Credit Rating

EXECUTIVE SUMMARY
The project entitled Credit Rating gives you an insight to the most important concept in any industry, be it service oriented or a manufacturing firm i.e. working capital. Credit rating is a qualified assessment and formal evaluation of companys credit history and capability of repaying obligations. It measures the default probability of the borrower, and its ability to repay fully and timely its financial debt obligations. The main purpose of credit rating is to provide investors with comparable information on credit risk based on standard rating scale, regardless of specifics of companies, separate sector of the economy and country as a whole. Credit rating has proven itself to be effective instrument of risk assessment in countries with advanced economy since it demonstrates transparency of an enterprise. Credit rating reflects financial, sectoral, operational, legal and organizational sides of companies, which characterize ability and willingness duly and in full amount to repay obligations. In world practice, credit rating can be assigned to sovereign governments, regional and local executive bodies, corporations, financial organizations and etc. Different Types of Credit Rating are explained in this project. Functions of Credit Rating are highlighted. Various advantages and limitation to Credit Rating are highlighted. This project has also covered the Rating Process, Rating Symbols for short term debentures and long term bonds, Rating Methodology, of various rating agencies like CRISIL, ICRA, SMERA, ONICRA, CARE and International Rating Agency. IPO Grading has also been included in this project.

Credit Rating

OBJECTIVE
The objectives of this study is to find out The concept of credit rating The need of credit rating How the credit rating agencies function Advantages and disadvantages of credit rating An analysis of credit rating is also included in the study.

Credit Rating

Chapter-

INTRODUCTION

Credit Rating

INTRODUCTION

The evaluation of a people or businesses ability and past performance in paying debts. A credit rating is generally established by a credit bureau and used by merchants, suppliers, and bankers to determine whether a loan should be granted or credit extended. With the increasing market orientation of the Indian economy, investors value a systematic assessment of two types of risks, namely business risk arising out of the open economy and linkages between money, capital and foreign exchange markets and payments risk. With a view to protect small investors, who are the main target for unlisted corporate debt in the form of fixed deposits with companies, credit rating has been made mandatory. India was perhaps the first amongst developing countries to set up a credit rating agency in 1988. The function of credit rating was institutionalized when RBI made it mandatory for the issue of Commercial Paper (CP) and subsequently by SEBI when it made credit rating compulsory for certain categories of debentures and debt instruments.
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Credit Rating In June 1994, RBI made it mandatory for Non-Banking Financial Companies (NBFCs) to be rated. Credit rating is optional for Public Sector Undertakings (PSUs) bonds and privately placed non-conveyable debentures upto Rs.50 million. Fixed deposits of manufacturing companies also come under the purview of optional credit rating. The removal of strict regulatory framework in recent years has led to a spurt in the number of companies borrowing directly from the capital markets. There have been several instances in the recent past where the fly-by-night operators have cheated unwary investors. In such a situation, it has become increasingly difficult for an ordinary investor to distinguish between safe and good investment opportunities' and unsafe and bad investments. Investors find that a borrower's size or name is no longer a sufficient guarantee of timely payment of interest and principal. Investors perceive the need of an independent and credible agency, which judges impartially and in a professional manner, the credit quality of different companies and assist investors in making their investment decisions. Credit Rating Agencies, by providing a simple system of gradation of corporate debt instruments, assist lenders to form an opinion on -the relative capacities of the borrowers to meet their Financial and Investment obligations. These Credit Rating Agencies, thus, assist and Institutions in India form an integral part of a broader programme of financial disintermediation and broadening and deepening of the debt market. Credit rating is used extensively for evaluating debt instruments. These include long-term instruments, like bonds and debentures as well as short-term obligations, like Commercial Paper. In addition, fixed deposits, certificates of deposits, inter-corporate deposits, structured obligations including non-convertible portion of partly Convertible Debentures (PCDs) and preferences shares are also rated. The Securities and Exchange Board of India (SEBI), the regulator of Indian Capital Market, has now decided to enforce mandatory rating of all debt instruments irrespective of their maturity. Let us recall that earlier only debt issues of over 18 months maturity had to be compulsorily rated. A credit rating evaluates a potential borrower's ability to repay debt. The credit rating demo describes one approach to assigning credit ratings to companies. The demo uses the same financial ratios as Altman's z-score as predictors of credit quality, and then it trains a classifier using one of the statistical learning tools available in Statistics Toolbox software. The classifier used in the demo outputs a classification score to help reviewers identify companies that fall into "gray areas" between ratings that require a closer look. The demo also discusses back-testing tools to evaluate the ratings accuracy. The impetus for the growth of Credit Rating came from the high levels of default in the US Capital markets after the Great Depression. Further impetus for growth came when regulatory agencies began to stipulate that institutions such as Government Pension Funds and Insurance Companies could not buy securities rated below a particular grade.
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Credit Rating Merchant bankers, underwriters and other intermediaries involved in the debt market also found rating useful for planning and pricing the placement of debt instruments. The other factors leading to the growing importance of the credit rating system in many parts of the world over the last two decades are 1. The increasing role of capital and money markets consequent to disintermediation; 2. Increasing securitization of borrowing and lending consequent to disintermediation; 3. Globalization of the credit market; the continuing growth of information technology; 4. The growth of confidence in the efficiency of the market mechanism: and 5. The withdrawal of Government safety nets and the trend towards privatization.

Credit Rating Function

1) Credit rating plays an important role in developed and developing capital markets throughout the world. 2) The use of ratings fosters growth in local and international markets, and streamlines their functioning. 3) Capital markets currently include bonds and other bond-like instruments guaranteeing a fixed income amounting to an aggregate total of over $80 trillion. 4) Ratings serve a wide array of players in the capital market. 5) The service is designed first and foremost to provide reliable ratings to fulfill the needs of investors interested in obtaining a reliable, independent estimate of a companys credit risk, of issuers and borrowers seeking flexible sources of financing on the capital market and brokering entities enjoying this service namely: savers, governments, economists, the financial media and other observers.

Credit Rating

ORIGIN

The first mercantile credit agency was set up in New York in 1841 to rate the ability of merchants to pay their financial obligations. Later on, it was taken over by Robert Dun. This agency published its first rating guide in 1859. The second agency was established by John Bradstreet in 1849 which was later merged with first agency to form Dun & Bradstreet in 1933, which became the owner of Moodys Investors Service in 1962. The history of Moodys can be traced back about 100 years ago. In 1900, John Moody laid stone of Moodys Investors Service and published his Manual of Railroad Securities. Early 1920s saw the expansion of credit rating industry when the Poors Publishing Company published its first rating guide in 1916. Subsequently Fitch Publishing Company and Standard Statistics Company were set up in 1924 and 1922 respectively. Poor and Standard merged together in 1941 to form Standard and Poors which was subsequently taken over by McGraw Hill in 1966. Between 1924 and 1970, no major new rating agencies were set up. But since 1970s, a number of credit rating agencies have been set up all over the world including countries like Malaysia, Thailand, Korea, Australia, Pakistan and Philippines etc. In India, CRISIL (Credit Rating and Information Services of India Ltd.) was setup in 1987 as the first rating agency followed by ICRA Ltd. (formerly known as Investment Information & Credit Rating Agency of India Ltd.) in 1991, and CARE (Credit Analysis and Research Ltd.) in 1994. All the three agencies have been promoted by the All-India Financial Institutions. The rating agencies have established their creditability through their independence, professionalism, continuous research, consistent efforts and confidentiality of information. Duff and Phelps has tied up with two Indian NBFCs to set up Duff and Phelps Credit Rating India (P) Ltd. in 1996.

Credit Rating

DEFINITION
A credit rating defines the financial strength of a borrower and helps the investor determine the likelihood that the bond issuer will pay coupon payments in a timely fashion and more importantly the initial investment at maturity. There are two major credit rating agencies; they are Standard & Poors and Moody. They both conduct extensive research on the bond issuer before assigning a credit rating to them. The bond rating will affect the interest rate that the issuer will need to pay investors; the stronger the credit rating, the lower the interest expense for the issuer. Each of the credit rating agencies rate debt securities with a slightly different ratings scale. Below, you will see what each of these agencies considers investment grade and non-investment grade securities. Lower credit ratings are not necessarily bad. In fact, many investors invest in lower grade securities to receive higher yields. Due diligence must always be done when investing in any bond, especially lower grade ones which are not investment grade. 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. An assessment of the credit worthiness of individuals and corporations. It is based upon the history of borrowing and repayment, as well as the availability of assets and extent of liabilities.

According to the MoodysA 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.

According to Standard & PoorsIt helps investors by providing an easily recognizable, simple tool that couples a possibly unknown issuer with an informative and meaningful symbol of credit quality.

According to ICRACredit ratings are opinions on the relative capability of timely servicing of corporate debt and obligations. These are not recommendations to buy or sell neither the accuracy nor are completeness of the information guaranteed.

Credit Rating

MEANING
Credit is important since individuals and corporations with poor credit will have difficulty finding financing, and will most likely have to pay more due to the risk of default. A credit rating evaluates the credit worthiness of a debtor, especially a business (company) or a government. It is an evaluation made by a credit rating agency of the debtor's ability to pay back the debt and the likelihood of default. Credit ratings are determined by credit ratings agencies. The credit rating represents the credit rating agency's evaluation of qualitative and quantitative information for a company or government; including non-public information obtained by the credit rating agencies analysts. Credit ratings are not based on mathematical formulas. Instead, credit rating agencies use their judgment and experience in determining what public and private information should be considered in giving a rating to a particular company or government. The credit rating is used by individuals and entities that purchase the bonds issued by companies and governments to determine the likelihood that the government will pay its bond obligations. A poor credit rating indicates a credit rating agency's opinion that the company or government has a high risk of defaulting, based on the agency's analysis of the entity's history and analysis of long term economic prospects.

Features of Credit Ratings

Specificity Relativity Guidance Not a Recommendation Broad Parameters No Guarantee Quantitative and Qualitative

Credit Rating

Function of Credit Ratings

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

Exercising responsibility
Credit is a part of everyday life. It enables people to buy everything from necessities to luxuries. However, if you do not exercise responsibility in managing your finances you will find that the concept of credit will cripple you instead of empower you. To make sure you exercise responsibilities always keep track of your purchases, loans, and overall expenses. Keep yourself informed and do not fall for the buy now pay later mentality. Buy only what you need and if buying for luxuries makes sure that it is planned and not a spontaneous buy. Pay your bills on time and do not allow yourself to go in debt. In the end being responsible will not only yield in an excellent credit history but will also ensure that you will have more options for finding money fast in case you need it in the future.

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Credit Rating

Chapter-

BACKGROUND ON CREDIT RATINGS

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Credit Rating

BACKGROUND ON CREDIT RATINGS

A Brief History of the Credit Rating Industry
Credit rating agencies (RAs) have existed for well over a century, and the market has been dominated by a few large players since its inception. The first securities ratings were issued in 1909, when John Moody published a book of ratings for U.S. railroad bonds. He extended his ratings to utilities and industrial bonds the following year. Additional entrants followed, with Poors Publishing Company issuing its first ratings in 1916,Standard Statistics Company six years later in 1922, and Fitch Publishing Company soon after in 1924. In 1962, Dun & Bradstreet bought Moodys; nearly 40 years later, in 2000, it spun Moodys off as an independent public corporation. Standard and Poors merged in1941, and then was acquired by McGrawHill in 1966. Fitch merged with a number of smaller ratings agencies: IBCA in 1997 (through the merger with IBCA, Fitch Ratings became owned by Fimalac S.A.), Duff & Phelps in 2000, and Thomson Bank Watch in 2000.Thus, by 2000, the three major RAs remaining were Moodys, Standard & Poors (S&P), and Fitch. An important change to the structure of the industry was the evolution in the 1970s from a subscriber pays model, in which bond investors pay the agencies for access to their analysis and ratings, to an issuer pays model, in which the bond issuers choose and pay the RAs that rate their bonds.

