Credit Rating Final

Dr.N.Moogana Goud, Professor RITM, Bangalore

CREDIT RATING An over view of Credit rating By Dr.N.Moogana Goud

Introduction In a market, financial markets play the role of efficient intermediary. They act as a link between savers and investors, mobilizing capital on one hand, and efficiently allocating them between competing users to the other hand.In addition to this an investor can also base the investment decision on the grading offered by credit rating agencies.

Definition Origin Features The credit rating system. Major issues. Regulatory Framework. Credit rating symbols.

Dr.N.Moogana Goud, Professor RITM, Bangalore

Definition The process of assigning a symbol with specific reference to the instrument being rated,that acts as an indicator of the Current opinion on relative capability on the issuer to service its debt obligation in a timely fashion, is known as credit rating. According to the Moody’s, “ A rating 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 of the expected monetary loss, should a default occur. Acc to Standard & poor’s, “ it helps investors by providing An easily recognizable, simple tool that couples a possibly Unknown issuer with an informative and meaningful symbol of credit quality Dr.N.Moogana Goud, Professor RITM, Bangalore

Origin of Credit Rating • Origin in 1840 following the crisis in 1837 • The First Merchantile Credit Agency was set up in New York By Louis Tappan in 1841. • First rating guide was published in 1859 • John Broad Street set up the similar agency in 1849 which published its rating books in 1857 • In 1900 John Moody founded “ Moody’s Investors Services and in 1909 Published his manual of “Rail Road Services” Dr.N.Moogana Goud, Professor RITM, Bangalore

IMPETUS The credit rating system originated in the USA in seventies. The high levels of default, which occurred after Great Depression, in the US capital markets, gave the impetus for the growth of credit rating. The default of $82 million of commercial paper by Penn Central in he year 1970. and the consequent panic of investor in commercial papers, resulted in massive defaults and liquidity crisis. US made rating Mandatory for institutions such as Govt Pension funds, and Insurance companies Dr.N.Moogana Goud, Professor RITM, Bangalore

IMPETUS

Reasons for the origin of credit rating agencies

• the increasing role of capital and money markets consequent to disintermediation. • Increased securitizaton of borrowing and lending consequent to disinitermediation. • Globalization of the credit market. • The continuing growth of information technology. • The growth of confidence in the efficiency of the market mechanism. • the withdrawal of Govt safety nets and the trend towards privatization

Dr.N.Moogana Goud, Professor RITM, Bangalore

Growth of Credit Rating Agencies 1841- Merchantile Credit Agency (USA) 1900191619221924194110741975198719911994-

Moody’s Investors Services(USA) Poor Publishing Company(USA) Standard Statistics Company(USA) Pitch Publishing Company(USA) Standard and Poor(USA) Thomson Bank Watch(USA) Japanese Bond Rating Institution (JAPAN) CRISIL by ICICI (INDIA) ICRA by IFCI (INDIA) CARE by IDBI (INDIA) Dr.N.Moogana Goud, Professor RITM, Bangalore

Features of Credit ratings. • • • • • • •

Specificity. Relativity. Guidance. Not a Recommendation. Broad Parameters. No Guarantee. Quantitative and Qualitative. Dr.N.Moogana Goud, Professor RITM, Bangalore

The credit rating system. Credit rating has facilitated authorities around the world to issue mandatory rating requirements. For instance, specific rules restrict the of new issues that are rated below a particular grade. Growth Factors : • Credibility and Independence. • Capital Market Mechanism. • Disclosure requirements. • Credit Education. • Creation of Debt Market. Dr.N.Moogana Goud, Professor RITM, Bangalore

Major issues • • • • • •

Investment Vs speculative Grades. Continuous Monitoring. Grade Surveillance. Rating Ceiling. Evaluation of Line. Ownership Consideration.

Dr.N.Moogana Goud, Professor RITM, Bangalore

Investment Grade Ratings S&P and Others Rating AAA AA+ AA AAA+ ABBB+ BBB BBB-

Interpretation Highest Quality High Quality High Quality High Quality Strong Payment Capacity Strong Payment Capacity Adequate Payment Capacity Adequate Payment Capacity Adequate Payment Capacity

Dr.N.Moogana Goud, Professor RITM, Bangalore

Speculative Grade Ratings

S&P and Others Moody's

Interpretation

BB+

Ba1

Ongoing uncertainty

BB

Ba2

Ongoing uncertainty

BB-

Ba3

Ongoing uncertainty

B+

B1

High Risk Obligations

B

B2

High Risk Obligations

B-

B3

High Risk Obligations

CCC+ CCC

Vulnerability to default Caa

CCCC

Vulnerability to default Vulnerability to default

Ca

In Bankruptcy

Dr.N.Moogana Goud, Professor RITM, Bangalore

Regulatory Framework credit rating has been made mandatory in India for issuance of instruments. Following are some of the important regulatory agencies connected with credit rating. SEBI : As per the regulations of SEBI, a public issue of

debentures and bonds convertible/redeemable beyond a period of 18 months, needs credit rating.

RBI : According to the guidelines of RBI, one of the conditions for issuance of commercial paper in India is that the issue must have a rating not below the P2 grade from CRISIL/A2 grade from ICRA/PR2 from CARE. Dr.N.Moogana Goud, Professor RITM, Bangalore

Rating Framework Credit rating at providing an opinion on the relative credit risk associated with an instrument. while assigning ratings, all the factors that have a bearing on future cash generation, and claims that require servicing, are considered. The major factors that determine the rating profile of a security issue are discussed below : Business Factors 1. Nature of industry 2. Market position 3. Efficiency of operation. 4. Project risk 5. Protective factors 6. Quality of management. Dr.N.Moogana Goud, Professor RITM, Bangalore

Financial Factors : 1.Financing Policies. 2.Flexibility of financial structure. 3.Past track record. 4. Quality of accounting policy. 5.Financial performance indicators. • • • • •

Profitability. Gearing. Coverage ratios. Liquidity. Cash flow.

Dr.N.Moogana Goud, Professor RITM, Bangalore

Advantages 1. To investors . Information service. . Systematic risk evaluation. . Professional competency. . Easy to understand. . Low cost. . Efficient portfolio management. .Other benefits.

Dr.N.Moogana Goud, Professor RITM, Bangalore

2. To Issuers . Index of faith. . Bench mark. . Wider investor base.

3. To Intermediaries . Efficient practice. . Effective monitoring

Dr.N.Moogana Goud, Professor RITM, Bangalore

Drawbacks • Guidance, not recommendation. • Based on assumptions. • Competitive ratings.

Dr.N.Moogana Goud, Professor RITM, Bangalore

Thank you

Dr.N.Moogana Goud, Professor RITM, Bangalore