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CREDIT RATING

A PROJECT SUBMITTED IN PART COMPLETION OF

Post Graduate Diploma in Business Administration (PGDBA)

BY

MR. DEVAL GUPTA

UNDER THE GUIDANCE OF PROF. RAVI KAMATH

THAKUR INSTITUTE OF MANAGEMENT


STUDIES & RESEARCH KANDIVILI (E), MUMBAI

MARCH 2007

CERTIFICATE
This is to certify that the study presented by MR. DEVAL GUPTA to Thakur Institute Of Management Studies & Research in part completion of Post Graduate Diploma in Business Administration (PGDBA) course under the title CREDIT RATING has been done under my guidance.

The project is in the nature of original work that has not so far been submitted for any course of this Institute or any other Institute. References of work and relative sources of information have been given at the end of the project.

Signature of the Candidate (MR. DEVAL GUPTA) Forwarded through the Research Guide

Signature of the Guide (PROF. RAVI KAMATH)

ACKNOWLEDGEMENT With a deep sense of pride, satisfaction and gratitude, I present my project report on: "CREDIT RATING" At this juncture, I feel deeply obliged to the most respected, Dr Uday Lajmi, Director of our Institute who provided me the required Infrastructure & guidance.

This project could not have seen the light of the day without the inspiring of Prof. Ravi Kamath who guided me like a beacon in the dark. I would like to thank him for giving me his valuable time, suggestions and practical views throughout my project work, without which the completion of the project would have been a difficult journey.

Finally, I would like to end this acknowledgement by emphasizing on something that I have learned from my interaction with people throughout my project.

"No effort or Knowledge ever gained is wasted"

INDEX
SR NO. 1
2 3 4 5 6 7 8 9 10 11 12 13 14 15

TITLE
Executive summary ,Introduction, Meaning Origin, Determinant Utility & Growth, Types & Kinds Symbol , Sebi Regulation Registration Steps ,Time Frame Principal & Mechanisim Accounting Ratio & Its Practicle Implication Illustration & Case Study Major Players & Their Research Methodology SMEs Rating (A New Concept) Limitation & Code Of Ethics Faq Conclusion Biblography

PAGE NO. 1-4


5-6 7-8 9-11 11-15 16-18 18-20 20-25 26-30 31-47 48-50 51-52 53-59 60 61

EXECUTIVE SUMMARY

Credit rating is slowly being recognized in India as a significant measure towards investor protection and self check for the corporate enterprises of their financial and operational strength. Credit rating provide s indicative guidance to the prospective investor in the fixed income securities or fixed deposit programs on the degree of risk involved in the timely repayment of principal and interest . A rated company is placed higher in the estimation of the investor than a an unrated company irrespective of better financial standing of the latter or the reputation attached as a familiar group company of a big business houses. This makes a transition in the corporate culture in this country. So far, the finding show that company are shy enough to opt for credit rating unless it is made mandatory under the government directives. With the commencement of CRISIL (1998) and ICRA in (1991) about 400 companies have under compulsion or voluntary gone for the rating for different debt instrument or fixed deposit programs issued by them. It is the need of an hour to create a deeper understanding of the rating process, procedure, practices & information requirements particularly in the minds of the persons managing the corporate enterprises. A lot of efforts are needed to educate the people in general and the corporate executive in particular on the systems, methodology and practices followed by them in rating the credit instrument and debt obligations.

INTRODUCTION TO CREDIT RATING The Ratings industry in India has been built up to its present position over a period of fifteen years.
Over the years, credit ratings have evolved into a 90-crore market, with four agencies providing rating services, and significant pull from investors for the product. The ratings business in India has seen three phases. During the first of these phases, as described above, there was no experience of credit ratings, and virtually no awareness, on the part of investors and issuers. The second phase saw the advent of regulatory support for credit ratings, with the introduction and Increasing rigor of regulations covering primarily the markets for public issue of debt and for fixed deposits. Aimed at protecting smaller investors, these measures also amounted to regulatory recognition of the role of credit ratings and the quality of the effort put in till then, in estimating credit quality. With these measures, credit ratings rapidly passed out of the arcane realm of high finance, and into the lexicon of the individual market participant. This phase also saw the arrival of competition, in the form of other domestic agencies entering the market. Recent years have seen a third phase of the markets development with public issues of debt reducing in volume; the focus has shifted to the market for private placements. Almost all the privately placed debt issued in the Indian market is rated, even though this is not a regulatory requirement. This shift is entirely driven by investors in these securities, who typically tend to be highly sophisticated financial sector entities. We are looking therefore at a qualitative maturing of the market, where a rating is required not as a compliance issue or a mandatory requirement, but as an opinion on credit quality demanded by discerning buyers. Going forward, following trends are expected to intensify in the Indian market: - More intensive use of ratings by investors. - Increasing sophistication in use of ratings. These two trends will result in credit ratings not being used only as a go- no-go input, as is currently often the case. We expect the major use of credit ratings to be in the pricing of debt instruments. The correlation of yields and ratings, already strong, will deepen as the bond market evolves further. Measures increasing the sophistication of the market, such as the introduction of credit derivatives, will add a further dimension to the use of ratings. Credit rating is also known as SECURITY RATING in India. It is mandatory for the issuance of debt instruments, debentures, commercial paper issued by corporate and public deposits of all NBFCs (Non Banking Financial Companies).

DEFINITION OF CREDIT RATING Credit ratings are judgments about firms financial and business prospects. Credit
rating is defined as a process by which a statistical service prepares various ratings identified by symbols which are indicators of the investment quality of the credit rated. The credit may be a debt instrument or equity. In case of debt, ratings are given while in the case of shares grading is done. It is an independent assessment of the creditworthiness of a bond (note or any security of any indebt ness) by a credit rating agency. It measures the probability of the timely repayment of principal and interest of a bond. Generally, a higher credit rating would lead to a more favorable effect on the marketability of a bond. The credit rating symbols (long term) are generally assigned with triple A as the highest and triple B as the lowest in investment grade. Anything below triple B is commonly known as a junk bond. Credit rating is the process of assigning standard scores which summarize the probability of the issuer being able to meet its repayment obligations for a particular debt instrument in a timely manner. Credit rating is integral to debt markets as it helps market participants to arrive at quick estimates and opinions about various instruments. In this manner it facilitates trading in debt and money market instruments especially in instruments other than Government of India Securities. Credit rating is not a recommendation to buy, hold or sell. Rating is usually assigned to a specific instrument rather than the company as a whole. In the Indian context, the rating is done at the instance of the issuer, which pays rating fees for this service. If it is unsatisfied with the rating assigned to its proposed instrument, it is at liberty not to disclose the rating given to it. There are 4 rating agencies in India. These are as follows: Credit rating is a dynamic concept and all the rating companies are constantly reviewing the companies rated by them with a view to changing (either upgrading or downgrading) the rating. They also have a system whereby they keep ratings for particular companies on "rating watch" in case of major events, which may lead to change in rating in the near future. Ratings are made public through periodic newsletters issued by rating companies, which also elucidate briefly the rationale for particular ratings. In addition, they issue press releases to all major newspapers and wire services about rating events on a regular basis.