The Meaning of Credit Ratings

Credit ratings provide a measure of the creditworthiness of debt securities to investors. Each of the RAs considers a number of factors to determine ratings, including firm and securityspecific factors, market factors, regulatory and legal factors, and macroeconomic trends. Their ratings intend to provide a means of comparison of credit risk across asset classes and time. Credit rating is the opinion of the rating agency on the relative ability and willingness of tile issuer of a debt instrument to meet the debt service obligations as and when they arise. Rating is usually expressed in alphabetical or alphanumeric symbols. Symbols are simple and easily understood tool which help the investor to differentiate between debt instruments on the basis of their underlying credit quality. Rating companies also publish explanations for their symbols used as well as the rationale for the ratings assigned by them, to facilitate deeper understanding. In other words, the rating is an opinion 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 may be a matter of days to thirty years or more.

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Credit Rating In fact, the credit rating is a symbolic indicator of the current opinion of the relative capability of the issuer to service its debt obligation in a timely fashion, with specific reference to the instrument being rated. It can also be defined as an expression, through use of symbols, of the opinion about credit quality of the issuer of security/instrument.

The Use of Ratings in Regulation

The RAs ratings of bonds and entities have been used in financial regulation since 1931, when the Office of the Comptroller of the Currency (OCC) required that bank holdings of publicly traded bonds have a rating of BBB or better in order to be allowed to be carried at book value. Publicly traded bonds with ratings below BBB would have to be valued on the banks balance sheet at a discount. The two primary uses of credit ratings in financial regulation are in (1) Determining capital requirements of financial institutions and (2) Restricting financial institutions asset allocations.

1. Determining Capital Requirements

Credit ratings have been used as a determinant of capital requirements in the United States since 1951, when the National Association of Insurance Commissioners began imposing higher capital requirements on lowerrated bonds held by insurers. However, the watershed event in the use of independent credit ratings in federal regulation occurred in1975, when the Securities and Exchange Commission (SEC) modified its minimum capital requirements for brokerdealers to take into account the riskiness of their portfolios and based its assessment of riskiness on bond ratings. Fearing that brokerdealer demand for high bond ratings would lead to inflated credit ratings from the RAs, the SEC created a new designation, the nationally recognized statistical rating organization (NRSRO), and only recognized the bond ratings of RAs designated as NRSROs. The SEC initially recognized Moodys, S&P, and Fitch as NRSROs, but additional firms have been recognized over time. Credit ratings have more recently played a role in the regulatory capital determinations of U.S. bank and thrift regulators as well. Regulators permit banks and thrifts to use ratings as an element in their internal assessments of the credit quality of the assets they hold. Further, ratings are used as a part of the regulatory capital calculations for certain classes of assets. In 2001, U.S. bank and thrift regulators passed a new capital rule governing asset securitization on depository institutions. Among other provisions, the new rule set risk weights for RMBS and other assetbacked securities based on the rating of the bond. Risk weights for bonds rated AAA or AA were below weights for lowerrated bonds. Institutions were required to hold capital in proportion to the risk weights. For example, relative to the required capital for AAA or AA securities, BBB securities required five times greater capital and BB securities required ten times greater capital. Internationally, credit ratings have even greater force in determining capital adequacy. The Basel II standards, an international
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Credit Rating attempt to standardize capital requirements that followed the 1988 Basel I standards, allow banks to rely on external credit ratings to determine the risk weights for the capital requirements associated with various exposures. The European Unions Capital Requirements Directive, adopted in 2006, introduced the riskweighted capital requirements in Basel II to financial institutions within the EU. For U.S. firms, Basel II had not been implemented when the financial crisis began.

2. Restrictions on Asset Allocation

A number of U.S. regulations use credit ratings to determine the permissibility of certain classes of investments. For example, the SEC makes the use of rated securities attractive by restricting money market mutual funds to securities that have received credit ratings from any two NRSROs in one of the two highest shortterm rating categories or comparable unrated securities. Similarly, in 1989 the federal government relaxed a Department of Labor rule restricting pension funds from investing in assetbacked securitiesincluding RMBSto allow them to invest in securities rated A or higher. Additionally, bank regulators restrict permissible investment securities by national banks using credit rating cutoffs. For example, under OCC regulations on investment securities, a national bank may buy and sell for its own account investment company shares that meet other requirements provided that the shares are rated investment grade or the credit equivalent of investment grade.

Statutory References to Credit Ratings

While much of the use of credit ratings in financial regulation has occurred via regulatory actions by federal agencies, Congress has explicitly prescribed the use of ratings in some statutes. Primarily, credit ratings have been used in order to define terms in legislation. For example, P.L. 98440, Secondary Mortgage Market Enhancement Act, which permitted federally chartered financial institutions to invest in mortgage related securities, included in the definition of mortgage related securities a requirement that the security be rated in one of the two highest categories by an NRSRO. Similar ratingsdependent definitions have been used in legislation to define allowable investments by federally chartered financial institutions in small business related securities, Federal Housing Administration eligibility to enter into partnerships or other contractual arrangements including reinsurance and risksharing agreements with a qualified housing finance agency, and to delineate the exemption of certain companies from provisions of the Investment Company Act of 1940. Further, P.L. 106102, GrammLeachBliley Act of 1999, in addition to other references to ratings agencies, gave authorization to conduct in subsidiaries certain activities that are financial in nature to qualifying banks which, among other requirements, cannot have fewer than 1 issue of outstanding eligible debt that is currently rated within the 3 highest investment grade rating categories by a nationally recognized statistical rating organization.

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Credit Rating In certain cases, legislation has incorporated credit ratings in other ways. For example, the Federal Deposit Insurance Act was amended in 1989 in P.L. 10173, Financial Institutions Reform, Recovery, and Enforcement Act, to disallow savings associations from acquiring or retaining any corporate debt security not of investment grade, and defines investment grade as rated in one of the 4 highest rating categories by at least one nationally recognized statistical rating organization. P.L. 109171, Federal Deposit Insurance Reform Act of 2005, mandated that the FDIC use ratings as one source of information for estimating risk of loss. Finally, as a part of the SarbanesOxley Act of 2002, the Securities and Exchange Commission was required to conduct a study of the role of credit rating agencies in the operation of the securities markets. The study identified a number of issues for future examination, including disclosure of ratings processes, potential conflicts of interest, anticompetitive practices, regulatory barriers to entry, and the need for additional SEC oversight.

The Use of Ratings by Firms, Investors, and Other Private Entities

Rating agencies influence economic activity through market channels as well. Most prominently, many private contracts rely upon credit ratings to protect creditors. Ratings triggers, for instance, can mandate that a debtor post collateral, or give creditors the right to demand immediate repayment of debts in full, in the event of a downgrade. In January2008 such triggers made mono line bond insurer MBIA liable for $2.9 billion in termination payments and $4.5 billion in collateral and left many of the securities it had insured vulnerable to downgrades. A 2004 survey by the Association for Financial Professionals revealed that 87 percent of responding organizations, which are mostly large corporations, with outstanding debt had been required to maintain a specified rating from at least one of the four NRSROs in existence at the time. Ratings also figure into the decisions of private and public entities to extend credit or purchase securities. Many institutional investors, such as pension funds or university endowments, do not have the resources to evaluate all of the securities they purchase, which in any case would be duplicative of the agencies work. In addition, these investors do not have access to the same information that the ratings agencies do. Consequently, they use credit ratings as a substitute for the more granular information they would otherwise have to gather. As former Moodys Managing Director Jerome Fons has acknowledged, subprime RMBS and their offshoots offer little transparency around the composition and characteristics of the loan collateral. Loanbyloan data, the highest level of detail, is generally not available to investors. Methods of credit analysis, he added, are quite technical, often relying on advanced statistical techniques and therefore beyond the grasp of many investors. However, not all investors and credit default swap protection writers relied exclusively upon ratings. AIG, for example, used internal models to calculate the exposure it would agree to assume on the super senior credit default swaps it wrote. However, provisions in the underlying

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Credit Rating contracts did stipulate that ratings downgrades would trigger collateral calls, which were a proximate cause of the firms problems that led to government intervention.

The Regulation of Rating Agencies

The primary regulation of RAs occurs via recognition as an NRSRO by the SEC. In 1975, when the SEC began relying on credit ratings to determine the capital adequacy of brokerdealers, it recognized S&P, Moodys, and Fitch as NRSROs and later recognized four additional NRSROs between 1982 and 1991. The procedure for approving a new NRSRO was not explicitly defined in statute. The principal requirement was that the agency be nationally recognized by the predominant users of ratings in the United States as an issuer of credible and reliable ratings. Following the request of an RA to become an NRSRO, the SEC investigated the RA with regards to internal processes, financial resources, and organizational structure. If an RA was approved, the SEC issued a noaction letter stating that it will not recommend enforcement action to the Commission if ratings from the rating agency are considered by registered brokerdealers to be ratings from an NRSRO for purposes of applying the relevant portions of the net capital rule. Following the expansion of the use of credit ratings in regulation, the SEC began a review of the potential need for greater regulatory oversight beginning in a Concept Release issued in1994, which solicited public comment on the Commissions use of NRSRO ratings. Following over a decade of discussion on RA reform, Congress passed Credit Rating Agency Reform Act of 2006, P.L. 109291, which defined an NRSRO and offered more concrete direction regarding the recognition process of NRSROs by the SEC. Introducing the first oversight or monitoring of NRSROs, the new application process required, among other things, an analysis of the historical performance of credit ratings by the applicant, rating procedures and methodologies, policies regarding potential misuse of material, organizational structure, potential conflicts of interest, and a list of the twenty largest issuers and subscribers that use its ratings by revenue in the year preceding the application date. The law took effect in June 2007, and existing NRSROs were recertified through the application process. However, the law focused on mandatory disclosure of rating agencies methods and expressly prohibited the SEC from regulating the substance of the credit ratings or the procedures and methodologies by which any NRSRO determines credit ratings. Over the years, ratings agencies have acquired strong defenses against being held liable for erroneous ratings through private litigation. Most prominently, Rule 436(g) (1) of the Securities Act of 1933 explicitly exempts them from liability for misstatements made in connection with securities registration statements. Moodys and S&P have also succeeded in using the First Amendment as a shield against liability and in quashing subpoenas with the argument that they are providing journalistic services protected by the First Amendment or reporters privilege.

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Credit Rating

Chapter-

IMPORTANCE AND RATING METHODOLOGY

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Credit Rating

IMPORTANCE OF CREDIT RATING

The importance of credit rating is to protect the investor who cannot get inside information about the instruments for investment due lack of time and lack of expertise . credit rating has assumed an important place in the modern and developed financial markets . It is a boon to the companies as well as investors. It facilities the company in raising funds in the capital market and helps the investors to select their risk return trade off. As investors are concerned with the timely payment of interest and principal, credit rating indicates the credit neediness of borrowers. Credit rating essentially indicates the risk involved in a debt instruments as well as its quality. Higher the credit rating greater is the probability that the borrower will make timely payment of principal and interest and vice versa Thus credit rating is not a general evaluation off the issuing organization. it essentially reflex the probability of timely repayment of principal and interest buy a borrower a 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 ratings have become a universal phenomenon throughout the capital markets, relied upon by investors, issuers and regulators alike. Credit rating agencies play a critical role in capital markets, guiding the assets allocation of institutional investors as private capital moves freely around the world in search of the best tradeoff between risk and return.

