Credit Rating

CREDIT RATING

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CREDIT RATING A credit rating assesses the credit worthiness of an individual, corporation, or even a country. It tells a lender or investor the probability of the subject being able to pay back a loan. Credit ratings are calculated from financial history and current assets and liabilities. The ratings are expressed in code numbers which can be easily comprehended by the lay investors. A poor credit rating indicates a high risk of defaulting on a loan, and thus leads to high interest rates. Credit rating, as exists in India, is done for a specific security and not for a company as a whole. A debt rating is not one time evaluation of credit risk, which can be regarded as valid for the entire life of the security.

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NEED FOR CREDIT RATING - It is necessary in view of the growing number of cases of defaults in payment of interest and repayment of principal sum borrowed by way of fixed deposits, issue of debentures or preference shares or commercial papers. - Maintenance of investors’ confidence, since defaults shatter the confidence of investors in corporate instruments. - Protect the interest of investors who can not into merits of the debt instruments of a company. - Motivate savers to invest in industry and trade.

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OBJECTIVES OF CREDIT RATING

The main objective is to provide superior and low cost information to investors for taking a decision regarding riskreturn trade off, but it also helps to market participants in the following ways; • Improves a healthy discipline on borrowers, • Lends greater credence to financial and other representations, • Facilitates formulation of public guidelines on institutional investment, • Helps merchant bankers, brokers, regulatory authorities, etc., in discharging their functions related to debt issues, • Encourages greater information disclosure, better accounting standards, and improved financial information (helps in investors protection), • May reduce interest costs for highly rated companies, • Acts as a marketing tool 10/19/09

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FUNCTIONS OF CREDIT RATING AGENCIES – – – – –

Superior information Low cost information Basis for proper risk, return & Trade off Healthy discipline on corporate borrowers Formulation of public policy guidelines on Institutional investment

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BENEFITS OF CREDIT RATING For Investors – Safeguards against bankruptcy – Recognition of risk – Credibility of the issuer – Easy understandability (ratings) of the investment proposal – Savings of resources (time and money) – Independence of investment and quick investment decision – Choice of investments – Good bye to thumb rules – Benefits of rating surveillance – Low cost information 10/19/09

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BENEFITS OF CREDIT RATING contd… For Rated Companies – Low cost of borrowing – Wider audience for borrowing (Increase the investor population) – Rating as a marketing tool – Self discipline by companies (Encourages financial Discipline) – Reduction of cost in public issues (attract investors with least efforts) – Motivation for growth – Sources of additional certification – Forewarns (caution) risk – Merchant bankers job made easy – Foreign collaborations made easy 10/19/09

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BENEFITS OF CREDIT RATING contd… For Brokers and financial intermediaries – Saves time, money, energy, and manpower in convincing their clients about investments. – Less effort in studying company’s credit position to convince their clients. – Easy to select profitable investment security – Helps to improve business

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CREDIT RATING AGENCIES IN INDIA 1. Credit Rating Information Services Limited (CRISIL) 2. Investment Information and Credit Rating Agency of India (ICRA) 3. Credit Analysis and research (CARE) 4. Duff Phelps Credit Rating Pvt. Ltd. (DCR India) and 5. Onicra Credit Rating Agency of India Limited: Is an established player in the individual credit assessment and scoring services space in the Indian market.

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Credit Rating Information Services Limited (CRISIL) The first credit agency floated on January 1, 1988, jointly started by ICICI and UTI with an equity capital of Rs. 4 crores, as public Ltd company.