Indian credit rating agencies define credit rating as follows:

According to CARE: Credit ratings is essentially, the opinion of the rating agency on the relative ability and willingness of the issuer of a debt instrument to meet the debt service obligation as and when they arise. 7

According to CRISL: Credit rating is an unbiased, objective and independent opinion to an issuers capacity to meet financial obligation, it is the current opinion as to the relative safety of timely payment of interest and principal on a particular debt instruments. Thus, rating applies to a particular debt obligation of the company and is not a rating for the company as a whole

According to ICRA: credit rating is a simple and easy to understand symbolic indicator of the opinion of the credit rating agency about the risk involved in a borrowing program of an issuer with reverence to the capability of the issuer to repay the debt as per terms of issues. This is neither a general purpose evaluation of the company nor the recommendation to buy, hold or sell a debt instrument.

Thus, precisely, rating is a measure of credit risks and is only element in the investment decision making. Credit rating does not indicate market risks or predict prices or yield of credits instrument. It evaluates only a specific instrument and indicates risk associated with such instrument only. It is general purpose evaluation of the issuer business or operations.

ORIGIN OF CREDIT RATINGS


The concept of Credit Rating originated in the United States. The first Credit Ratings were published by John Moody during 1909 in his analysis or rail road investments. This evolved into the rating company, Moodys Investors Services Inc, a division of Dun and Bradstreet Inc. Moody was followed by Poors publishing Company in 1916 and the Standard Statistics Company in 1922, which merged, into Poor to become the largest bond rating concern, Standard and Poors corporation, a subsidiary of Mc Graw Hill, Inc. The third is Fitch publishing company of New York, which was established in 1924. The fourth agency is Duff & Phelps of Chicago, which was recognized by Securities and Exchange Commission in 1982. It acquired Crisanti and Maffei Inc. of New York in 1991. These four security raring agencies are the only ones with Securities and Exchange Commission recognition as national bond rating agencies. There are other services that rate securities especially stock, like Value Line Investment Survey. The recognition of rating agency by Securities and Exchange Commission in U.S.A does not constitute approval. Actually, such recognition is not necessary to enter the security rating business. SEC uses the ratings of recognized agencies for evaluation of bong assets of brokers and dealers registered with it. In India there are 5 credit rating agencies. First, Credit Rating Information Services Of India Limited (CRISIL) set up by ICICI AND UTI in 1988. Secondly Investment Information and Credit Rating Agency of India limited (ICRA) set up by IFCI in 1991. Thirdly, Credit Analysis and Research Limited (CARE) promoted by IDBI in 1993 in association with financial institutions. Fourthly, Duff and Phelps Credit Rating India Private Limited (DCR India) for rating non-banking financial companies for fixed deposits.

DETERMINANTS OF CREDIT RATINGS


Credit rating is a symbolic indicator of the current opinion of a rating agency of the willingness and relative of an issuer debt instrument to pay interest and repay principal as per the terms of the contract. A rating agency assigns quality ratings that measures the default risk of a security and sells rating to their subscribers. The default risks primarily determined by the amount of work available to the issuer relative to the amount of funds to be paid to the security holders. The ability to pay is evaluated by financial ratios. Ratio analysis is done to analyze the present and future earning power of the company issuing the security. Ratio analysis of the issuers financial statements yields insights about the strength and weaknesses of the company. The credit rating agencies have written guidelines about what values particular ratios should have in order to earn each different quality ratings.

Credit rating appraises the default risk which is a combination of business risk and financial risk. Business Risk: Business risk relates to the market position of the company, operating efficiency and management quality. The key factor taken into consideration are: the nature of the industry the company is in, the demand-supply position, cyclical/ seasonal factors and government policies vis-vis the industry; and the competition its facing within the industry. Market Position: The market share the company enjoys, it is competitive advantages and selling and distribution arrangements. Operating Efficiency: Locational advantages, labor relationships, cost structure, technological and manufacturing efficiency as compared to its competitors. Legal Position: Terms of prospectus, systems for timely payment, and for protection against fraud. Financial Risk: Financial risk is a function of the profitability, debt leverage flexibility and adequate cash flow. The assessment of financial risk is done on the basis of: a) Financial analysis, including accounting quality: accuracy of statement of profit, auditors comments, valuation and depreciation policies. b) Earnings protection: Sources of future earning growth, profitability ratios and earnings in relation to fixed income charges. c) Adequacy of cash flow: Sustainability of cash flows and working capital management. d) Financial flexibility: Ability to raise funds. Management: An evaluation of the management, which is qualitative in nature and imparts certain amount of subjective element, is done on the basis of track record of the management; planning and control system, depth of managerial talent, succession plans. Evaluation of capacity to meet adverse situations, goals, philosophy and strategies. Environment: An analysis of environment covering regulatory and operating environment, national economic outlook, pending litigation and unpaid taxes are also attempted. Rating thus is not based on a predetermined formula which specifies the relevant variables and as well as weights attached to each one of them. Further the emphasis on different aspects varies from agency to agency. Broadly the rating agencies assures itself that there is good congruence between assets and liabilities of a company and downgrades the rating if the quality of the assets depreciates. The rating agencies employ qualified professionals to ensure consistency and reliability. The agencies also ensure the integrity of rating by insulating rating from conflicts of interest. The rating agencies employ nearly identical symbols. They examine the above factors before assigning a grade. The symbols are A, B, C and D and each symbol is graded with associated risk by adding two or one of the same symbol, like AAA, AA and A; BBB, BB and b; and so on

