Credit Rating Vivek

CREDIT RATING The initial rating exercise was started by Henry Poor who published financial statistics of Railroad companies in 1860. In addition to his publishing business, John Moody (Moody’s Investors Services) started publishing ratings for railroad bonds from the year1909. The rating activity got a boost post Great Depression of 1933 when US Government Controller of Currency directed the banks in USA to purchase bonds rated BBB/Baa and above and the rest came to be known as ‘junk’ bonds. At present in US markets all commercial bonds are invariably rated. Why rating is necessary. In the competitive market, rating gives an edge to the company when they place their bond/debenture or other debt instruments in the market for subscription. The investor relies on the independent rating agency since he does not have the time, expertise, analytical skills and the past data on the company’s performance available with him. Comparison between 2 similar types of instruments is made easier if rating of the issues is available. The investor who knows the risk he has bargained for when he decides to take a decision to invest vis-a-vis his own risk appetite and the rewards he could expect. Rating helps the issuing companies to place their issues at competitive rates of interest and reduce the cost of funds to a reasonable level keeping with their credit standing, reputation and ability to repay the debts in time. It should be noted that when a rating is attached to an issue, it by no means, reflects the total financial capacity of the company. In other words, rating agencies carry out the rating exercise for an issue of debt instrument and not a company as a whole. A company may get highest rating for a particular size of an issue whereas if size is increased beyond a particular level, same issue may be allotted a lower rating if the company’s financial capacity is unable to sustain the servicing of the issue. Also if after the issue is launched with a higher credit rating and company undertakes operations which are likely to put their financial capacity under strain, the credit rating may be lowered by the rating agency anytime during the maturity of the instrument before it becomes due for payment. Benefits of rating: For the company: • Attracting higher number of investors, • Competitive rates of interest, • Added investors’ confidence • Ability to raise money from foreign markets at cheaper rates, • Encourages financial discipline amongst the corporates and better financial planning, • Helps to build reputation in the market. For the investors: • Helps to diversify risk, • Saves the time and energy in studying company’s financials, 1

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Strong indicator of company’s financial capacity, Periodical evaluation of company’s financial capacity by rating agency helps the investor to exit the investment, in case rating is downgraded subsequently.

Credit Rating Agencies in India: •

Credit Rating Information Services of India Ltd (CRISIL)

CRISIL was established on 1st Jan 1988, promoted by ICICI and UTI jointly, with initial equity capital of Rs.4 crs. Each one of these promoters holds 18% of the capital. Other contributions to the capital are as follows: 1. Asian Development bank 15% 2. LIC, GIC & SBI 5% each 3. HDFC 6.2% 4. Banks (Indian) 19.25% 5. Banks (Foreign) Balance Process of Credit Rating: Following factors are taken into account while assigning specific ratings to the issues. a) Financial Analysis: i. Quality of accounting such as profitability aspects, method of income recognition, valuation of inventory, auditors’ comments etc. ii. Adequate cash flows iii. Financial flexibility. b) Business Analysis: i. Industry risk, ii. Product demand, iii. Locational advantages, availability of skilled labour, transportation etc. c) Management Competency: Philosophy, outlook, capacity, flexibility of the management d) Regulatory framework. CRISIL Rating Symbols: Pref. shares: “Pf” Fixed Deposits: “F” Short Term Instruments: “P” Debentures: “AAA”: Highest safety of timely payment of interest and principal. “AA”: Offer high safety of interest and principal. Differ in safety from AAA only marginally. “A”: Adequate safety; however changes in circumstances can affect adversely more than those in higher rated

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categories. “BBB”: Sufficient safety, however change in circumstances likely to lead a weakened capacity. “BB”: Inadequate safety but less susceptible to default than other speculative grade debentures. “B”: Greater susceptibility to default. “C”: Vulnerable to default. “D”: In default and in arrears of interest or principal or expected to default on maturity. Additionally CRISIL also uses (+) or (-) signs to denote higher or lower safety within the grade (AA+, AA- etc.). AAA/AA are considered High Investment Grades. A/BBB are considered Investment Grades. BB/B/C/D are considered speculative grade. In case of short term instruments CRISIL uses symbols as P1/P2/P3/P4/P5 to denote various degrees attached to the instruments. •

Investment Information and Credit Rating Agency of India (ICRA): ICRA was set up by ICICI and other leading investment institutions and commercial banks and financial services companies. Rating Scales: Long Term (Debentures, Bonds, Pref. Shares): L AAA Highest safety. L AA+ } L AAA } High safety L AA} LA+ LA LA-

} } Adequate safety }

L BBB+ L BBB L BBB-

} } Moderate safety }

L BB+ L BB L BB-

} } Inadequate safety }

L B+ LB L B-

} } Risk Prone }

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L C+ LC L CLD

} } Substantial Risk } Default- Extremely speculative.

Medium Term: (Cert. of Deposits & Fixed Deposits) M AAA to M D. Short Term: (Including Commercial Papers) A1+ / A1 / A2+ / A2 / A3+ / A3 / A4+ / A4 / A5 •

Credit Analysis and Research Ltd. (CARE) CARE was promoted by leading financial institutions, banks and private sector finance companies. Care prefixes CARE to the ratings given to the issue e.g. CARE AAA or CARE AA to the Debenture or Bond issue to indicate High safety. Similarly in case of Fixed / Short Deposit issue the rating issued is CARE AAA (FD) or CARE AA (SD) and so on. ------------------------------------------------------------------------------------------------

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