Determinants of Rating
The default-risk assessment and quality rating assigned to an issue are primarily determined by three factors: 1. The issuers ability to pay, 2. The strength of the security owners claim on the issue, and 3. The economic significance of the industry and market place of the issuer. Ratio analysis is used to analyse the present and future earning power of the issuing corporation and to get insight into the strengths and weaknesses of the firm. Bond rating agencies have suggested guidelines about what value each ratio should have within a particular quality rating. Different ratios are favoured by rating agencies. For any given set of ratios, different values are appropriate for each industry. Moreover, the values of every firm's ratios vary in a cyclical fashion through the ups and downs of the business cycle. To assess the strength of security owner's claim, the protective provisions in the indenture, designed to ensure the safety of bondholder's investment, are considered in detail. The factors considered in regard to the economic significance and size of issuer includes nature of industry 'in which issuer is operating and the competition faced by the issuer (market share, technological leadership, production efficiency, financial structure, etc.)

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Credit Rating

RATING METHODOLOGY
Rating is a search for long-term fundamentals and the probabilities for changes in the fundamentals. Each agency's rating process usually includes fundamental analysis of public and private issuer-specific data, industry analysis, and presentations by the issuers senior executives, statistical classification models, and judgement. Typically, the rating agency is privy to the issuers short and long-range plans and budgets. The analytical framework followed for rating methodology is divided into two interdependent segments. The first segment deals with operational characteristics and the second one with the financial characteristics. Besides, quantitative and objective factors; qualitative aspects, like assessment of management capabilities play a very important role in arriving at the rating for an instrument. The relative importance of qualitative and quantitative components of the analysis varies with the type of issuer.

Key areas considered in a rating include the following: i) Business Risk:

To ascertain business risk, the rating agency considers Industry's characteristics, performance and outlook, operating position (capacity, market share, distribution system, marketing network, etc.), technological aspects, business cycles, size and capital intensity. This includes an analysis of industry risk, market position of the company, operating efficiency of the company and legal position of the company. a. Industry risk: The rating agencies evaluates the industry risk by taking into consideration various factors like strength of the industry prospect, nature and basis of competition, demand and supply position, structure of industry, pattern of business cycle etc. Industries compete with each other on the basis of price, product quality, distribution capabilities etc. Industries with stable growth in demand and flexibility in the timing of capital outlays are in a stronger position and therefore enjoy better credit rating. b. Market position of the company: Rating agencies evaluate the market standing of a company taking into account: i. Percentage of market share ii. Marketing infrastructure iii. Competitive advantages iv. Selling and distribution channel v. Diversity of products vi. Customers base
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Credit Rating vii. Research and development projects undertaken to identify obsolete products viii. Quality Improvement programs etc. c. Operating efficiency: Favourable locational advantages, management and labour relationships, cost structure, availability of raw-material, labour, compliance to pollution control programs, level of capital employed and technological advantages etc. affect the operating efficiency of every issuer company and hence the credit rating. d. Legal position: Legal position of a debt instrument is assessed by letter of offer containing terms of issue, trustees and their responsibilities, mode of payment of interest and principal in time, provision for protection against fraud etc. e. Size of business: The size of business of a company is a relevant factor in the rating decision. Smaller companies are more prone to risk due to business cycle changes as compared to larger companies. Smaller companies operations are limited in terms of product, geographical area and number of customers. Whereas large companies enjoy the benefits of diversification owing to wide range of products, customers spread over larger geographical area. Thus, business analysis covers all the important factors related to the business operations over an issuer company under credit assessment.

ii) Financial Risk:

To assess financial risk, the rating agency takes into account various aspects of its Financial Management (e.g. capital structure, liquidity position, financial flexibility and cash flow adequacy, profitability, leverage, interest coverage), projections with particular emphasis on the components of cash flow and claims thereon, accounting policies and practices with particular reference to practices of providing depreciation, income recognition, inventory valuation, off-balance sheet claims and liabilities, amortization of intangible assets, foreign currency transactions, etc. Financial analysis aims at determining the financial strength of the issuer company through quantitative means such as ratio analysis. Both past and current performance is evaluated to comment the future performance of a company. The areas considered are explained as follows. a. Accounting quality: As credit rating agencies rely on the audited financial statements, the analysis of statements begins with the study of accounting quality. For the purpose, qualification of auditors, overstatement/ understatement of profits, methods adopted for recognising income, valuation of stock and charging depreciation on fixed assets are studied. b. Earnings potential/profitability: Profits indicate companys ability to meet its fixed interest obligation in time. A business with stable earnings can withstand any adverse conditions and also generate capital resources internally. Profitability ratios like operating profit and net profit ratios to sales are calculated and compared with last 5 years figures or compared with the

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Credit Rating similar other companies carrying on same business. As a rating is a forward-looking exercise, more emphasis is laid on the future rather than the past earning capacity of the issuer. c. Cash flow analysis: Cash flow analysis is undertaken in relation to debt and fixed and working capital requirements of the company. It indicates the usage of cash for different purposes and the extent of cash available for meeting fixed interest obligations. Cash flows analysis facilitates credit rating of a company as it better indicates the issuers debt servicing capability compared to reported earnings. d. Financial flexibility: Existing Capital structure of a company is studied to find the debt/equity ratio, alternative means of financing used to raise funds, ability to raise funds, asset deployment potential etc. The future debt claims on the issuers as well as the issuers ability to raise capital is determined in order to find issuers financial flexibility.

iii) Management Evaluation:

Management evaluation includes consideration of the background and history of the issuer, corporate strategy and philosophy, organisational structure, quality of management and management capabilities under stress, personnel policies etc.

iv) Business Environmental Analysis:

This includes regulatory environment, operating environment, and national economic outlook, areas of special significance to the company, pending litigation, tax status, and possibility of default risk under a variety of scenarios. Rating is not based on a predetermined formula, which specifies the relevant variables as well as weights attached to each one of them. Further, the emphasis on different aspects varies from agency to agency. Broadly, the rating agency assures itself that there is a good congruence between assets and liabilities of a company and downgrades the rating if the quality of assets depreciates. The rating agency employs qualified professionals to ensure consistency and reliability. Reputation of the Credit Rating Agency creates confidence in the investor. Rating Agency earns its reputation by assessing the client's operational performance, managerial competence, management and organizational set-up and financial structure. It should be an independent company with its own identity. It should have no government interference. Rating of an instrument does not give any fiduciary status to the credit rating agency. It is desirable that the rating be done by more than one agency for the same kind of instrument. This will attract investor's confidence in the rating symbol given. A rating is a quality label that conveniently summarizes the default risk of an issuer. The credibility of the issuer's proposed payment schedule is complemented by the credibility of the rating agency. Rating agencies perform this certification role by exploiting the economies of scale in processing information and monitoring the issuer. There is an on-going debate about whether the rating agencies perform an information role in addition to a certification role. Whether agencies have access to superior (private) information, or if agencies are superior
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Credit Rating processors of information; security I ratings provide information to investors, rather than merely summarizing existing information. Empirical research confirms the information role of rating agencies by demonstrating that news of actual and proposed rating changes affects the price of issuer's securities. Most studies document numerically larger price effects for downgrades than for upgrades, consistent with the perceived predilection of management for delaying bad news.

v) Geographical Analysis:
Geographical analysis is undertaken to determine the locational advantages enjoyed by the issuer company. An issuer company having its business spread over large geographical area enjoys the benefits of diversification and hence gets better credit rating. A company located in backward area may enjoy subsidies from government thus enjoying the benefit of lower cost of operation. Thus geographical analysis is undertaken to determine the locational advantages enjoyed by the issuer company.

vi) Fundamental Analysis:

Fundamental analysis includes an analysis of liquidity management, profitability and financial position, interest and tax rates sensitivity of the company. This includes an analysis of liquidity management, profitability and financial position, interest and tax rates sensitivity of the company. 1. Liquidity management involves study of capital structure, availability of liquid assets corresponding to financing commitments and maturing deposits, matching of assets and liabilities. 2. Asset quality covers factors like quality of companys credit risk management, exposure to individual borrowers and management of problem credits etc. 3. Profitability and financial position covers aspects like past profits, funds deployment, revenues on non-fund based activities, addition to reserves. 4. Interest and tax sensitivity reflects sensitivity of company following the changes in interest rates and changes in tax law. Fundamental analysis is undertaken for rating debt instruments of financial institutions, banks and non-banking finance companies.

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Chapter-

NATURE OF CREDIT RATING

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Credit Rating

NATURE OF CREDIT RATING

1. Rating is based on information: Any rating based entirely on published information has serious limitations and the success of a rating agency will depend, to a great extent, on its ability to access privileged information. Cooperation from the issuers as well as their willingness to share even confidential information are important pre-requisites. The rating agency must keep information of confidential nature possessed during the rating process, a secret. 2. Many factors affect rating: Rating does not come out of a predetermined mathematical formula. Final rating is given taking into account the quality of management, corporate strategy, economic outlook and international environment. To ensure consistency and reliability a number of qualified professionals are involved in the rating process. The Rating Committee, which assigns the final rating, consists of specialised financial and credit analysts. Rating agencies also ensure that the rating process is free from any possible clash of interest. 3. Rating by more than one agency: In the well-developed capital markets, debt issues are, more often than not, rated by more than one agency. And it is only natural that ratings given by two or more agencies differ from each other e.g., a debt issue, may be rated AA+ by one agency and AA or AA- by another. It will indeed be unusual if one agency assigns a rating of AA while another gives a BBB. 4. Monitoring the already rated issues: A rating is an opinion given on the basis of information available at particular point of time. Many factors may affect the debt servicing capabilities of the issuer. It is, therefore, essential that rating agencies monitor all outstanding debt issues rated by them as part of their investor service. The rating agencies should put issues under close credit watch and upgrade or downgrade the ratings as per the circumstances after intensive interaction with the issuers. 5. Publication of ratings: In India, ratings are undertaken only at the request of the issuers and only those ratings which are accepted by the issuers are published. Thus, once a rating is accepted it is published and subsequent changes emerging out of the monitoring by the agency will be published even if such changes are not found acceptable by the issuers. 6. Right of appeal against assigned rating: Where an issuer is not satisfied with the rating assigned, he may request for a review, furnishing additional information, if any, considered relevant. The rating agency will undertake a review and thereafter give its final decision. Unless the rating agency had over looked critical information at the first stage chances of the rating being changed on appeal are rare.

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Credit Rating 7. Rating of rating agencies: Informed public opinion will be the touchstone on which the rating companies have to be assessed and the success of a rating agency is measured by the quality of the services offered, consistency and integrity. 8. Rating is for instrument and not for the issuer company: The important thing to note is that rating is done always for a particular issue and not for a company or the Issuer. It is quite possible that two instruments issued by the same company carry different ratings, particularly if maturities are substantially different or one of the instruments is backed by additional credit reinforcements like guarantees. In many cases, short-term obligations, like commercial paper (CP) carry the highest rating even as the risk profile changes for longer maturities. 9. Rating not applicable to equity shares: By definition, credit rating is an opinion on the issuers capacity to service debt. In the case of equity there is no pre-determined servicing obligation, as equity is in the nature of venture capital. So, credit rating does not apply to equity shares. 10. Credit vs. financial analysis: Credit rating is much broader concept than financial analysis. One important factor which needs consideration is that the rating is normally done at the request of and with the active cooperation of the issuer. The rating agency has access to unpublished information and the discussions with the senior management of issuers give meaningful insights into corporate plans and strategies. Necessary adjustments are made to the published accounts for the purpose of analysis. Rating is carried out by specialised professionals who are highly qualified and experienced. The final rating is assigned keeping in view the number of factors. 11. Time taken in rating process: The rating process is a fairly detailed exercise. It involves, among other things analysis of published financial information, visits to the issuers offices and works, intensive discussion with the senior executives of issuers, discussions with auditors, bankers, creditors etc. It also involves an in-depth study of the industry itself and a degree of environment scanning. All this takes time; a rating agency may take 6 to 8 weeks or more to arrive at a decision. For rating short-term instruments like commercial paper (CP), the time taken may vary from 3 to 4 weeks, as the focus will be more on short-term liquidity rather than on long-term fundamentals. Rating agencies do not compromise on the quality of their analysis or work under pressure from issuers for quick results. Issuers are always advised to approach the rating agencies sufficiently in advance so that issue schedules can be adhered to.