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UTILITY OF RATINGS
Investors have always received credit ratings with enthusiasm. But issuers do not share the enthusiasm since they have to share their securities at higher yields if their issue gets inferior rating. Credit rating gives an investor a simple and easy indicator to the credit quality of the debt instrument, the risks and likely returns, thus providing a yardstick against which the risk inherent in an instrument can be measured. An investor uses the rating to assess the risk level and compares the offered rate of return, which is expected rate of return (for the given level of risk) to optimize his risk return trade- off. Ratings also provide a comparative framework, which allows the investor to compare investment opportunities. Credit rating also benefits the issuer. If a public offer is contemplated, the financial manager must bear in mind the rating while determining the appropriate leverage. Additional debt may lower the rating from an investment to a speculative grade category, thus rendering the security ineligible for investment by many institutional investors. It may well be that the advantages of debt outweigh the disadvantages of the lower credit rating. Junk bonds, for instance, are a high risk and a high yield (16 to 25% in USA) instruments. Investment may be limited in such instrument to what an investor can afford to loose. Ratings will also effect the pricing of the issue. Actually pricing should reflect the rating. The marketability of a relatively unknown issuer who is competent is enhanced and the role of name recognition in an investment decision is minimized. In actual practice ratings are reflected in prices. There is no difference between the interest rates that are paid on the fixed deposits of two companies even if they are rated differently. Same is true of long dated debentures. But in commercial paper market where banks are major players differentials in ratings are reflected in pricing. A reliance CP would be cheaper than of a company, which is not rated well. Ratings are used by brokers for opinions and as a service for their customers. Insurance companies and mutual funds use them in the purchase of securities even though their own staff prepares investment analysis. Portfolio managers also use them in security management. Banks depend on them for their investment in commercial paper. Individual investors depend on them for their decisions to place fixed deposits. Ratings are bound to assume greater importance with the institutionalization of investors in the form of unit trusts, mutual funds, pension and provident funds. The debt has shown considerable buoyancy in 1996 not only at the wholesale level (institutional investors) but also at retail level in view of poor offerings of equity in the primary market. This has come about largely on account of the availability of ratings on debt instruments, which boosted investor confidence.

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THE GROWTH OF CREDIT RATING INDUSTRY IN INDIA


The prominent rating agencies in India are: i) CRISIL: - Credit Rating Information Services of India Limited. ii) ICRA: - Investment Information and Credit Rating Agency of India Limited. iii) CARE: - Credit analysis and Research Limited. iv) Fitch Ratings India Private Limited. Fitch Rating India Limited was formally known as DCR India- Duff and Phelps Credit Rating Co. USA and DCR India merged to form a new entity called Fitch India. Fitch India is a 100% subsidiary of Fitch IBCA, and is the only wholly owned foreign operator in India. Fitch is the only international rating agency with a presence on the ground in India. The Indian credit rating industry is next to US in terms of number of ratings issued and in the number of agencies. Between the four rating agencies in India, over 5,000 ratings have been issued for around 1,400 issuers. CRISIL is the market leader in credit rating agency with a 65% market share. The regulators support played an important role in the development of the credit rating industry. In 1992, for the first time, the Reserve Bank introduced the requirement of rating for commercial papers. SEBI followed up by introducing mandatory ratings of bonds. The other growth drivers of the credit rating industry were declining interest rates, a shift towards market borrowings from bank loans and a steep increase in the state government borrowings through special purpose vehicles. Besides these factors the growth in the private placement market of debt increased business volume in the credit rating industry. For private placements, rating is not mandatory but mutual funds and banks ask for a rating. In 1997, the penetration of rating, that is, the number of rated issues, out of the total number of issues was 35%. In the year 2002, it was 97%. This means that the credit rating industry has transited from a regulatory driven market to an investor driven market in the growing debt markets. Between fiscal 1997 and 2001, rated debt volumes increased from Rs. 13,743 crore to Rs. 52,746 crore, which is 84% of the total issuance.

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TYPES OF CREDIT RATINGS

Two type of credit rating has been noticed : 1) Traditional debt rating (TDR) 2) Private placement rating (PPR) Traditional debt ratings (TDR): Traditional debt ratings are a symbolic prediction about the debt security probability resulting in a default in timely payment of interest and principal. In other words, traditional debt rating reflects the current opinion of a credit rating agency of the relative capability and willingness of an issuer of a debt instrument to service the debt obligation as per the term of contract .Traditional debt rating is specific to specific to to a debt instrument in term of credit risk associated with such instrument .Traditional debt rating enable an investor to establish a link between risk and return and provide a symbolic yardstick to identify the risk level associated with the instrument and the return it offers to match with his preferences with expectations Private placement rating (PPR): Privately rating is newly introduced credit rating system finding in the literature generated by standard & poor on credit rating , private placement rating is not much different to traditional debt rating but it goes one step ahead to traditional debt rating ,ie. Apart from evaluating a risk of default in timely payment it also evaluates the likelihood of loss to an investor in the vent of default according on the investment . Never the less, either or both of the two types of rating can be used for new issues of debt securities or structured obligations.

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KINDS OF INSTRUMENT RATED


Followings are the bodys or organization which can be rated : 1) 2) 3) 4) 5) 6) 7) Manufacturing Companies Banks Non Banking Financial Institution Financial Institutions Housing Finance Companies Municipal Bodies Companies In Infrastructure Sector To keep the pace with the changing credit requirements of new instruments the rating agencies have been upgrading the technology and bringing in analytical innovation. The instrument being rated by such agencies include: 1) 2) 3) 4) 5) 6) Mortgage & Asset Backed Securities Letter Of Credit Backed Bonds, Commercial Paper and Structure Finance For Global Market; Project Finance Municipal and Corporate Bond Insurance; Bonds and Money Market Funds; Syndicated Banks Loans: In Indian context With reference to India the rating agencies have been rating the following types of debts & debt obligations: 1) 2) 3) 4) 5) a) b) c) d) Debenture Bonds Fixed Deposits Commercial Paper Structured Obligations other ratings : Utilities Rating State Government Ratings Asset Backed Securieties Mutual Funds Rating

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e) f) g)

Equity Grading/Assessment Bank Lines Of Credit Others

DUAL RATINGS s Dual Rating would mean rating opinion on one or more instrument s from two different rating agencies. Such dual rating leaves several question unanswered in the minds of the investor ,viz. firstly, which of the two CRAS rating opinion relied upon ;secondly ,why the difference in two rating should occur when both follow alike methodology, and thirdly, if such difference is unavoidable why should not the rating s be rendered unreliable etc