Capital Structure of CRISIL Institution

Percentage

ICICI UIT Asian Development Bank LIC of India GIC & its Subsidiaries SBI HDFC Nationalized Banks – BOI, BOB, UCO, Canara bank, Central Bank of India, Allahabad

15 15 15 05 05 05 05 18

Foreign Banks–SC Bank, Banque Indo-Suez, Mitsui bank, Bank of Tokyo, Hongkong Bank,

17

bank, IOB, Vysya Bank, and Bank of Madura

Citi Bank, Grindlays Bank, Deutsche Bank, SOciete General Banque, Nationale de Paris. 10/19/09

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Credit Rating Information Services Limited (CRISIL) • The first credit agency floated on January 1, 1988, jointly started by ICICI and UTI with an equity capital of Rs. 4 crores, as public Ltd company. • CRISIL is India's leading rating agency, and is the fourth largest in the world. • With over a 60% share of the Indian Ratings market, CRISIL Ratings is the agency of choice for issuers and investors. • CRISIL Ratings is a full service rating agency that offers a comprehensive range of rating services. CRISIL Ratings provides the most reliable opinions on risk by combining its understanding of risk and the science of building risk frameworks, with a contextual understanding of business. 10/19/09

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Credit Rating Information Services Limited (CRISIL) contd…. Objective of CRISIL - The principal objective of CRISIL is to rate the debt obligations of Indian companies. Its rating guides the investors about the risk of timely payment of interest and principal on a particular debt instrument. Credit Rating Committee - CRISIL's rating process and rating committee are designed to ensure that all assigned ratings are based on the highest standards of independence and analytical rigor. The rating committee comprises members who have the professional competence to meaningfully assess the credit analysis that underlies the rating, and have no interest in the entity being rated. A team of analysts carries out the credit analysis. 10/19/09

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Credit Rating Information Services Limited VALUES (CRISIL) contd….

1. Analytical Rigour Our service offerings are underlined by analytical rigour. We blend in-depth conceptual understanding – the science of building analytical frameworks – with the art of evaluation. CRISIL combines an extensive knowledge base, understanding of the dynamics of business and the market place, expertise, judgment and experience to offer world-class solutions to clients. Our Policy level assignments in the area of Infrastructure Advisory are but one example of this. 2. Independence We pride on being non-partisan and unbiased. Our culture fosters objectivity and neutrality of views and opinions. Independence and objectivity are ingrained in our processes and call for a participatory approach, individual thinking and transparency for arriving at logical conclusions.

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Credit Rating Information Services Limited (CRISIL) contd…. 3. Integrity Our credibility in the market place is the result of unimpeachable integrity, honesty and transparency in our work and dealings. Our people are characterised by a strong sense of fairness and ethics. CRISIL seeks to become the benchmark on integrity by adopting the best professional practices regarding client confidentiality, integrity of analysis and lack of bias

4. Innovation Our dedicated Centres of Excellence provide thought leadership. The core teams lead the way by developing and sharing insights from the extensive corpus available, building innovative analytical frameworks and developing new methodologies and products in line with requirements of the market place. 5. Commitment - We are committed to… Setting standards for integrity, analytical rigour and best practices in the marketplace Consistently providing value to constituents through analytically relevant and reliable opinions and solutions Upholding independent evaluation processes and a non-partisan, unbiased and fearless approach to functioning

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CRISIL’S RATING PROCESS

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CRISIL RATING SYMBOLS Debenture Rating Symbols High Investment Grades: AAA (triple A): Highest Safety AA (double A): High Safety Investment Grades: A: Adequate Safety BBB (triple B): Moderate Safety Speculative Grades: BB: Inadequate Safety B: High Risk C: Substantial Risk D: Default 10/19/09

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CRISIL RATING SYMBOLS Fixed Deposit Rating Symbols – FAAA (triple A): Highest Safety – FAA (double A): High Safety – FA: Adequate Safety – FB: Inadequate Safety – FC: High Risk – FD: Default Ratings for short-term instruments – P-1: Timely payment very strong – P-2: Strong – P-3: Adequate Safety – P-4: Minimal – P-5: Expected to be in default on maturity or is in default 10/19/09

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RATING METHODOLOGY OF CRISIL Key factors considered for rating are:

1. Business Analysis, 2. Financial Analysis, 3. Management evaluation, 4. Regulatory and competitive environment, and 5. Fundamental analysis. Factors listed above at serial numbers 1, 2, and 3 are evaluated for manufacturing companies, while 4 and 5 factors are used to evaluate finance companies apart from the 1, 2 and 3 factors. 10/19/09