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Credit Rating

Non-rating related activities

CRAs often undertake a variety of non-rating related activities these include the following: 1. Economy and company research: Some Indian CRAs have set up research arms to complement their rating activities. These arms carry out research on the economy, industries and specific companies, and make the same available to external subscribers for a fee. In addition, they disseminate opinions on the performance of the economy or specific industries, available through releases to the media. The research would also be used internally by the rating agencies for arriving at their rating opinions. SEBI permits CRAs to carry out this activity subject to relevant firewalls. 2. Risk consulting: With the application of Basel II regulations for banks, there is considerable demand for tools and products that will allow banks to compute their capital adequacy ratios under the revised guidelines. The risk consulting groups of credit rating agencies would leverage the agencies understanding of credit risk to develop and provide the tools and data that banks would require. The products in this area include tools for internal ratings, operational risk evaluation, and overall capital calculation. 3. Funds research: Some CRAs have diversified from mutual fund ratings into mutual fund research. The services that are available under this head include fund rankings, performance attribution tools (to help users understand the reasons for funds performance), desktop tools, and fixed income research. 4. Advisory services: CRAs offer various kinds of advisory services, usually through dedicated advisory arms. Most of this is in the nature of developing policy frameworks, bid process management, public private partnership consulting, and creating an enabling environment for business in India and globally. 5. Knowledge Process Outsourcing: Some Indian CRAs (CRISIL and ICRA) have KPO arms that leverage their analytical skills and other process and manpower capabilities. These arms provide services to the CRAs affiliates in developed markets, and also to other clients outside India.

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Credit Rating

Chapter-

CREDIT SCORE

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Credit Rating

CREDIT SCORE
Credit score is a number which lenders use to assess the risk of extending credit to you. In other words, credit score is an estimate of the risk that a bank will take to lend you money. It is also a snapshot of your credit file at a certain point in time. The FICO score is developed by Fair Isaac Corporation and based on credit files maintained by consumer credit reporting agencies. It is widely used by banks, credit unions, insurance agencies, financing companies and other lenders. However, it is not the only factor determining your ability to obtain credit. Other important factors include: income, employment history, previous and current relationships with a lender, to name a few. Each lender decides on its own what will be taken into account when it considers lending money to you. Credit score is a mathematical formula which takes into account many different pieces of information and compares it with hundreds of thousands of other credit reports from the past, to create patterns, which identify statistical possibility of future credit risk. Every person with a credit file has three credit scores based on information from three credit bureaus. They are not exactly the same, but for most people they will be only slightly different. If your credit report does not contain enough information, your score cannot be calculated as there aren't enough items to be compared with generated patterns. In that case, a different formula is used to provide your credit rating to a lender. Tips to improve and maintain a good credit score 1. Collect credit report from Experian, Trans Union and Equifax. Review the report for any error or mistake. 2. Try to reduce the debt of those with high interest. 3. If not in full, try to make payment of minimum balance due of credit cards. 4. Pay all you bills on time. Late payment can do a serious damage to your report. 5. Avoid credit from financial companies. It can negatively affect your score. 6. Don't apply for too many credit accounts. Credit score determine your financial status, so one should always try to keep it as good as possible and avoid any such actions that can affect it and result a low score.

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Credit Rating

Chapter-

BENEFITS OF CREDIT RATING

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Credit Rating

BENEFITS OF CREDIT RATING

Rating serves as a useful tool for different constituents of the capital market namely investors, issuers of debt instruments, financial intermediaries, business enterprises, regulators, etc. These benefits are described below:

Benefits of Credit Rating to investors:

1. Helps in Investment Decision: Credit rating gives an idea to the investors about the credibility of the issuer company, and the risk factor attached to a particular instrument. So the investors can decide whether to invest in such companies or not. Higher the rating, the more will be the willingness to invest in these instruments and vice-versa. 2. Benefits of Rating Reviews: The rating agency regularly reviews the rating given to a particular instrument. So, the present investors can decide whether to keep the instrument or to sell it. For e.g. if the instrument is downgraded, then the investor may decide to sell it and if the rating is maintained or upgraded, he may decide to keep the instrument until the next rating or maturity. 3. Assurance of Safety: High credit rating gives assurance to the investors about the safety of the instrument and minimum risk of bankruptcy. The companies which get a high rating for their instruments will try to maintain healthy financial discipline. This will protect them from bankruptcy. So the investors will be safe. 4. Easy Understand ability of Investment Proposal: The rating agencies give rating symbols to the instrument, which can be easily understood by investors. This helps them to understand the investment proposal of an issuer company. For e.g. AAA (Triple A), given by CRISIL for debentures ensures highest safety, whereas debentures rated D are in default or expect to default on maturity. 5. Choice of Instruments: Credit rating enables an investor to select a particular instrument from many alternatives available. This choice depends upon the safety or risk of the instrument. 6. Saves Investor's Time and Effort: Credit ratings enable an investor to his save time and effort in analysing the financial strength of an issuer company. This is because the investor can depend on the rating done by professional rating agency, in order to take an investment decision. He need not waste his time and effort to collect and analyse the financial information about the credit standing of the issuer company.

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Credit Rating 7. Recognition of risk and returns: Credit rating symbols indicate both the returns expected and the risk attached to a particular issue. It becomes easier for the investor to understand the worth of the issuer company just by looking at the symbol because the issue is backed by the financial strength of the company.

Benefits of Credit Rating to Company:

1. Improves Corporate Image: Credit rating helps to improve the corporate image of a company. High credit rating creates confidence and trust in the minds of the investors about the company. Therefore, the company enjoys a good corporate image in the market. 2. Lowers Cost of Borrowing: Companies that have high credit rating for their debt instruments will get funds at lower costs from the market. High rating will enable the company to offer low interest rates on fixed deposits, debentures and other debt securities. The investors will accept low interest rates because they prefer low risk instruments. A company with high rating for its instruments can reduce the cost of public issue to raise funds, because it need not spend heavily on advertising for attracting investors. 3. Wider Audience for Borrowing: A company with high rating for its instruments can get a wider audience for borrowing. It can approach financial institutions, banks, investing companies. This is because the credit ratings are easily understood not only by the financial institutions and banks, but also by the general public. 4. Good for Non-Popular Companies: Credit rating is beneficial to the non-popular companies, such as closely-held companies. If the credit rating is good, the public will invest in these companies, even if they do not know these companies. 5. Act as a Marketing Tool: Credit rating not only helps to develop a good image of the company among the investors, but also among the customers, dealers, suppliers, etc. High credit rating can act as a marketing tool to develop confidence in the minds of customers, dealer, suppliers, etc. 6. Helps in Growth and Expansion: Credit rating enables a company to grow and expand. This is because better credit rating will enable a company to get finance easily for growth and expansion. 7. Self-Discipline: Rating encourages the companies to match with the existing practices and to come out with more disclosure about their accounting system, financial reporting and management pattern, etc.

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Credit Rating

Benefits of Credit Rating to Intermediaries:

1. Highly credit rated instruments does not requires brokers to convince their clients to select a particular investment proposal. 2. High Rated instruments speak themselves about the financial soundness and the strength of the instrument rated by the credit rating agency. 3. It also facilitates pricing and underwriting as Investment banks and other intermediaries active in the fixed income markets may find credit ratings useful in the planning, pricing and placement of securities. 4. Credit ratings can also help intermediaries monitor their risk exposure, either on behalf of clients or for their own accounts. 5. The time, cost, energy and manpower saved for convincing clients can be utilized in expanding the clientele and intensifying the business activities.

Benefits of Credit Rating to Business Counter-parties:

The credit rating helps business counter-parties in establishing business relationships particularly for opening letters of credit, awarding contracts, entering into collaboration agreements, etc. The independent risk evaluation of SMEs by an unbiased third party lends credibility to them and opens doors for them while dealing with MNCs and corporates. One can submit credit rating for tenders and make oneself more credible to get bigger orders. It also provides easier access to other sources of finance such as private equity. Better ratings have helped the SMEs retain customers and suppliers, and negotiate better terms with them. Thus, in this way rating serves as a useful tool for different constituents of the capital market. For different classes of persons, different benefits accrue from the use of rated instruments.

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Credit Rating

Chapter-

TYPES OF CREDIT RATING

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Credit Rating

TYPES OF CREDIT RATING

Corporate Rating
The credit rating of a corporation is a financial indicator to potential investors of debt securities such as bonds. These are assigned by credit rating agencies such as Standard & Poor's, Moody's or Fitch Ratings and have letter designations such as AAA, B, CC. The Standard & Poor's rating scale is as follows: AAA, AA, A, BBB, BB, B, CCC, CC, C, D. Anything lower than a BBB rating is considered a speculative or junk bond. The Moody's rating system is similar in concept but the verb age is a little different. It is as follows: AAA, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, and C

Sovereign Credit Rating

A sovereign credit rating is the credit rating of a sovereign entity, i.e., a national government. The sovereign credit rating indicates the risk level of the investing environment of a country and is used by investors looking to invest abroad. It takes political risk into account.
Source: Euro money country risk Country risk rankings (June2012) Least risky countries, Score out of 100 Rank 1 2 3 4 5 6 7 8 9 10 1 2 3 4 4 5 7 8 9 7 Previous Country Overall score

Norway Switzerland Singapore Luxembourg Sweden Finland Canada Denmark Netherlands Germany

90.30 88.83 88.03 87.90 86.79 84.30 84.26 83.52 83.07 82.24

The table shows the ten least-risky countries for investment as of June 2012. Ratings are further broken down into components including political risk, economic risk. Euro money's biannual country risk index monitors the political and economic stability of 185 sovereign

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Credit Rating countries. Results focus foremost on economics, specifically sovereign default risk and/or payment default risk for exporters (a.k.a. "trade credit" risk). A. M. Best defines "country risk" as the risk that country-specific factors could adversely affect an insurer's ability to meet its financial obligations.

Short-term Rating
A short-term rating is a probability factor of an individual going into default within a year. This is in contrast to long-term rating which is evaluated over a long timeframe. In the past institutional investors preferred to consider long-term ratings. Nowadays, short-term ratings are commonly used. First, the Basel II agreement requires banks to report their one-year probability if they applied internal-ratings-based approach for capital requirements. Second, many institutional investors can easily manage their credit/bond portfolios with derivatives on monthly or quarterly basis. Therefore, some rating agencies simply report short-term ratings.

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Chapter-

CREDIT RATING AGENCIES

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Credit Rating

CREDIT RATING AGENCIES

The largest credit rating agencies (which tend to operate worldwide) are Dun & Bradstreet, Moody's, Standard & Poor's and Fitch Ratings. Other agencies include A. M. Best (U.S.), Baycorp Advantage (Australia), Egan-Jones Rating Company (U.S.), Global Credit Ratings Co. (South Africa),Levin and Goldstein(Zambia),Agusto & Co(Nigeria), Japan Credit Rating Agency, Ltd. (Japan). Muros Ratings (Russia alternative rating agency), Rapid Ratings International (U.S.) And Credit Rating Information and Services Limited Bangladesh) A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. In some cases, the servicers of the underlying debt are also given ratings. In most cases, the issuers of securities are companies, special purpose entities, state and local governments, non-profit organizations, or national governments issuing debt-like securities (i.e., bonds) that can be traded on a secondary market. A credit rating for an issuer takes into consideration the issuer's credit worthiness (i.e., its ability to pay back a loan), and affects the interest rate applied to the particular security being issued. The value of such security ratings has been widely questioned after the 2007-09 financial crisis. In 2003, the U.S. Securities and Exchange Commission submitted a report to Congress detailing plans to launch an investigation into the anti-competitive practices of credit rating agencies and issues including conflicts of interest. More recently, ratings downgrades during the European sovereign debt crisis of 2010-11 have drawn criticism from the EU and individual countries. A company that issues credit scores for individual credit-worthiness is generally called a credit bureau (US) or consumer credit reporting agency (UK).

