTI, Private Sector banks and Insurance Companies. The services offered by CARE include credit rating of debt instruments, credit assessment of companies, advisory services, credit reports and performance ratings.
Duff & Phelps Credit Ratings India(DCR): DCR is a joint venture between Duff and Phelps, USA and Alliance Capital Ltd., Calcutta. This is youngest of all the credit rating agencies in India. Its expertise is in the rating of structured obligation with international standards. Its offers rating of all other short-term, medium –term and long-term debt instrument. In US, Standard and Poor’s(S&P), Moody’s Investor Services and Fitch’s are some of the important firms engaged in credit rating functions.
Benefits of Credit Rating:
The benefits to various parties concerned with credit rating are listed below:
INVESTORS:
 It enables the investors to get superior information at low cost.
 It enables the investors to take calculated risk in their investments.
 It encourages the common man to invest his savings in corporate securities and get high returns.
CORPORATE BORROWERS:
 It facilitates companies with good rating enter the capital market confidently and raise funds at comparatively cheaper rates.
 It can be used as a marketing tool.
GOVERNMENT:
 Credit Rating system plays a vital role in investor protection without casting burden for that responsibility on the government.
 It facilitates formulation of public policy guidelines on institutional investments.
Types of Credit Rating:
Credit rating are off different types, the following the common types of credit rating:
BOND RATING: Rating the bonds or debt securities issued by a company, governmental or quasi-governmental body is called ‘bond rating’. This occupies the major business of credit rating agencies.
EQUITY RATING: The rating of equity of capital market is called ‘equity rating’.
COMMERCIAL PAPER RATING: It is mandatory on the part of corporate body to obtain the rating of approved credit rating agency to issue commercial paper.
RATING THE BORROWERS:  This includes rating a borrower to whom a loan/credit facility may be sanctioned.
SOVEREIGN RATING: This includes rating a country as to its creditworthiness, probability to risk etc.

CREDIT RATING SYMBOLS OF CRISIL:

Debenture Rating:
High Investment Grades:                              
AAA-Highest Safety                                                                        
AA-High Safety                                                
Investment Grades:                                      
A-Adequate safety                                        
BBB-Moderate safety
Speculative Grades:
BB-Inadequate safety  
 B-High Risk
C-Substantial Risk
D-Default
FIXED DEPOSIT RATING:
FAAA-Highest safety
FAA-High safety
FB-Inadequate safety
FC-High Risk
FD-Default
SHORT-TERM INSTRUMENTS:
P-1 Very strong as to timely
P-2 Strong as to timely
P-3 Adequate as to timely
P-4 Minimal as to timely
P-5 Default
STRUCTURED OBLIGATION:
High Investment Grades
AAA-Highest safety
AA-High safety
Investment Grades
A-Adequate safety
BBB-Moderate safety

Speculative Grades
A-Inadequate safety
B-High risk
C-Substantial risk
D-Default
CREDIT RATING PROCESS:
The entire credit rating process is normally completed in three stages in practical scenario-namely:
1. Initial stages:
 Mandate
 Assign Rating Team

2. Fact Finding and Analysis stage:
 Receive initial information conduct basic research
 Meeting and Visit
 Analysis and Preparation of report

3. Rating Finalization stage:
 Preview Meeting
 Rating Meeting
 Assign Rating
 Communicate the Rating and Rationale
CREDIT RATING METHODOLOGY:
BUSINESS ANALYSIS:
 Industry risk including analysis of the structure of the industry, the impact of government policies, seasonality of the industry.
 Market position of the company within the industry including market share, competitive advantage.
 Operating efficiency of the company, this would include locational advantages, technology, manufacturing efficiency as compared to competitors etc.
FINANCIAL ANALYSIS:
 Accounting quality it refers overstatement/understatement of profits, auditors qualification in their report, method of valuation of inventor, depreciation policy etc.
 Earning protection checks the future earnings growth for the company.
 Adequacy of cash flows to meet debt servicing in addition to fixed and working capital needs.
MANAGEMENT EVALUATION:
 The quality and ability of the management would judge on the basis of past track record, their goals, philosophies and strategies and their ability to overcome difficult situations etc.
FUNDAMENTAL ANALYSIS:
 Capital adequacy including an assessment of the true net worth.
 Asset Quality this would encompass the company’s credit risk management, system for monitoring credit.
 Liquidity management it includes capital structure, term matching of assets and liabilities and policy on liquid assets in relation to financing commitments would be some of the areas examined.
 Profitability and Financial position- A great deal of weightage would be paid by the agency on past historical profits.
 Interest and tax sensitivity-exposure to interest rate changes, tax law changes etc.
BANKS RATING:
To increase transparency in the banking system, the government and the regulator (RBI) are considering bringing the risk based assessment of banks in public domain. At present, a risk-based rating of banks done by the RBI is kept confidential due to sensitive nature of the information.


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