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RATING METHODOLOGY OF CRISIL contd… 1. Business Analysis – Industry risk, market position and operating efficiency of the company, legal position. 2. Financial Analysis – Accounting quality, earnings position, adequacy of cash flows, and financial flexibility. 3. Management Evaluation – Goals, philosophy, strategies, ability to overcome adverse situations, managerial talents and succession plans, commitment, consistency and credibility. 4. Regulatory and Competitive Environment 5. Fundamental Analysis – Liquidity management, assets quality, profitability and financial position, interest and tax sensitivity. 10/19/09

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Investment Information and Credit Rating Agency of India (ICRA) ICRA was set up by IFCI on 16th January 1991. ICRA Limited is an Associate of Moody's Investors Service and an independent and professional company. It is a public limited company with an authorized share capital of Rs.10 crores, Rs. 5 crores is paid up. ICRA’s major shareholders IFCI (26%), and the balance by UTI, LIC, GIC, PNB, Central Bank of India, Bank of Baroda, UCO Bank and banks (SBI) 10/19/09

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OBJECTIVES OF ICRA To access the credit instrument and award it a grade consonant to the risk associated with such instrument. - To assist investors in making well informed investment decision - To assist issuers in raising funds from a wider investors base - To enable banks, investment bankers and brokers in placing debt with investors by providing them with a marketing tool - To provide regulators with a market driven system to encourage the healthy growth of the capital markets in a disciplined manner without costing an additional burden on the Government for this purpose.

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STRATEGIES OF ICRA – Create awareness of the rating concept and benefits among issuers, investors, regulators, and financial institutions. - Win the credibility, confidence and trust of the constituents by demonstrating that its methodology is transparent and its ratings are independent and consistent. - Aggressively focus on business development whitish would result in a significant increase in the volume of rating assignments and spur the Govt. into introducing an exclusively market-driven interest rate structure. 10/19/09

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Investment Information and Credit Rating Agency of India (ICRA)

- With the growth and globalisation of the Indian capital markets leading to an exponential surge in demand for professional credit risk analysis, ICRA has been proactive in widening its service offerings, executing assignments including credit ratings, equity gradings, specialised performance gradings and mandated studies spanning diverse industrial sectors. - In addition to being a leading credit rating agency with expertise in virtually every sector of the Indian economy, ICRA has broad-based its services for the corporate and financial sectors, both in India and overseas, and currently offers its services under the following banners: – Rating Services Information. – Grading and Research Services. – Advisory Services. – Economic Research Outsourcing.

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Investment Information and Credit Rating Agency of India (ICRA) contd… Long term Debentures, Bonds and Preference shares-Rating Symbols

LAAA LAA : LA : LBBB LBB : LB : LC : LD : 10/19/09

: Highest Safety High Safety Adequate Safety : Moderate Safety Inadequate Safety Risk prone Substantial Risk Default, Extremely speculative 25

Investment Information and Credit Rating Agency of India (ICRA) contd… Medium term including Fixed deposits Rating Symbols MAAA: Highest Safety MAA: High Safety MA : Adequate Safety MB : Inadequate Safety MC : Risk prone MD : Default Short-term including CPs A-1: Highest Safety A-2: High Safety A-3: Adequate Safety A-4: Risk prone A-5: Default

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RATING METHODOLOGY OF ICRA The rating methodology comprises the study of industry as well as the company’s SWOT analysis. - Marketing strategies, - Competitive edge, - Level of technological development, - Operational efficiency, - Competence and effectiveness of management, - HRD policies and practices, - Hedging of risks, - Cash flow trends and potential, - Liquidity, - Financial flexibility, - Asset quality and past record of servicing debts and obligations, and - Government policies and status affecting the industry. 10/19/09

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Credit Analysis and Research Limited (CARE) • Incorporated in April 1993, is a credit rating, information and advisory services company promoted, • By Industrial Development Bank of India (IDBI), Canara Bank, Unit Trust of India (UTI) and other leading banks and financial services companies. In all CARE has 14 shareholders. Canara Bank, UTI, Credit Capital Venture Fund (I) Ltd, Sundaram Finance Ltd, The Federal Bank Ltd, The Vysya Bank, First Leasing Company of India, ITC Classic Finance Ltd, Kotak Mahindra Finance Ltd, IFB Leasing and Finance Ltd, Kalimati Investment Company Ltd, The Investment Corporation of India Ltd, Varuna Investments Ltd, and 20the Century Finance Corporation Ltd. 10/19/09