Reasons for the origin of credit rating agencies

The increasing role of capital and money markets consequent to disintermediation Increased securitization of borrowing and lending consequent to disintermediation 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 Government safety nets and the trend towards privatization
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Credit Rating

Objectives of Credit rating agencies

The objectives of credit rating may be summarized as follows: The main objective is to provide superior and low cost information to investors for taking a decision regarding risk-return 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 for the issuer It lends credence to financial and other representations made by the issuer of debt instruments. It helps the investor to differentiate between debt instruments on the basis of their underlying credit quality. It provides the investors, a system of gradation to identify the ability of the issuers to make timely payment of interest and repayment of a particular debt security. Thus, Credit rating agencies aim to provide investors with objective analyses and independent assessments of companies and countries that issue such securities. Credit ratings provide individual and institutional investors with information that assists them in determining whether issuers of debt obligations and fixed-income securities will be able to meet their obligations with respect to those securities.

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Credit Rating

List of credit rating agencies

Agencies that assign credit ratings for corporations include: M. Best (U.S.) Baycorp Advantage (Australia) Capital Intelligence (Cyprus) Capital Standards Rating (Kuwait) Dagong Global (People's Republic of China) Dominion Bond Rating Service (Canada) Egan-Jones Rating Company (U.S.) Fitch Ratings (Dual-headquartered U.S./UK) CIBIL (India) ONICRA (India) Moody's Investors Service (U.S.) Muros Ratings (Russia alternative rating agency) Rapid Ratings International (U.S.) Standard & Poor's (U.S.) Weiss Ratings (U.S.) Japan Credit Rating Agency, Ltd. (Japan) CRISIL (India)

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Credit Rating

Chapter-

RATING GRADES AND PROCESS OF CREDIT RATING

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Credit Rating

RATING GRADES
Each rating agency has developed its own system of rating grades for sovereign and corporate borrowers. Fitch Ratings developed a rating grade system in 1924that was adopted by Standard & Poor's. Moody's grading is slightly different. Moody's sometimes argues that their ratings embed a conceptually superior approach that directly considers not only the likelihood of default but also the severity of loss in the event of default.

Long Term Credit Rankings

Fitch Ratings and Standard & Poor's use a system of letter sliding from the best rating "AAA" to "D" for issuers already defaulting on payments. Investment Grade AAA: best quality borrowers, reliable and stable without a foreseeable risk to future payments of interest and principal AA: very strong borrowers; a bit higher risk than AAA A: upper medium grade; economic situation can affect finance BBB: medium grade borrowers, which are satisfactory at the moment Non- Investment Grade BB: lower medium grade borrowers, more prone to changes in the economy, somewhat speculative B: low grade, financial situation varies noticeably, speculative CCC: poor quality, currently vulnerable and may default CC: highly vulnerable, most speculative bonds C: highly vulnerable, perhaps in bankruptcy or in arrears but still continuing to pay out on obligations CI: past due on interest R: under regulatory supervision due to its financial situation SD: has selectively defaulted on some obligations D: has defaulted on obligations and S&P believes that it will generally default on most or all obligations NR: not rated
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Credit Rating

Moodys grading follows a different system

Investment Grade Aaa: Obligations rated Aaa are judged to be of the highest quality, with the "smallest degree of risk" Aa1, Aa2, and Aa3: Obligations rated Aa are judged to be of high quality and are subject to very low credit risk, but "their susceptibility to long-term risks appears somewhat greater". A1, A2, and A3: Obligations rated A are considered upper-medium grade and are subject to low credit risk, but that have elements "present that suggest a susceptibility to impairment over the long term". Baa1, Baa2, and Baa3: Obligations rated Baa are subject to moderate credit risk. They are considered medium-grade and as such "protective elements may be lacking or may be characteristically unreliable". Non-Investment Grade Ba1, Ba2, and Ba3: Obligations rated Ba are judged to have "questionable credit quality." B1, B2, and B3: Obligations rated B are considered speculative and are subject to high credit risk, and have "generally poor credit quality." Caa1, Caa2, and Caa3: Obligations rated Caa are judged to be of poor standing and are subject to very high credit risk, and have "extremely poor credit quality. Such banks may be in default..." Ca: Obligations rated Ca are highly speculative and are "usually in default on their deposit obligations". C: Obligations rated C are the lowest rated class of bonds and are typically in default, and "potential recovery values are low". Others WR: Withdrawn Rating NR: Not Rated P: Provisional

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Credit Rating

PROCESS OF CREDIT RATING

The rating process begins with the receipt of formal request from a company desirous of having its issue obligations rated by credit rating agency. A credit rating agency constantly monitors all ratings with reference to new political, economic and financial developments and industry trends. The process/ procedure followed by all the major credit rating agencies in the country are almost similar and usually comprises of the following steps. 1. Receipt of the request: The rating process begins, with the receipt of formal request for rating from a company desirous of having its issue obligations under proposed instrument rated by credit rating agencies. An agreement is entered into between the rating agency and the issuer company. The agreement spells out the terms of the rating assignment and covers the following aspects: It requires the CRA (Credit Rating Agency) to keep the information confidential. It gives right to the issuer company to accept or not to accept the rating. It requires the issuer company to provide all material information to the CRA for rating and subsequent surveillance. 2. Assignment to analytical team: On receipt of the above request, the CRA assigns the job to an analytical team. The team usually comprises of two members/analysts who have expertise in the relevant business area and are responsible for carrying out the rating assignments. 3. Obtaining information: The analytical team obtains the requisite information from the client company. Issuers are usually provided a list of information requirements and broad framework for discussions. These requirements are derived from the experience of the issuers business and broadly confirms to all the aspects which have a bearing on the rating. The analytical team analyses the information relating to its financial statements, cash flow projections and other relevant information. 4. Plant visits and meeting with management: To obtain classification and better understanding of the clients operations, the team visits and interacts with the companys executives. Plants visits facilitate understanding of the production process, assess the state of equipment and main facilities, evaluate the quality of technical personnel and form an opinion on the key variables that influence level, quality and cost of production. A direct dialogue is maintained with the issuer company as this enables the CRAs to incorporate non-public information in a rating decision and also enables the rating to be forward looking. The topics discussed during the management meeting are wide ranging including competitive position, strategies, financial policies, historical performance, risk profile and strategies in addition to reviewing financial data. 5. Presentation of findings: After completing the analysis, the findings are discussed at length in the Internal Committee, comprising senior analysts of the credit rating agency. All the
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Credit Rating issue having a bearing on rating are identified. An opinion on the rating is also formed. The findings of the team are finally presented to Rating Committee. 6. Rating committee meeting: This is the final authority for assigning ratings. The rating committee meeting is the only aspect of the process in which the issuer does not participate directly. The rating is arrived at after composite assessment of all the factors concerning the issuer, with the key issues getting greater attention. 7. Communication of decision: The assigned rating grade is communicated finally to the issuer along with reasons or rationale supporting the rating. The ratings which are not accepted are either rejected or reviewed in the light of additional facts provided by the issuer. The rejected ratings are not disclosed and complete confidentiality is maintained. 8. Dissemination to the public: Once the issuer accepts the rating, the credit rating agencies disseminate it through printed reports to the public. 9. Monitoring for possible change: Once the company has decided to use the rating, CRAs are obliged to monitor the accepted ratings over the life of the instrument. The CRA constantly monitors all ratings with reference to new political, economic and financial developments and industry trends. All this information is reviewed regularly to find companies for, major rating changes. Any changes in the rating are made public through published reports by CRAs.

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Credit Rating

Criticism
Credit rating agencies have been subject to the following criticisms: Credit rating agencies do not downgrade companies promptly enough. For example, Enron's rating remained at investment grade four days before the company went bankrupt, despite the fact that credit rating agencies had been aware of the company's problems for months. This has led to suggestions that, rather than rely on CRA ratings in financial regulation, financial regulators should instead require banks, broker-dealers and insurance firms (among others) to use credit spreads when calculating the risk in their portfolio. Large corporate rating agencies have been criticized for having too familiar a relationship with company management, possibly opening themselves to undue influence or the vulnerability of being misled. These agencies meet frequently in person with the management of many companies, and advise on actions the company should take to maintain a certain rating. Furthermore, because information about ratings changes from the larger CRAs can spread so quickly (by word of mouth, email, etc.), the larger CRAs charge debt issuers, rather than investors, for their ratings. This has led to accusations that these CRAs are plagued by conflicts of interest that might inhibit them from providing accurate and honest ratings. These accusations are not entirely consistent: on one hand, the larger CRAs are accused of being too cozy with the companies they rate, and on the other hand they are accused of being too focused on a company's "bottom line" and unwilling to listen to a company's explanations for its actions. While often accused of being too close to company management of their existing clients, CRAs have also been accused of engaging in heavy-handed "blackmail" tactics in order to solicit business from new clients, and lowering ratings for those firms. The lowering of a credit score by a CRA can create a vicious cycle, as not only interest rates for that company would go up, but other contracts with financial institutions may be affected adversely, causing an increase in expenses and ensuing decrease in creditworthiness. In some cases, large loans to companies contain a clause that makes the loan due in full if the companies' credit rating is lowered beyond a certain point. The purpose of these "ratings triggers" is to ensure that the bank is able to lay claim to a weak company's assets before the company declares bankruptcy and a receiver is appointed to divide up the claims against the company. Agencies are sometimes accused of being oligopolists because barriers to market entry are high and rating agency business is itself reputation-based (and the finance industry pays little attention to a rating that is not widely recognized). Of the large agencies, only Moody's is a separate, publicly held corporation that discloses its financial results without dilution by non-ratings businesses, and its high profit margins (which at times have been greater than 50 percent of gross margin) can be construed as consistent with the type of returns one might expect in an industry which has high barriers to entry.
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Credit Rating It has also been suggested that the credit agencies are conflicted in assigning sovereign credit ratings since they have a political incentive to show they do not need stricter regulation by being overly critical in their assessment of governments they regulate. Rating agencies have come under criticism for a narrow-minded view of government default from investors' perspective. A government that does not run a sustainable budget might be forced to print money to meet credit payments; this will then inflate the economy and devalue the currency. USA is for example thought to be unlikely to default on their payments since they have the printing power of the dollar, which a country like Greece does not have for its currency, the Euro. Owing to time and cost constraints, credit ratings are unable to capture all characteristics for an issuer and issue. Credit ratings are not recommendations to buy or sell or hold a specific rated securityn or are they offered as guarantees or protections against default. They are opinions only and not the guarantee. Specific credit rating opinions are not intended to measure many of the other factors that fixed income investors must consider in relation to risk- such as liquidity risk, pre-payment risk, interest rate risk, risk of secondary market loss, or exchange loss risk. The rating is specific to the instrument and is not the rating of the issuer. The information collected by the rating agency may be subject to personal bias of the rating team. However, rating agencies try their best to provide an unbiased opinion of the credit quality of the company and/or instrument. If not, they will not be trusted. There are cases, where different ratings are provided by various rating agencies for the same instrument. These differences may be due to many reasons. This will create confusion in the minds of the investor. Thus, these are some of the demerits from which credit rating agencies suffer. In December 2004, the International Organization of Securities Commissions (IOSCO) published a Code of Conduct [30] for CRAs that, among other things, is designed to address the types of conflicts of interest that CRAs face. All of the major CRAs have agreed to sign on to this Code of Conduct and it has been praised by regulators ranging from the European Commission to the U.S. Securities and Exchange Commission.