RATING SYMBOLS
Rating agencies use symbols such as AAA, AA, BBB, B, C, D, to convey the safety grade to the investor. Ratings are classified into three grades: High investment grades, investment grades and speculative grades. In all ratings is classified into 14 or 15 categories. Signs + or - are used to show the certainty of timely payment. The suffix + or may be used to indicate the comparative position of the instrument within the group covered by the symbol. Thus FAA- lies one notch above FA+. To provide finer gradations, rating industry attach + or to their ratings. The rating symbols for different instruments of the same company need not necessarily be the same. High Investment Grades AAA: - Triple A denotes highest safety in terms of timely payment of interest and principal. The issuer is fundamentally strong and any adverse changes are not going to affect it. AA: - Double A denotes high safety in terms of timely payment of interest and principal. The issuer differs in safety from AAA issue only marginally. Investment Grades A : - denotes adequate safety in terms of timely payment of interest and principal. Changes in circumstances can adversely affect such issues. BB: - Triple B denotes moderate safety in terms of timely payment of interest and principal speculative grades.

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Speculative Grades BB: - Double B denotes inadequate safety terms of timely payment of interest and principal. Uncertain changes can lead to inadequate financial capacity to make timely payments in the immediate future. B: - denotes high risk. Adverse changes could lead to inability or unwillingness to pay timely payment. C: - denotes substantial risk. Issue rated is vulnerable to default. D: - denoted default in terms of timely payment of interest and principal. These symbols are just a current opinion of an agency and they are not recommendations to invest or not to invest. The rating assigned applies to a particular instrument of the company and is not a general evaluation of the company. Rating Fees: -In the credit rating business, the users of rating service, such as investors, financial intermediaries and other end- users, do not pay for it. The issuer of the financial instrument pays fees to the credit rating industry and this is the major source of revenue to the rating agency. Today issuers fees constitute 95% of the total revenues of the rating agencies. In India rating agencies charge 0.1 % of the instrument size as rating fees. They also charge an annual surveillance fees at a rate of 0.03% to monitor the instrument during his life.

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SEBI REGULATIONS FOR CREDIT RATING AGENCIES


SEBI issued regulations for credit rating agencies in 1999. These regulations are called as Securities and Exchange board of India. (Credit Rating Agencies) Regulations, 1999. 1) Only commercial banks, public financial institutions, foreign banks operating in India, foreign credit rating agencies, and companies with a minimum net worth of Rs 100 crore as per its audited annual accounts for the previous five years are eligible to promote rating agencies in India. 2) 3) them. Rating agencies are required to have a minimum net worth of Rs 5 crore. Rating agencies cannot assess financial instruments of their promoters who have 10 % stake in

4) Rating agencies cannot rate a security issued by an entity, which is (a) a borrower of its promoter. (b) a subsidiary of its promoter. (c) an associate of its promoter, if (i) there are common chairman, directors between credit rating agency and these entities (ii) there are common employees (iii) there are common chairman, directors, employees on the rating committee. 5) Rating agencies cannot rate a security issued by its associated or subsidiary, if the credit rating agency or its rating committee has a chairman, director or employee, who is also a chairman, director or employee of any such entity. 6) A penalty of suspension of the certificate of registration or a penalty of cancellation of registration may be imposed on the rating agency if it fails to comply with the condition or contravenes any of the provisions of the Act.

REGISTRATION OF CREDIT RATING AGENCIES


1) Grant of Certificate i) Any person proposing to commence any activity as a credit rating agency on or after the date of commencement of these regulations shall make an application to the Board for the grant of a certificate of registration for the purpose. ii) A non- refundable application fee shall accompany an application for the grant of a certificate. 2) Promoter of Credit Rating Agency The Board shall not consider an application under unless a person belonging to any of the following categories promotes the applicant: a) A Public Financial Institution. b) A Scheduled Commercial Bank. A Foreign Bank operating in India. 17

c)

d) A foreign credit rating agency having at least five years experience in rating securities. e) Any company or a body corporate, having continuous net worth of minimum rupees of one hundred crores for the previous five years prior to filling of the application with the board for the grant of certificate under these regulations. 3) Eligibility Criteria The Board shall not consider an application for the grant of a certificate unless the applicant satisfies the following condition: a) The applicant is set up and registered as a company under the Companies Act, 1956; b) The applicant has, in its memorandum of Association, specified rating activity as one of its main objects; c) The applicant has a minimum net worth of rupees five crores. d) The applicant has adequate infrastructure, to enable it to provide rating service. e) The applicant and the promoters of the applicant have professional competence, financial soundness and general reputation of fairness and integrity in business transactions, to the satisfaction of the Board. f) Neither the applicant, nor its promoter, nor any director of the applicant or its promoter, s involved in any legal proceeding connected with the securities market, which may have an adverse effect on the interest of the investors; g) Neither the applicant, nor its promoters, nor any director, or its promoter has at any time in the past been convicted of any offence involving moral turpitude or any economic offence. h) The applicant has, in its employment, persons having adequate professional and other relevant experience to the satisfaction of the Board. i) The applicant in all other respects is a fit and a proper person for the grant of a certificate. j) The grant of certificate to the applicant is in the interest of the investors and the securities market.

4) Application to Conform to the Requirements The Board shall reject any application for a certificate, which is not complete in all aspects or does not confirm to the requirements of regulation or instructions. Providing that, before rejecting any such application, the applicant shall be given an opportunity to remove. Within thirty days of the date of receipt of relevant communication, from the Board such objections as may be indicated by the Board. Provided further, that the Board may, on sufficient reason being shown, extend the time for removal of objections by such further time, not exceeding thirty days, as the Board may consider fit to enable the applicant to remove such objections.