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Credit Analysis and Research Limited (CARE) Services offered by CARE are 1. Credit rating 2. Information services 3. Equity research, and 4. Advisory services

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Services Offered by CARE

1. Advisory Services: • Credit Reports - CARE offers credit reports on companies based on published information and CARE's in-house data base. These confidential credit reports are useful to entities considering financing options, joint ventures, acquisitions and collaborations with Indian companies. • Sector Studies - CARE from time to time conducts studies on select sectors of the Indian economy, particularly those which were largely government controlled and funded till recently, but have been thrown open for private investment. Studies on the Indian Power Sector, Fertilizer Industry and Municipal Finances have been completed. CARE has also prepared reports on twelve of the larger states of the Indian Union, which account for the bulk of foreign direct investment into India. CARE also regularly prepares reports on important segments of the Indian economy. These reports are used by industry participants, financial intermediaries and also by analysts in CARE for their rating reports. 10/19/09

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Services Offered by CARE contd…. • Project Advisory Services - For financing its infrastructure, India is increasingly relying on private sector participation. CARE uses the expertise gained in evaluating the credit risk of projects in areas such as roads, ports, power and telecom to advise investors and banks about the regulatory framework, the specific project risks and the ways of risk mitigation. CARE has helped independent power producers in India understand the functioning of the principal power purchasers, the State Electricity Boards and evaluate options for mitigating purchaser risk. CARE has also worked closely with project sponsors to structure their debt securities based on estimates of cash flows.

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Services Offered by CARE contd…. • Financial Restructuring - The business risk faced by Indian companies increased following the liberalisation of Indian economy in 1991. To compete in the changed environment, companies have had to reassess their capital structures. CARE uses its knowledge about various industry sectors to advise companies about the optimal capital structure and the financial restructuring options. • Valuation - CARE carries out enterprise valuations for company managements, prospective and exisiting business partners or large investors. The Disinvestment Commission, Government of India, has used CARE's services for valuing 20 state owned enterprises. • Credit Appraisal Systems - CARE helps banks and non banking finance companies to set up or modify their credit appraisal systems. • Debt Market Review - CARE's Advisory division also publishes a monthly bulletin "debt market review" on the happenings in the debt market and general development in the economy in the previous month. 10/19/09

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Services Offered by CARE

contd….

2. Credit Rating Services - CARE's Credit Rating is an opinion on the relative ability and willingness of an issuer to make timely payments on specific debt or related obligations over the life of the instrument. - CARE rates rupee denominated debt of Indian companies and Indian subsidiaries of multinational companies. - CARE undertakes credit rating of all types of debt and related obligations (all types of medium and long term debt securities such as debentures, bonds and convertible bonds and all types of short term debt and deposit obligations such as commercial paper, inter-corporate deposits, fixed deposits and certificates of deposits). - CARE also rates quasi-debt obligations such as the ability of insurance companies to meet policyholders obligations. - CARE's preference share ratings measure the relative ability of a company to meet its dividend and redemption commitments. 10/19/09

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Credit Analysis and Research Limited (CARE) • Long term debt instruments-Rating Symbols CARE AAA CARE AA CARE A CARE BB CARE B

: Highest Safety : High Safety : Adequate Safety : Inadequate Safety : High Risk

• Medium term debt instruments-Rating Symbols CARE AAA CARE AA CARE A CARE BB CARE C 10/19/09

: Highest Safety : High Safety : Adequate Safety : Inadequate Safety : High Risk 34

CARE Short term debt instruments Rating Symbols PR 1: Superior capacity PR 2: Strong capacity PR 3: Adequate capacity PR 4: Minimal degree of safety PR 5: Default or likely in default on maturity .Credit Analysis Rating CARE 1: Excellent Debt Management Capacity CARE 2: Very good Debt Management Capability CARE 3: Good capability for Debt Management CARE 4: Barely satisfactory capability for debt management CARE 5: Poor capability for debt management 10/19/09

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Services Offered by CARE

contd….