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Credit Rating

Chapter-

10

FUNCTIONS OF A CREDIT RATING AGENCY AND DISADVANTAGES

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Credit Rating

FUNCTIONS OF A CREDIT RATING AGENCY

A credit rating agency serves following functions: 1. Provides unbiased opinion: An independent credit rating agency is likely to provide an unbiased opinion as to relative capability of the company to service debt obligations because of the following reasons: It has no vested interest in an issue unlike brokers, financial intermediaries. Its own reputation is at stake. 2. Provides quality and dependable information: A credit rating agency is in a position to provide quality information on credit risk which is more authenticated and reliable because: It has highly trained and professional staff who has better ability to assess risk. It has access to a lot of information which may not be publicly available. 3. Provides information at low cost: Most of the investors rely on the ratings assigned by the ratings agencies while taking investment decisions. These ratings are published in the form of reports and are available easily on the payment of negligible price. It is not possible for the investors to assess the creditworthiness of the companies on their own. 4. Provide easy to understand information: Rating agencies first of all gather information, then analyses the same. At last these interpret and summarize complex information in a simple and readily understood formal manner. Thus in other words, information supplied by rating agencies can be easily understood by the investors. They need not go into details of the financial statements. 5. Provide basis for investment: An investment rated by a credit rating enjoys higher confidence from investors. Investors can make an estimate of the risk and return associated with a particular rated issue while investing money in them. 6. Healthy discipline on corporate borrowers: Higher credit rating to any credit investment enhances corporate image and builds up goodwill and hence it induces a healthy/ discipline on corporate. 7. Formation of public policy: Once the debt securities are rated professionally, it would be easier to formulate public policy guidelines as to the eligibility of securities to be included in different kinds of institutional port-folio.

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Credit Rating

DISADVANTAGES OF CREDIT RATING

1. Non-disclosure of significant information: Firm being rated may not provide significant or material information, which is likely to affect the investors decision as to investment, to the investigation team of the credit rating company. Thus any decisions taken in the absence of such significant information may put investors at a loss. 2. Static study: Rating is a static study of present and past historic data of the company at one particular point of time. Number of factors including economic, political, environment, and government policies has direct bearing on the working of a company. Any changes after the assignment of rating symbols may defeat the very purpose of risk indicative of rating. 3. Rating is no certificate of soundness: Rating grades by the rating agencies are only an opinion about the capability of the company to meets its interest obligations. Rating symbols do not pinpoint towards quality of products or management or staff etc. In other words rating does not give a certificate of the complete soundness of the company. Users should form an independent view of the rating symbol. 4. Rating may be biased: Personal bias of the investigating team might affect the quality of the rating. The companies having lower grade rating do not advertise or use the rating while raising funds from the public. In such a case the investors cannot get the true information about the risk involved in the instrument. 5. Rating under unfavorable conditions: Rating grades are not always representative of the true image of a company. A company might be given low grade because it was passing through unfavorable conditions when rated. Thus, misleading conclusions may be drawn by the investors which hamper the companys interest. 6. Difference in rating grades: Same instrument may be rated differently by the two rating agencies because of the personal judgment of the investigating staff on qualitative aspects. This may further confuse the investors.

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Chapter-

11

BIG THREE (CREDIT RATING AGENCIES)

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Credit Rating

BIG THREE (CREDIT RATING AGENCIES)

The Big Three credit rating agencies are Standard & Poor's, Moody's Investor Service, and Fitch Ratings. Moodys and S&P each control about 40 percent of the market. Third-ranked Fitch Ratings, which has about a 14 percent market share, sometimes is used as an alternative to one of the other majors. The Standard & Poor's rating scale is as follows, from excellent to poor: AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-, BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, CC, C, D. The Moody's rating system is similar in concept but the naming is a little different. It is as follows, from excellent to poor: Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3.

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Credit Rating

STANDARD & POOR'S (U.S.)

Standard & Poor's (S&P) is a United States-based financial services company. It is a division of The McGraw-Hill Companies that publishes financial research and analysis on stocks and bonds. It is well known for its stock-market indices, the US-based S&P 500,the Australian S&P/ASX 200, the Canadian S&P/TSX, the Italian S&P/MIB and India's S&PCNX Nifty. Its head office is located on 55 Water Street in Lower Manhattan, New York City. As a credit-rating agency (CRA), the company issues credit ratings for the debt of public and private corporations. Standard & Poors credit ratings express the agencys opinion about the ability and willingness of an issuer, such as a corporation or state or city government, to meet its financial obligations in full and on time. It is one of several CRAs that have been designated a nationally recognized statistical rating organization by the U.S. Securities and Exchange Commission. It issues both short-term and long-term credit ratings.

Long-term credit ratings

The company rates borrowers on a scale from AAA to D. Intermediate ratings are offered a teach level between AA and CCC (e.g., BBB+, BBB and BBB-). For some borrowers, the company may also offer guidance (termed a "credit watch") as to whether it is likely to be upgraded (positive), downgraded (negative) or uncertain (neutral).

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Credit Rating

Short-term issue credit ratings

The company rates specific issues on a scale from A-1 to D. Within the A-1 category it can be designated with a plus sign (+). This indicates that the issuer's commitment to meet its obligation is very strong. Country risk and currency of repayment of the obligor to meet the issue obligation are factored into the credit analysis and reflected in the issue rating. It publishes a large number of stock market indices, covering every region of the world, market capitalization level and type of investment (e.g., indices for REITs and preferred stocks).

RECENT EXAMPLE OF DOWNGRADING BY S&P

Downgrade of U.S. long-term credit rating

On August 5, 2011, following enactment of the Budget Control Act of 2011, S&P lowered the US's sovereign long-term credit rating from AAA to AA+, slamming the nations political process and criticizing lawmakers for failing to cut spending or raise revenue enough to reduce record budget deficits. The press release sent with the decision said, in part:
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Credit Rating The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics. More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April18, 2011. Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government's debt dynamics any time soon. " The United States Department of the Treasury, which had first called S&P's attention to its $2 trillion error in calculating the ten-year deficit reduction under the Budget Control Act, commented, "The magnitude of this mistakeand the haste with which S&P changed its principal rationale for action when presented with this error raise fundamental questions about the credibility and integrity of S&Ps ratings action. The following day, S&P acknowledged in writing the USD$2 trillion error in its calculations, saying the error "had no impact on the rating decision" and adding: In taking a longer term horizon of 10 years, the U.S. net general government debt level with the current assumptions would be $20.1 trillion (85% of 2021 GDP). With the original assumptions, the debt level was projected to be $22.1 trillion (93% of 2021GDP).

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Credit Rating

MOODY'S INVESTORS SERVICE (U.S.)

Moody's Corporation (NYSE: MCO) is the holding company for Moody's Analytics and Moody's Investors Service, a credit rating agency which performs international financial research and analysis on commercial and government entities. Moody's Investors Service is a leading provider of credit ratings, research, and risk analysis. Moody's commitment and expertise contributes to transparent and integrated financial markets, protecting the integrity of credit. The company also ranks the credit-worthiness of borrowers using a standardized ratings scale. Moodys Analytics helps capital markets and credit risk management professionals worldwide address an evolving marketplace with confidence. It is one of the Big Three credit rating agencies and has a 40% share of the world market, as does its main rival, Standard & Poor's; Fitch Ratings has a smaller share. Moody's was founded in 1909 by John Moody. The top institutional owner and only shareholder holding more than 5% of all shares of Moody's is Warren Buffett's company Berkshire Hathaway, holding a share of ~13%.

Moody's rating methodology

Moody's analyzes all relevant risk factors and viewpoints in arriving at a rating opinion. Several analytical principles guide the process, including: 1. Focus on the long term- Moody's analytical focus is on fundamental factors that will drive an issuer's long-term ability to meet debt payments, such as major economic downturns, a

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Credit Rating radical change in management strategy, or major regulatory developments. The ratings are not intended to ratchet up and down with business or supply-demand cycles or to reflect short-term market movements. 2. Emphasis on stability and predictability of cash flow- One of Moody's main analytical concentrations is on understanding the drivers of cash flow generation and, in particular, the predictability and sustainability of cash flow. Moody's will conduct financial analysis to determine an issuer's cash flow resilience in the event of an economic downturn. Specific risk factors likely to be weighed in a given rating will vary considerably by sector. RECENT EXAMPLE OF DOWNGRADING BY MOODYS INVESTORS SERVICE Moody's lowers outlook of Indian banks

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Credit Rating Global rating agency Moodys Investors Service on Wednesday downgraded the outlook on Indias Rs.64 trillion banking sector to negative from stable, saying a slowing domestic economy and chaos in global markets could lead to more bad loans, impact banks ability to raise money and profitability, but bankers, a domestic rater as well as the government uniformly dubbed the action unwarranted and uncalled for as the banking system is adequately capitalized and strongly regulated. The outlook is applicable for the next 12-18 months. The announcement was made in Singapore, in the early hours of trading in Indian markets. The Bankex, BSEs banking index, dropped 2.62% on Wednesday to close at 11,020.96 even as the benchmark equity index, the Sensex, lost 1.18%. Since January, the Bankex has lost 17.82%against a 15.45% fall in the Sensex. Other sector stocks like ICICI Bank, HDFC Bank and Axis Bank also fell between 1.4 per cent and 2.5 per cent. Moody's decision, which will make overseas borrowings for Indian banks costlier, triggered intense selling in stock markets, including the state-owned SBI which had planned to raise about $500 million. Downgrading its outlook, Moody's said slowing economic growth could dent the asset quality and profitability of the Indian banking sector. Moody's rates 15 commercial banks in India, which together account for about 66% of the system's total assets as of March 2011. "With asset quality, given the tightening environment, we anticipate that it will deteriorate over the next 12-18 months, thereby causing an increase in provisioning needs for the banks in FY'12 and FY'13," Moody's said. The rating agency however said that there was a possibility of the ratings for the individual banks changing. Earlier in September, another rating agency Standard & Poor's had downgraded country's largest lender SBI's rating to D+ from C- on account of worsening asset quality. This had also evoked sharp criticism from the government. Brushing aside Moody's projection, Financial Services Secretary DK Mittal said, "We are not concerned. We are not affected by the downgrade. Looking at how the global banks are faring, we are much stronger and the ratings have no significance." Critical of the decision of Moody's, State Bank of India (SBI) CMD Pratip Chaudhuri said state of Indian banks is much better as compared to global lenders.

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Credit Rating

FITCH RATINGS

An international rating agency for financial institutions, insurance companies, and corporate, sovereign, and municipal debt. The Fitch Group is a majority-owned subsidiary of FIMALAC, headquartered in Paris. Fitch Ratings and Fitch Solutions are part of the Fitch Group. Dual-headquartered in New York and London with 51 offices worldwide, Fitch Ratings positions itself as a global rating agency dedicated to providing value beyond the rating through independent and prospective credit opinions, research and data. The company's ratings are used as a guide to investors as to which investments are most likely going to yield a return. It is based on factors such as how small an economic shift would be necessary to affect the standing of the bond, and how much, and what kind of debt is held by the company. The firm was founded by John Knowles Fitch on December 24, 1913 in New York City as the Fitch Publishing Company. It merged with London-based IBCA Limited in December 1997. In2000 Fitch acquired both Chicago-based Duff & Phelps Credit Rating Co. (April) and Thomson Financial Bank Watch (December).Fitch Ratings is the smallest of the "big three" NRSROs, covering a more limited share of the market than S&P and Moody's, though it has grown with acquisitions and frequently positions itself as a "tie-breaker" when the other two agencies have ratings similar, but not equal, in scale.

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Credit Rating FITCH RATING METHODOLOGY Fitch Ratings make use of both qualitative and quantitative analyses to assess the business and financial risks of fixed-income issuers. Because short- and long-term ratings are based on a company's fundamental credit characteristics, a correlation exists between them. Analysis typically involves at least five years of operating history and financial data as well as company and rating agency forecasts of future performance. To achieve a clearer perspective on relative performance, a company's performance is compared with that of others in its peer group. In addition, a sensitivity analysis is performed through several "what if" scenarios to assess a company's capacity to cope with changes in its operating environment. A key rating factor is financial flexibility, which depends, in large part, on the company's ability to generate cash from operations.