5) Furnishing of Information, Clarification and Personal Representation

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The Board may require the applicant to furnish such further information or clarification, as the Board may consider necessary, for the purpose of processing of the application. ii) The Board, if it so desires, may ask the applicant or its authorized representative to appear before the Board, for personal representation in connection with the grant of a certificate. 6) Grant of certificate i) The Board. On being satisfied that the applicant is eligible for the grant of a certificate of registration, shall grant a certificate. ii) The grant of certificate of registration shall be subject to the payment of the registration fee specified. 7) Conditions of Certificate and Validity Period The certificate shall be granted subject to the following conditions, namely; a) The credit rating agency shall comply with the provisions of the Act, the regulations made there under and the guidelines, directives, circulars and instructions issued by the Board from time to time on the subject of credit rating. b) Where any information furnished to the Board by a credit rating agency: i) is found to be false or misleading in any material particular; or ii) has undergone change subsequently to its furnishing at the time of the application for the certificate; the credit rating agency shall forthwith inform the Board in writing; The period of validity of the certificate of registration shall be three years. 8) Renewal of certificate A credit rating agency, if it desires renewal of the certificate granted to it, shall make to the Board an application for the renewal of the certificate or registration within 3 months before expiry of the period of the validity of the certificate. The application for the renewal shall be accompanied by a renewal fee.

c)

STEPS IN CREDIT RATING PROCESS


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Rating may differ with respect to different instrument of same organization . Also , different rating assigned to different instrument of two different organizations does not indicate the superiority or inferiority of the organizations . the steps involved in credit rating activity are given below :

PROCESS FLOW CHART OF CREDIT RATING

MANDATE INITIAL STAGE ASSIGN RATING TEAM RECEVE INITIAL INFORMATION, CONDUCT BAIC RESEARCH MEETING & VISIT ANALYSIS & PREPARTION OF REPORT PREVIEW MEETING RATING FINALISATION STAGE RATING MEETNG ASIGN RATING COMMUNICATE THE RATING & RATIONALE ACCEPTNCE SURVEILLANCE FRESH INPUT CLARIFICATION
REQUEST FOR REVIEW NON ACCEPTANCE

FACTS FINDING & ANALYSIS STAGE

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The entire rating process is normally completed in three stage in practical scenario1) Primary Or Initial Stages. 2) Facts Finding & Analysis Stage. 3) Rating Finalization Stage. 1) The rating process begins at the request of the company.

2) The tem consisting of professionally qualified analyst well versed with the workings of the industry in which the company operates, first visits the company plants and inspect the operations first hand . 3) Meeting with different levels of management follow culminating with the meeting with chief executive officer. 4) Generally, middle & top level management meeting cover the field of operations , finance , marketing , project, etc. 5) In completion of the assignment , the tem interacts with the back up tem that has separately collected the additional industry information and prepares a report 6) The report is then placed before n internal committee consisting of senior executives of credit rating agency who themselves have hands on experience in rating assignments. 7) The internal committee then has an open discussion with the tem member and amongst themselves arrives at rating. 8) To avoid any type ort of bias, the ratings proposed are placed before an external committee consisting of eminent people unconnected with credit rating agency . 9) The external committee then takes the final decision which is communicated to the company .

10) The company may volunteer ny further information at this point which could effect the ratings, it is passed ion to the external committee again for affirmation/change. 11) The company has the option to request the agency for review of the rating.

TIME FRAME FOR FOR RATING PROCESS


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From Initial request Meeting with management Initial rating indication

To Meeting with management Initial rating indication Publication of rating

Time frame 4-6 weeks 4-6weeks Time depends Upon completion of formalities

FUNDAMNETAL PRINCIPLE OF RATING & GRADING


The basic requirement in risk grading is that it should reflect a clear and fine distinction between credit grades covering default risks and safe risks in the short run. While there is no ideal number of grades covering default raks in the short run . while there uis no ideal number of grades that would facilitate achieving this objective, it is expected that more granularity may serve the following purpose :

1) Objective analysis of portfolio risks. 2) Appropriate pricing of various risks grade borrowers, with a focus on low risk borrower in term of lower pricing 3) Allocation of risk capital for high risk graded exposures 4) Achieving accuracy and consistency. According to the RBI, there should be an ideal balance (in numbers) between acceptable credit risk and unacceptable credit risk in a grading system. It is suggested that: 1) A rating scale may consisit of 8 9 levels. 2) Of the above, the first levels may represent acceptable credit risks 3) The remaining four levels may represent unacceptable credit risks.

MECHANISIM OF CREDIT RATING


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The quantitative & qualitative factors in the case of whole sale exposure and four type factors in the case of retail sector needed to be accorded weight or scores. The aggregate outcome will reflect the rating /grade of an exposure against a benchmark. Hence the mechanism must lay down the following: 1) For wholesale exposure : The marks for each parameter , with a randge of marks for various ranges of a parameter have to be fixed . If the growth in the last completed year compared with the previous year is : 20% & above 15% to less than 20% 5% to less than 15% 0% to less than 5% Negative growth: 4 marks 3 marks 2 marks 1 marks 0 marks

For qualitative factors, also, there can be suitable scoring based on excellent (maximum marks) and the lowest one non satisfactory (zero marks) may be fixed. 2) Aggregate marks for all the applicable parameters for each category may then be mapped into various grades taking the maximum marks as 100, as shown below. 3) Wherever a particular parameter is not applicable for an exposure , it may be ignored and the aggregate marks be readjusted / graded accordingly Sl. No. 1 2 3 4 5 6 7 8 Total score for an exposure 86-100 71-85 61-70 51-60 41-50 36-35 31-35 0-30 Grade accorded AA+ AA A BB+ BB B C D Implication of grade accorded Excellent safety Very good safety Good safety Ordinary safety Less ordinary safety Low safety Unsafe safety Loss category

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For retail exposure (consumer lending): 1) As with the wholesale exposure, maximum marks for each parameter can be fixed. for example, age, months, income etc. 2) Similarly, aggregate marks for each parameter can be determined the overall grading of the account. While there may be eight grades in wholesale exposure because of the risk related issue in pricing involved, in the case of retail exposure, four/five grades are considered sufficient. 3) The scoring /grading system in various banks / financial institution may vary substantially depending on inter alia, risk perceptions, thrust area and other allied factors.

ACCOUNTING RATIOS FOR RISK EVALUTION

A ratio conveys a quantitative interrelationship between two attribute/variable for eventual comparison against the bench mar and for trend analysis. in business , accounting ratios facilitate meaningful and purpose oriented decision ma,ing . Its utility I determined according to the purpose for which the ratio is computed. From the age of credit risk valuation , accounting ratios plays significant role for a lending/investment banks, since the overall computation of type credit rating of their account /exposure I aided/ supported by ratio analysis also. Hence, not , not only is it necessary to identify the relevant ratios depending upon the purpose, quantum, tenure of exposure etc but also in marketable securities ( rated by approved external rating agency ) , one may focus more on current ratio/net profit/sales ratio than an long-term solvency ratios. Internationally, there are no prescribed accounting ratios for risk evaluation. In India, too, the banking regulatory authorities have left such matter to the the judgments and discretion of the banks/financial institution to go by established financial practices and frame an accounting ratio policy that is relevant to the purpose of its credit risk evaluation .