3. Other Rating / Grading Services : IPO Grading - CARE's IPO grading is a service aimed at facilitating the assessment of equity issues offered to public. - CARE's IPO grading is an independent and professional opinion on the fundamentals of the issuer. - The grade assigned to any individual issue represents a relative assessment of the 'fundamentals' of that issuer. Utility to market participants - CARE’s IPO grading would help the investors particularly the retail investors better appreciate the meaning of the disclosures in the issue document to the extent that they affect its fundamentals. IPO grading is expected to be one of the inputs in the investor’s decision making process. - Moreover, such a service would be particularly useful for assessing the offerings of companies accessing the equity markets for the first time where there is no track record of their market performance. Issuers would also benefit from CARE's IPO grading as it would help them in benchmarking themselves in the market place. 10/19/09

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Services Offered by CARE contd…. 3. Other Rating / Grading Services : IPO Grading What IPO Gradings are not? • As IPO grading does not take cognizance of the price of the security, it is not a recommendation to buy, sell or hold shares/securities. • They are not a comment on the offer price or the listed price of the scrip. • They do not imply that CARE performs an Audit function or forensic exercise to detect fraud. IPO Grading scale • CARE would assess the overall fundamentals of an IPO on a five-point scale. Highest score to be assigned by CARE to any IPO would be 5 and the lowest score would be 1.

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Services Offered by CARE contd…. IPO Grading Scale CARE IPO Grade CARE IPO Grade 5 CARE IPO Grade 4 CARE IPO Grade 3 CARE IPO Grade 2 CARE IPO Grade 1

Evaluation Evaluation Strong fundamentals Average fundamentals Below average fundamentals Poor fundamentals IPO Grading Process

Client Requests for grading

CARE 1. CARE's grading team commences assignment

Submits offer document & other information

2. The grading team analyses the information.

Interacts with the grading team, responds to 3. The grading team interacts with clients, undertakes site queries raised and provides any additional data visits, and analyses data submitted by the client.

Accepts grading *

4. Internal committee previews analysis. 5. GRADING COMMITTEE awards grading to IPO 6. Notification in press

* Client may ask for a review of the grading assigned and furnish additional information for the purpose. However, clients do not have the option of not accepting the final grading 10/19/09

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Services Offered by CARE contd…. IPO Grading Criteria - CARE would assess the fundamentals of an issue based on the following factors: Quantitative – growth prospects of the industry, financial strength & operating performance of the issuer Qualitative - business fundamentals & prospects, management quality, promoter evaluation, accounting policies, corporate governance practices, project risk, and compliance and litigation history. CARE would consider a time horizon of around 3 years for its assessment.

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RATING METHODOLOGY OF CARE CARE has prescribed a format for obtaining requisite information required for rating the instruments. These are different formats for manufacturing company, and for financial services company. The formats collects information relating to key factors business analysis, financial analysis, management evaluation, regulatory and competitive environment, and fundamental analysis.

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ONICRA

• In India there has been a absence of rating agency for individuals. • ONICRA has filled this gap and it is the India’s first individual credit rating system. • It brings to India the internationally established concept of providing credit rating of individuals, for the use of lending institutions. • Rating of Individuals: ONICRA credit rating systems is based on the sophisticated software developed in collaboration with James Martin & Co, that has provided to ONICRA the most comprehensive methodology that addresses the needs of a mega credit rating system ONICRA takes up credit rating for individuals customer at the request of a lending firm/institution. In the process customer is required to fill the form given by ONICRA. Benefit of Rating: It is beneficial to lenders because it saves time, and helps in concentrating on core area of interest.

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DISADVANTAGES OF CREDIT RATING • Biased rating and misrepresentation, • Static study, • Concealment of material information, • No guarantee for soundness of the company, • Human bias, • Reflection of temporary and adverse conditions, • Present rating may change (down grade), • Differences in rating of two agencies. 10/19/09

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