RECENT EXAMPLE OF DOWNGRADING BY

FITCH RATINGS Fitch cuts RBS, Lloyds ratings

Lloyds Banking and Royal Bank of Scotland, two of Britains government-backed lenders, had their credit ratings cut by Fitch Ratings, which said the UK is less likely to provide support in future.

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Credit Rating Lloydss and RBSs long-term issue default ratings were lowered two steps to A from AA-, the ratings company said in a statement on Thursday. Fitch reduced its support rating floorswhich measure the likelihood of government supportfor systemically important British banks to A from AA- and A+. Lenders are under pressure from regulators to raise capital thats been depleted by write downs of Greek and other European peripheral sovereign debt. RBS and Lloyds shares were down 3.8% and 2.5% respectively, underperforming a 0.8% decline in the FTSE 100 share index. Fitch follows Moodys Investors Service, which downgraded 12 British lenders, including RBS and Lloyds on 7 October, and also cited a lessening of government support.

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12

TOP THREE CREDIT RATING AGENCIES IN INDIA

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CREDIT RATING AGENCIES IN INDIA

The credit rating agencies in India offer varied services like mutual consulting services, which comprises of operation up gradation, risk management. In India, at present, there are four credit Rating Agencies: i) Credit Rating and Information Services of India Limited (CRISIL), Associate of Standards & Poors ii) Investment Information and Credit Rating Agency of India Limited (ICRA) , Associate of Moodys Investors Service iii) Credit Analysis and Research Limited (CARE). iv) Duff Phelps Credit Rating Pvt. Ltd. (DCR India) v) Onicra Credit Rating Agency of India Limited: Is an established player in the individual credit assessment and scoring services space in the Indian market.

Guidelines for Credit rating agencies in India:

The Securities and Exchange Board of India (Credit Rating Agencies) Regulations, 1999 offers various guidelines with regard to the registration and functioning of the credit rating agencies in India. The registration procedure includes application for the establishment of a credit rating agency, matching the eligibility criteria and providing all the details required. They have to undergo the strict examination procedure with regard to the details furnished by them. They are required to prepare internal procedures, abidance with circulars. They are offered guidelines regarding the credit rating procedure, by the Act. The credit rating agencies are provided with compliance officers. They are required to show their accounting records.

TOP THREE CREDIT RATING AGENCIES IN INDIA

CRISIL
ICRA

CARE

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CRISIL

Credit Rating and Information Services of India Ltd. (CRISIL) a global analytical company providing ratings, research, and risk and policy advisory services. CRISIL was set up in 1987, jointly by ICICI Ltd, UTI,GIC,ADB,HDFC Ltd, However, in 2005,Standard and Poor Inc. Of U.S. acquired 51% equity shares in CRISIL and since then it is working as the subsidiary of the former. In November 1993, CRISIL went public with its maiden issue of shares. CRISIL is the largest credit rating agency in India. CRISIL pioneered ratings in India more than 20 years ago, and is today the undisputed business leader, with the largest number of rated entities and rating products: CRISIL's rating experience covers more than 45,676 entities; including 23,500 small and medium enterprises (SMEs). Nearly half of its ratings on the instruments are being used. CRISIL's market share is around75%. It has launched innovative products for credit risks assessment viz., counter party ratings and bank loan ratings. CRISIL rates debentures, fixed deposits, commercial papers, preference shares and structured obligations. Of the total value of instruments rated, debentures accounted for 3 1.196, fixed deposits for 42.3%and commercial paper 6.6%.

Rating Process
CRISIL's ratings process is designed to ensure that all ratings are based on the highest standards of independence and analytical rigor. CRISIL's analysis on each credit is carried out by a team of at least two analysts. The analysis is based on information obtained from the issuer, and on an understanding of the business environment in which the issuer operates. The analysis is then presented to a rating committee comprising members who have the professional competence to meaningfully assess the credit, and have no interest in the entity being rated. The rating committee determines the rating to be assigned. From the initial meeting with the management to the assignment of the rating, the rating process normally takes three to four weeks. However, CRISIL has sometimes arrived at rating
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Credit Rating decisions in shorter timeframes, to meet urgent requirements. The process of rating starts with a rating request from the issuer, and the signing of a rating agreement. CRISIL employs a multilayered, decision-making process in assigning a rating. A detailed flow chart of CRISIL's rating process is as below:

Methodology
CRISIL evaluation is carried out by professionally qualified persons and includes data collection, analysis and meeting with key personnel in the company to discuss strategies, plans and other issues that may effect ,evaluation of the company. CRISIL ratings are based on a robust and clearly articulated analytical framework, which ensures comprehensiveness, standardization, comparability, and effective communication of the ratings assigned and of every timely rating action.

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ICRA

ICRA: Investment Information and Credit Rating Agency of India Ltd. Now it is known as ICRA Limited. According to ICRA, Ratings are opinions on the relative capability of timely servicing of corporate debt and obligations. These are not recommendations to buy or sell neither the accuracy nor the completeness of the information is guaranteed. ICRA was set up by Industrial Finance Corporation of India on 16th January, 1991. It is a public limited company with an authorized share capital of 101 crores and share listed on Bombay stock exchange and National stock exchange. The initial paidoff capital of Rs. 3.50 crores is subscribed by IFCI, UTI, LIC, GIC, SBI and 17 other banks. ICRA started its operation from 15thMarch, 1991. Today, ICRA and its subsidiaries together form the ICRA Group of Companies (Group ICRA). ICRA is the second largest credit rating agency in India after CRISIL. Beside Ratings, ICRA Group offers Consulting services, IT based services, Information services and Outsourcing services through its subsidiaries.

Rating Process
ICRA's Rating process is initiated on receipt of a formal request (or mandate) from the prospective issuer. A Rating team, which usually consists of two analysts with the expertise and skills required to evaluate the business of the issuer, is involved with the Rating assignment. An issuer is provided a list of information requirements and the broad framework for discussions. These requirements are worked out on the basis of ICRA's understanding of the issuer's business, and broadly cover all aspects that may have a bearing on the Rating. ICRA also draws on secondary sources of information, including its own Research Division, while working on the Rating assignment. The Rating involves assessment of a number of qualitative factors with a view
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Credit Rating to estimating the future earnings of the issuer. This requires extensive interactions with the issuer's management, specifically on subjects relating to plans, outlook, competitive position, and funding policies. In the case of manufacturing companies, plant visits are made to gain a better understanding of the issuer's production process, make an assessment of the state of equipment and main facilities, evaluate the quality of technical personnel, and form an opinion on the key variables that influence the level, quality and cost of production. These visits also help in assessing the progress of projects under implementation. After completing the analysis, a Rating Report is prepared, which is then presented to the ICRA Rating Committee. A presentation on the issuer's business and management is also made by the Rating Team. The Rating Committee is the final authority for assigning Ratings. The assigned Rating, along with the key issues, is communicated to the issuer's top management for acceptance. Non-accepted Ratings are not disclosed and complete confidentiality is maintained on them unless such disclosure is required under any laws/regulations. If the issuer does not find the Rating acceptable, it has a right to appeal for a review. Such reviews are usually taken up if the issuer provides certain fresh inputs. During a review, the issuer's response is presented to the Rating Committee. If the inputs and/or fresh clarifications so warrant, the Rating Committee would revise the initial Rating decision. As part of a mandatory surveillance process, ICRA monitors all accepted Ratings over the tenure of the Rated instruments. The Ratings are generally reviewed once every year, unless the circumstances of the case warrant an earlier review. The Rating outstanding may be retained or revised (that is, upgraded or downgraded) on surveillance.

Methodology
The factors that ICRA takes into consideration for rating depend on the nature of borrowing entity. The inherent protective factors, marketing strategies, competitive edge, competence and effectiveness of management, human resource development policies and practices, hedging of risks, trends in cash flows and potential liquidity, financial flexibility, asset quality and past record of servicing of debt as well as government policies affecting the industry are examined.

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CARE

CARE: Credit Analysis and Research Ltd. is a leading credit rating company headquartered in Mumbai, India, promoted by leading Banks and Financial Institutions (FIs). The three largest shareholders of CARE are IDBI Bank, Canara Bank and State Bank of India. CARE commenced its operations in October 1993 and announced its first rating in November 1993. CAREs ratings are recognized by Government of India and all regulatory authorities in India including Reserve Bank of India (RBI), and Securities and Exchange Board of India (SEBI)

The other shareholders include Federal Bank Ltd., IL&FS Ltd., Vysya Bank Ltd., ITC Classic Finance Ltd., Kodak Mahindra Finance Ltd, etc. CARE is a full service rating company offering a wide range of rating and grading services which includes rating debt instruments/enterprise ratings of Corporate, Banks, Financial
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Credit Rating Institutions(FIs), Public Sector Undertakings (PSUs), State Government Bodies, Municipal Corporations, Non-banking Finance Companies (NBFCs), SMEs, Micro finance Institutions, Structured Finance Securitization Transactions etc.

Rating Process
The rating process takes about two to three weeks, depending on the complexity of the assignment and the flow of information from the client. Ratings are assigned by the Rating Committee.

Methodology
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 format collects information relating to key factors business analysis, financial analysis, management evaluation, regulatory and competitive environment, and fundamental analysis.
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SEBI REGULATIONS, 1999

A credit rating agency shall make all efforts to protect the interest of investors. A credit rating in the conduct of its business, shall observed high degree of integrity, dignity & fairness in the conduct of its business. A credit rating agency shall fulfill its obligation in a prompt, ethical & professional manner. A credit rating agency shall at all times exercise due diligence, ensure proper care &exercise independent professional judgment in order to achieve & maintain objectivity. A credit rating agency shall have a reasonable & adequate basis for performing rating evaluations, with the support of appropriate & in depth rating researches. A credit rating agency shall, wherever necessary, disclose to the clients, possible sources of conflict of duties & interest, which could impair its ability to make fair, objectives & unbiased ratings. A credit rating agency shall not make any exaggerated statement, whether oral or written, to the client either about its qualification or its services or its achievement with regard to the services rendered to other client. A credit rating agency shall not make any untrue statement, suppress any material fact or make any misrepresentations in any documents, reports, papers or information furnished to the board, stock exchange or public at large. A credit rating agency shall ensure that the board is promptly informed about any action, legal proceeding etc. initiated against it alleging any material breach or noncompliance by it, of any law, rules, regulations &directions of the board or of any other regulatory body. A credit rating agency shall ensure that there is no misuse of any privileged information including prior knowledge of rating decision or changes. A credit rating agency or any of his employees shall not render, directly or indirectly any investment advice about any security in the publicly accessible media. A credit rating agency shall not offer fee-based services to the rated entities, beyond credit ratings & research. All credit rating agencies (CRAs) have to get an internal audit done every six months. Every credit rating agency shall, during the lifetime of securities rated by it, continuously monitor the rating of such securities.

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13

CONCLUSIONS

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CONCLUSIONS
Credit rating in recent times is being looked upon as an important investment advisory function. In countries with highly developed markets, such as the US, and Japan, though there is no statutory requirement to have the securities rated, as high as 90 per cent of the securities floated are voluntarily rated due to the pressure exerted by investors and bankers. In India, a beginning has been made with the establishment of CRISIL and the RBI insisting that all commercial papers prior to their issue must be rated. With the growth in volume and depth of capital markets and the increasing knowledge and awareness of the investors, it can be expected that voluntary credit rating would be on the increase. A credit rating is a useful tool not only for the investor, but also for the entities looking for investors. An investment grade rating can put a security, company or country on the global radar, attracting foreign money and boosting a nation's economy. Indeed, for emerging market economies, the credit rating is key for showing their worthiness of money from foreign investors, and because the credit rating acts to facilitate investments, many countries and companies will strive to maintain and improve their ratings, hence ensuring a stable political environment and a more transparent. They can best serve markets when they operate independently, adopt and enforce internal guidelines to avoid conflicts of interest and protect confidential information received from issuers. Credit rating agencies cannot afford to commit too many mistakes as it the investors who pays the price for their mistakes. Credit rating agencies should be made accountable for any faulty rating by panelizing them or even de-recognizing them, if needed.