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RATIOS FOR CREDIT EVALUATION


For identification criteria for example, items of current asset , current liabilities, etcone is to be guided by standard accounting practices 1) short term solvency angle : a) Current ratio: Current asset Current liabilities Minimum expected level: 1.3:1 For financing working capital requirement based on the turnover method for small & medium enterprise (sme) and others, the mininmum expected level may be 1.10:1. b) Acid test ratios: Quick assets Quick liabilities Minimum expected level : 1:1 For SMEs the minimum expected level may be 0.8:1 c) Cash ratio: Cash +Bank Balance+Marketable Securities Current liabilities Minimum expected level: 0.5:1 For SME the minimum may be lower 2) Long term solvency angle: d) Debt eqity ratio : Total external liabilities Equity (owned funds) Maximum allowable level: 2:1

e) Debt servicing coverage ratio: 25

Earning available for debt service One year debt installment payment + interest thereon Earning includes:

Net Profit : (+) depreciation on fixed asset , (-) loss on the sale of fixed assets Interest on debt for one year

**** ** ** ** ****

Minimum expected level: 1.5:1 For the priority sector. SME etc, the minimum may be allowed at 1:30:1 3) Profitability angle: a) Operating profit ratio : Profit before deduction of depreciation ,tax & finance charges Sales/income the expected level will depend upon the nature of the industry/business, operational area, size of the unit, the duration of the business being carried on, trend analysis and other relevant factors. However, a good unit is likely to show at least a margin of 25-30 % b) Return on capital employed ratio (ROCE) : Operating profit Owned funds+long term loan funds The expected level will depend upon the nature of the industry /business, operational area, size of the unit, the duration of the business being carried on, trend analysis and other relevant factors, however, a good unit is likely to show at least a margin of 15-20%

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c) Interest coverage ratio : Operating profit Interest liability Subjected to the factor as stated above: d) Profit asset ratio : Operating profit Total tangible asset Subjected to the factor as stated e) Indirect overhead ratios finance charges+ depreciation + selling and administrative cost Sales/income The maximum allowable unit as stated above , however , it might be 10-15% . From the asset movement angle a) Inventory holding *300 days** sales

b) Trade debtors*300 days** (Preferably average outstanding in a year ) Sales/income

27

c) Trade creditors*300 days** (preferably average outstanding in a year ) Credit purchase of current assets (preferably average level in a year) ** computation based on 300 days in a year is advisable in Indian context keeping in the view the usual 52 weekly offs, national holidays,etc The expected level varies from case to case as stated above , however ,generally , the maximum level in terms of days may be between 90 and 120 . From the stress angle: (the Basel committee states : stress testing has been adopted as a generic term describing various technique used by banks to gauge their potential vulnerability to exceptional , but plausible, events.) Stress tested cash flow Debt payment +preference dividend+interest

For this purpose, cash flow would include only operating cash flow (ignoring investing cash flow @ financing cash flow). As a point of the stress testing scale, a reduction of a certain percentage in incomes/sales with the simultaneous increase in the expenses (for example. Direct costs etc ) may result in charge ( reduction) in cash flow . There is no minimum or maximum. The stress percentage depends upon the industry, operating envoirment and also the overall business envoirment at the time of analysis. The above cluster is only indicative of the ratios that a commercial bank/financial institution may find usefull from the credit risks evaluation angle. There, may be other important ratios as well, such as : 1) 2) 3) 4) Finished Good Holding Cash Flow Interest Coverage Capital Gearing Ratio Proprietary Ratio.

28

PRACTICAL IMPLICATION OF ACCOUNTING RATIO IN CREDIT RISKS EVALUATION


Accounting ratios are usually computed on the year end position of asset , liabilities, profit/loss account competent ( over a position of generally 12 months) as reflected in the financial statements . This is based on a going concern concept approach. However , one limitation here is that the static view of the asset liability at the end of the year may not reflect the true and correct position .the alternative is to collect the figures from the party concerned say , on a monthly basis( or as frequently as may be possible) and average the same on a 12 months basis . This may then, for credit risks evaluation process, be a more effective and dynamic tool . Irrespective of whether a bank financial institution follows the year end or average method of computation, the implication from the credit risks evaluation angle will depend upon: Adopting an appropriate credit rating system with generally a large number of grades , where one of the inputs would be accounting ratios. The bank/financial institution will have to decide as a matter of corporate finance policy the nature of the accounting ratio to be used for credit risk evaluation/( for example , there may be different focus in assessing working capital for loans for fixed asset or for non funded facilities/investment in securities, etc. Specific weight has to be allocated for accounting ratios (from the credit rating angle). Say,20 out of the total of 100 points for the entire credit rating structure . The benchmarking for each ratio should be consistent with the bank/financial institutions corporate finance policy. The maximum weight age for each component of the ratio should be fixed- say.4 out of 20 points (20 being the total for all accounting ratios put together) Ratios conforming to the benchmark should be awarded the highest points .those below the benchmark should be ranked with the varying points. Down to even zero. Total marks awarded for all adopted ratios should then be carried forward to the overall credit rating structure so as to arrive at final grade for each account /exposure. In sum, accounting ratios is inseparable arm of the credit risks evaluation and its actual implication will depends upon the purpose, quantum and tenure of the exposure on a case by case basiss