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14

APPENDIX

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APPENDIX 1
CRISILs Credit Rating Symbols for Securities Other Than Debentures (Based on CRISILS Booklet on Rating)

Rating Symbol Fixed Deposits FAAA-High safety (F-AAA) FAA-High safety (F-AA) FA - Adequate Safety

Interpretation

This rating indicates that the degree of safety regarding timely payment of interest and principal is very strong. This rating indicates that the degree of safety, timely payment of interest and principal is strong. However, the relative degree of safety is not high as for fixed deposits with "FAAA" rating. This rating indicates that the degree of safety regarding timely payment of interest and principal is satisfactory. Changes in circumstances can affect such issues more than those in higher rated categories. This rating indicates inadequate safety of timely payment of interest and principal. Such issues are less susceptible to default than fixed deposits rated below this category, but the uncertainties that the issuer faces would lead to inadequate capacity to make timely interest and principal payments. This rating indicates that the degree of safety regarding timely payment of interest and principal is doubtful. Such issues have factors at present that make them vulnerable to default. Adverse business or economic conditions would lead to lack of ability or willingness to pay interest or principal. This rating indicates that the issue is either in default or is expected to be in default upon maturity.

FB -Inadequate safety

FC - High Risk

FD - Default

CRISIL may apply '+' (plus') or '-' (minus) signs for rating from "FAA' to "FC" to indicate the relative position within the rating category of the company raising Fixed Deposits.

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Credit Rating Commercial Paper: P1 P2 This rating indicates that the degree of safety regarding timely payment on the instrument is very strong. This rating indicates that the degree of safety regarding timely payment on the instrument is strong. However, the relative degree of safety is lower than that for instruments rated "P-1". This rating indicates that the -degree of safety regarding timely payment on the instrument is adequate; however, the instrument is more vulnerable to the adverse effects of changing circumstances than an instrument rated in the two higher categories. This rating indicates that the degree of safety regarding timely payment on the instrument is minimal and it is likely to be adversely affected by short-term adversities or less favorable conditions. This rating indicates that the instrument is expected to be in default on maturity or is in default.

P3

P4

P5

CRISIL may apply '+' (plus) sign for ratings from 'P- I' to 'P-3' to reflect a comparatively high standing within the category.

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APPENDIX 2
Tata Motors Limited: Credit Ratings
CRISIL
Rating Current* Prior
*Rating change April 2012

Short-Term CRISIL A1+ CRISIL A1+

Long-Term CRISIL AACRISIL AA-

Outlook Positive Stable

ICRA
Rating Current* Prior
*Rating change April 2012

Short-Term ICRA A1+ ICRA A1+

Long-Term ICRA AAICRA AA-

Outlook Positive Stable

S&P
Rating Current* Prior
*Rating change July 2012

Long-Term BB BB-

Outlook Positive Stable

Moodys
Rating Current* Prior
* Rating change October 2010

Long-Term Ba3 B2

Outlook Stable Positive

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ARTICLES: S&P upgrades Tata Motors, downgrades Tata Power

MUMBAI, July 9, 2012

It fears that Tata Powers cash flow could deteriorate International ratings agency Standard & Poors Ratings Services (S&P), on Monday, said it had raised its long-term corporate credit rating on Tata Motors to BB from BB- with a positive outlook. Simultaneously, it raised the issue ratings on the company's senior unsecured notes to BB from BB-. We upgraded Tata Motors because we believe the companys competitive position and cash flow stability have improved. We assess the companys business risk profile as fair, S&P said in a statement. The S&P statement said Tata Motors significant financial risk profile reflects our expectation that the companys ratio of consolidated debt to operating profit will be about 2.0x-2.5x in 2013. Our view is based on the improved operating performance of Jaguar Land Rover (JLR), Tata Motors fully owned U.K. subsidiary. JLR, which accounted for about 60 per cent of Tata Motors consolidated revenues and two-thirds of its operating profit in the fiscal year ended March 31, 2012, outperformed our expectations. We expect JLR to sustain the improvement in its operating performance.

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Credit Rating Tata Power S&P also revised its outlook on Tata Power Company from stable to negative. In a statement, S&P said it simultaneously affirmed its BB- long-term corporate credit rating on the company and its BB- issue rating on its senior unsecured notes. The outlook revision reflects our expectation that Tata Powers cash flow and financial risk profile could deteriorate over the next six to nine months because the company has breached a debt-to-equity ratio covenant on loans to its Mundra project, said S&Ps credit analyst Rajiv Vishwanathan. The availability of loans to the project, which Tata Powers 100 per cent-owned subsidiary Coastal Gujarat Pvt. Ltd. (CGPL) controls, could therefore be limited. S&P said it might lower Tata Powers rating if it was unable to secure a waiver from its lenders on the breach of covenant; or an increase in expenditure due to the Mundra project or otherwise substantially weakens Tata Powers financial risk profile. A ratio of funds from operations to adjusted debt of less than 10 per cent on a sustainable basis would indicate such deterioration.

S&Ps warns Indian companies on FCCBs repayment

CHENNAI, June 22, 2012 Fifty-six companies, including Tata Motors and JSW Steel, will possibly have to pay $700 million in additional interest if they restructure the $5-billion foreign debt that is due for redemption this year, according to a recent report released by global rating agency Standard and Poors. The report attributed the problem to the steep slump in the stock valuation since the time of the foreign currency convertible bond (FCCB) issuance, which, in turn, is exacerbated by the fall in the rupee. The companies had initially issued the bonds, most of which are dollar-denominated, during 2006-2008, before the global economic slowdown hit - when the rupee was trading at 48 to a dollar. Restructuring options The depreciation of the rupee against the dollar, a 30 per cent drop over the last two years, has added a redemption amount of about Rs. 100 crore. According to the report, companies can restructure the bonds in three different ways; rolling over the bonds with later maturity dates and higher coupons, lowering the conversion-to equity price or convincing the bondholders to accept partial repayment of the principal. Of the rated entities, Tata Motors is likely to redeem its FCCBs at manageable costs this year and Tata Steel has already rolled over the maturity of its bonds. Standard and Poors Rating Services fears that out of the 48 companies it has rated, over half may default.
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Fitch cuts rating for Spain's two largest banks

MADRID, June 11, 2012 Fitch, on Monday, downgraded its credit rating for Spain's two largest banks, Santander and BBVA, by two notches in a move that follows the agency's downgrade of Spain's sovereign rating last week. The move reflect similar concerns to those that have affected the Spanish sovereign rating, in particular, that Spain is forecasted to remain in recession through the remainder of this year and 2013 compared to the previous expectation that the economy would benefit from a mild recovery,'' rating agency Fitch said.

DBRS upgrades India's credit rating outlook

NEW DELHI, June 24, 2011 Fiscal and monetary policy response to global credit crisis helped restore the economy to a path of higher growth International credit rating agency DBRS has, for the first time, upgraded India's long-term foreign and local currency debt rating outlook to stable' from BBB (low) negative' on the strength of its fiscal consolidation and return to pre-crisis growth levels in the wake of a robust policy framework. DBRS has changed the trend on India's long-term foreign and local currency debt ratings to stable from negative. The reasons for the change are progress in fiscal consolidation in the context of a strengthening policy framework, and a return to pre-crisis growth, the rating agency said in a statement. Elaborating on the upgrade, DBRS, which has been rating India's debt since June 2007, lauded the government's efforts stating that there was evidence of a stronger commitment to fiscal deficit reduction [in the] 2011-12 Budget. [The] government is addressing the country's infrastructure deficit by spending $514 billion or 9 per cent of gross domestic product (GDP), on infrastructure between 2007 and 2012, and an additional $1 trillion from 2013 to 2017, approximately one-half of which may come from the private sector and public-private partnerships, DBRS said, according to a Finance Ministry statement. It has also highlighted the possibility of the new Direct Taxes Code (DTC) contributing to improved tax efficiency and the national identification card increasing labour market formality, raising tax compliance and streamlining subsidies and social security expenditure.

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Credit Rating India's fiscal and monetary policy response to the global credit crisis helped restore the economy to a path of higher growth. The economy has weathered the global credit crisis relatively well, and a strong private sector-led recovery has returned India's growth rates to pre-crisis levels, DBRS said while recognising that the country has adopted a more responsible medium-term fiscal policy and commitment to debt reduction which bodes well for the ratings. DBRS, however, cautioned the government against the high debt ratio and the high inflationary pressure. India's debt ratios are among the highest among developing economies, it said. Government debt While the net general government debt has come down to 66.5 per cent of GDP in 2010-11, as per DBRS definition which includes transfer and subsidies, from 81.9 per cent in 2005-06, this is still among the highest among low to middle income countries. Furthermore, the general government deficit was a relatively high 8.3 per cent of GDP in 201011, food and fertiliser price subsidies are costly, and an estimated 33.9 per cent of revenues went to paying interest on debt in 2011-12, it said. As for inflation, currently at above 9 per cent, DBRS said the country suffers from high inflation inertia and poorly anchored inflation expectations. Apart from rising international prices of commodities, DBRS sought to blame domestic pressures like high money supply growth and inefficiencies in agriculture as reasons for high inflation. Tighter fiscal and monetary policies and, over time, better infrastructure and structural reforms should help to anchor inflation expectations, it said.

SEBI issues norms for credit rating agencies

MUMBAI, May 3, 2010 New rules to be implemented latest by June 30 The Securities and Exchange Board of India (SEBI) has issued transparency and disclosure norms for credit rating agencies (CRAs) order to impart higher credibility to the processes and procedures associated with credit rating. Recent events in the global financial system have underlined the pivotal role that credit ratings play. Effective use of credit ratings by the users is crucially dependent upon quality and quantity of disclosures made by the credit rating agencies (CRAs), SEBI stated in a circular to all credit rating agencies on Monday.

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Credit Rating The CRAs were asked to take necessary steps to implement this circular immediately and ensure its full compliance at the latest by June 30. The half-yearly disclosures, stipulated by the regulator, would be made by the CRAs within days from the end of the half-year (March/September). The yearly disclosures stipulated would be made by the CRAs within 30 days from the end of the financial year. However for 2009-10 only, the half yearly and yearly disclosures stipulated would be made by the CRAs by June 30. SEBI stated that a CRA can make additional disclosures other than those stipulated with the prior approval of its board. The CRAs were asked to communicate to SEBI the status of the implementation of the provisions of this circular by July 15. They shall also place the compliance status of this circular before their boards. The CRA shall disclose its shareholding pattern as prescribed by stock exchanges for a listed company under clause 35 of the Listing Agreement. A CRA would be formulating policies and internal codes for dealing with the conflict of interests: A CRA shall ensure: that its analysts do not participate in any kind of marketing and business development including negotiations of fees with the issuer whose securities are being rated; that the employees' involved in the credit rating process and their dependants do not have ownership of the shares of the issuer; prompt review of the credit ratings of the securities as and when any of its employees joins the respective issuer. The CRAs were asked to keep all records in support of each credit rating and review/surveillance thereof: The important factors underlying the credit rating and sensitivity of such credit rating to changes in these factors; summary of discussions with the issuer, its management, auditors and bankers which have a bearing on the credit rating; decisions of the rating committee(s), including voting details and notes of dissent, if any, by any member of the rating committee. If a quantitative model is a substantial component of the credit rating process, the rationale for any material difference between the credit rating implied by the model and the credit rating actually assigned. These records should be maintained till five years after maturity of instruments and be made available to auditors and regulatory bodies when sought by them, it stated.

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BIBLIOGRAPHY

Websites: www.scribd.com www.crisil.com www.care.com www.timesofindia.com

Newspaper: Economic times

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