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ILLUSTRATION
Sunrise ltd, a company incorporated under the company act, is enjoying credit facilities from mega bank. The banks want to have the account rated using its credit rating model. the rating model comprises subjective and objective parameter . The banks has dedicated , well trained officer in its centralized credit analysis cell. The company manufactures seamless pipes/tubes used in industrial applications. It has a substantial export business in Europe and some African countries. The export business account for a major portion of its total turnover and contributes significantly to its bottom-line. The top management comprises technocrat with very rich and varied experience of at least 20 yrs in manufacturing and project implementation. The company is controlled by the miller group, which has 26% sharing in it , including the portion held by their close relatives. Reliable sources say there are some disputes regarding the sharing of property in the miller family. its most likely that the dispute has emerged due to the failer of a venture capital plan initiated by one of the brother of the family this involve substantial sums and could not take up due to the exact of strategic partner from the venture at the crucial time also sunrise limited has no secession plan . The financing banks (the company enjoys substantial credit facilities from the consortium) have objected to the deployment of funds without their prior permission for the expansion in to an unrelated area- a mini cement plant, which is incurring huge cash losses due to its uneconomic size. The group is keeping its fingure crosses as to whether it should continue with this business or dispose it off , even at the discounted price. Sunrise ltd. Has been constantly upgrading its system with the latest technology available across the world to cut costs and improve efficiency . The business is banking on getting huge orders so that the there is optimal utilization of facilities. Thus way they can keep margin at the minimum and make competitive price. But there are problems. Competitors are quite aggressive. Another major area of concern is its urgent need for backward integration into solids rods. The company is facing a problem getting clearance ( such as pollution due to certain chemical waste discharged during the process) and certain control mechanism have also to be put in place before seeking the necessary permission from the government for the expansion.. The company is ISO certified and was given the best corporate governance practice award last year by the manufacturer association. The operating result of last two years were as :

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Operating results sales Cost of sales Selling and admin. cost OPBDIT Interest cost depriciation Operating profit before tax Net non operating income Profit before tax Profit for tax Net profit ratio Growth in sales Growth in OPBDIT ROCE Total debt equity ratio Current ratio Debtor collection period ( days) Inventory holding period(days) Finished goods holding period(days) Creditors payment period (days) Cash flow DSCR Stress test cash flow DSCR Stress test flow interest coverage Level of contingent liability (cont liab/TNW)

31.03.03 355.42 314.91 7.04 33.47 16.47 1.62 15.38 3.66 19.04 1.28 17.76

31.03.04 388.53 351.24 5.83 31.46 15.25 1.56 14.65 1.59 16.24 1.45 14.79 9.31% -6.01% 11.71% 1.83 1.49 72 62 63 55 2.2 1.92 3 0.49

14.14% 2.04 1.42 95 63 50 60 2 1.8 2.78 0.5

31

A s s1 2 3 4 5 6 7 8 9 10 11 12 13 14

Objective parameters

Marks awarded based on

Marks obtained 0 Negative growth Negative growth =0% 3 times 1 times 1 120 days 100 days 90 days 75 days 1.5 1.75 1 1.5

Rating parameter Growth in sales Growth in operating profit (OPBDIT) Return on capital employed (ROCE) Total debt-equity ratio Current ratio Level of contingent liabilities (coverage) Debtors collection Inventory holding Finished goods holding Creditors payment period Cash flow DSCR Cash flow intersest coverage Stress tested CF DSCR Stress tested CF interest coverage

4 20% 5% 15% 2.25% 1.33% 0.5 times 45 days 45

3 1520% 4-5% 1115% 2.252.5 1.171.33 0.51.70 45-75 days 45-60

2 5-15% 2-4% 5-10% 2.52.75% 1-1.17 0.7-0.85 75-100 days 60-75 45-60 30-50 days 1.75-2.0 2.5-2.75 1.25-1.5 1.75-2

1 0-5% 0-2% 0-5% 2.75-3% 0.75-1 0.85-1 100-120 days 75-100 60-90 50-75 days 1.5-1.75 1.75-2.5 1-1.25 1.5-1.75

2 0 3 4 4 4 3 2 1 1 3 3 4 4 38

30days 30-45 20 days 2.25 3.5 1.75 2.25 20-30 days 2-2.25 2.753.5 1.51.75 2-2.25

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B subjective parameter

marks awarded based on

mar ks obta ined 0 Litigation /proceeding/n oncompliance Nil 2

Rating parameter 4 1 Laid down If regulatory complied framework, fully standard 2 Experience of Very top management good yrs Succession plan for top management Initiatives of management in new business areas Corporate governance Honoring financial commitments End use of funds Affiliate concern performance Cyclical/seasona l factors Characteristis of products of the comapny Threat of substitute m Well planned Success in initiative s Well devised & executed timely proper good low superior Very low/no threat

2 partially

Goo d (1015)

Moderate (5-10) adhoc Certain problems/delay s but executed moderate

Littl e (0.5)

No plan No initiative

0 2

No corporate governance Not honored Unauthorized diversion npa high inferior high

Delayed but honored Certain diversion with permission average moderate Same as other moderate

4 0 2 4 2 2

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Module A B

No Of Parameter 14 11 25 Marks Obtained 38 26

Max Marks 4 4 Max. Marks 56 44

Total Marks 56 44 100 Weight 60 40

Weight Assigned 60 40 100 Net Marks 40.71 23.64 A RATED ACCOUNT

A B

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MAJOR PLAYER IN CREDIT RATING & THEIR RESEARCH METHODOLOGY

CRISIL
INTRODUCTION: The rating industry in India was ushered in 1988 with the setting up of Credit Rating and Information Services of India Limited (CRISIL) followed by three more, the latest entirely devoted to rating NBFCs. The industry is sustained by mandatory requirement for rating debt instruments. Crisil was set up by ICICI and UTI in 1988. Standard and Poor rating service (S&P) has formed a strategic alliance in 1996 with CRISIL for providing analytical and business development co-operation. S&P will share with CRISIL its advanced rating methodologies and analytical criteria and assist on other aspects of credit rating agency operations. CRISIL would in turn offer business development assistance in India and insight into local debt market and issuers. The purchase by S&P of 6 lakhs shares in 1997 of CRISIL from Asian development Bank to acquire a stake of 9.6 % in CRISIL is a logical culmination of the strategic alliance into earlier. Asian Development Bank invested in 1988 in CRISIL as an effort to play a catalystic role in its establishment.

CRISIL RTAING METHODLOGY: The rating methodology followed by CRISIL involves an analysis of the following factors: i) BUSINESS ANALYSIS a) Industry risk, including analysis of the structure of the structure, the demandsupply position, a study of the success factors, the nature and basis of competition, the impact of government policies, cyclicity and seasonality of the industry. b) Market position of the company within the industry including market shares, product and customer diversity, competitive advantages, selling and distribution arrangements. 35

c) Operating efficiency of the company like locational advantages, labour relationships, technology, manufacturing efficiency as compared to competitors. d) Legal position including the terms of the prospectus, trustees and their responsibilities as systems for timely payments. ii) FINANCIAL ANALYSIS a) Accounting quality like any overstatement or understatement of profits, auditors qualification in their reports, methods of valuation of inventory, depreciation policy. b) Earnings protection in terms of future earning growth for the company and future profitability. c) Adequacy of cash flows to meet debt servicing requirements in addition to fixed and working capital needs. An opinion would be formed on the sustainability of the cash flows in the future and working capital management of the company. d) Financial flexibility including the companies ability to source funds from other sources like group companies, ability to defer capital expenditure and alternative financing plans in times of stress. iii) MANAGEMENT EVALUATION a) The quality and ability of the management would be judged on the basis of past track record, their goals , philosophies and strategies their ability to overcome difficult situations, etc. In addition to ability to repay, an assessment would be made of the managements willingness to pay debt. This would involve an opinion of the integrity of the management. Iv) FUNDAMENTAL ANALYSIS a) Capital adequacy, that is the true net worth as compared to the volume of business and risk profile of assets. b) Asset quality including the companies credit risk management, systems for monitoring credit, exposure to individual borrowers and management of problem credits. c) Liquidity management, Capital structure, term matching of assets and liabilities and policies on liquid assets in relation to financial commitments would be some of the areas examined. d) Profitability and financial position in terms of past historical profits, the spread on funds deployed and accretion to reserves. 36

e) Exposure to interest rate changes and tax law changes.

RATING PROCESS

CRISIL's rating process and rating committee are designed to ensure that all assigned ratings are based on the highest standards of independence and analytical rigor. The rating committee comprises members who have the professional competence to meaningfully assess the credit analysis that underlies the rating, and have no interest in the entity being rated. A team of analysts carries out the credit analysis . Each team has at least two members. CRISIL's analysis is based on issuer meetings and an understanding of the business environment. The analysis is carried out within the framework of clearly spelt-out rating criteria.

Rating Process Management Meeting Rating Committee and assignment of rating Confidentiality Advice to Issuer Publication Surveillance and Annual Review

CRISIL ensures confidentiality of the information obtained for the rating exercise by putting in place appropriate process safeguards. All CRISIL employees are required to sign a confidentiality agreement. CRISIL does not disclose confidential information that it has obtained for the purpose of credit rating to anyone (other than market regulators or law enforcement authorities, if required).

37

A detailed flow chart of CRISIL's rating process is as under :

38

CRISIL RATING SYMBOLS

Long Term Rating Scale: 1) High Investment Grades AAA Debentures rated `AAA' are judged to offer highest safety of (Triple A) Highest timely payment of interest and principal. Though the Safety circumstances providing this degree of safety are likely to change, such changes as can be envisaged are most unlikely to affect adversely the fundamentally strong position of such issues. AA (Double A) High Debentures rated 'AA' are judged to offer high safety of timely Safety payment of interest and principal. They differ in safety from `AAA' issues only marginally.

2) Investment Grades Debentures rated `A' are judged to offer adequate safety of timely payment of interest and principal; however, changes in circumstances can adversely affect such issues more than those in the higher rated categories.

A Adequate Safety BBB (Triple B) Moderate Debentures rated `BBB' are judged to offer sufficient safety of Safety timely payment of interest and principal for the present; however, changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal than for debentures in higher rated categories.

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3) Speculative Grades Debentures rated `BB' are judged to carry inadequate safety of BB timely payment of interest and principal; while they are less (Double B) susceptible to default than other speculative grade debentures in Inadequate Safety the immediate future, the uncertainties that the issuer faces could lead to inadequate capacity to make timely interest and principal payments. B High Risk Debentures rated `B' are judged to have greater susceptibility to default; while currently interest and principal payments are met, adverse business or economic conditions would lead to lack of ability or willingness to pay interest or principal Substanti C Substantial Risk Debentures rated `C' are judged to have factors present that make them vulnerable to default; timely payment of interest and principal is possible only if favourable circumstances continue. Debentures rated `D' are in default and in arrears of interest or principal payments or are expected to default on maturity. Such debentures are extremely speculative and returns from these debentures may be realized only on reorganisation or liquidation.

D In Default

As mentioned above CRISIL have ratings for the following: 1) Fixed Deposit Rating (Start From FAAA To FD) 2) Short Term Instruments Rating (Start From P-1 To P-5) 3) Structured Obligations Rating ( Strat From AAA To D(So) ) 4) Non Credit Risk Rating Scale ( Start From AAA To Dr) 5) Real Estate Developers/Projects Rating (Start From DA1 To DA5) 6) Rating Scales For Real Estate Projects ( Start From PA1 To PA5)

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LIMITATIONS OF CRISIL RATINGS

A Credit Rating from CRISIL is NOT

1) A general-purpose credit or performance evaluation of the rated entity: CRISIL Credit Ratings are always issue-specific 2) A recommendation to invest in, or not to invest in, any shares, debentures or other instruments issued by the rated entity, or derivatives thereof. 3) An opinion on associate, affiliate or group companies of the rated entity, or on promoters, directors or officers of the rated entity

4) A statutory or non-statutory audit of the rated entity 5) An indication of compliance or otherwise with legal or statutory requirements

CARE

41

Credit Analysis & Research Ltd. (CARE), incorporated in April 1993, is a credit rating, information and advisory services company promoted by Industrial Development Bank of India (IDBI), Canara Bank, Unit Trust of India (UTI) and other leading banks and financial services companies. In all CARE has 14 shareholders. CARE assigned its first rating in November 1993, and upto March 31, 2005, had completed 2875 rating assignments for an aggregate value of about Rs 4438 billion. CARE's ratings are recognised by the Government of India and all regulatory authorities including the Reserve Bank of India (RBI), and the Securities and Exchange Board of India (SEBI). CARE has been granted registration by SEBI under the Securities & Exchange Board of India (Credit Rating Agencies) Regulations,1999. The rating coverage has extended beyond industrial companies, to include public utilities, financial institutions, infrastructure projects, special purpose vehicles, state governments and municipal bodies. CARE's clients include some of the largest private sector manufacturing and financial services companies as well financial institutions of India. CARE is well equipped to rate all types of debt instruments like Commercial Paper, Fixed Deposit, Bonds, Debentures and Structured Obligations. CARE's Information and Advisory services group prepares credit reports on specific requests from banks or business partners, conducts sector studies and provides advisory services in the areas of financial restructuring, valuation and credit appraisal systems. CARE was retained by the Disinvestment Commission, Government of India, for assistance in equity valuation of a number of state owned companies and for suggesting divestment strategies for these companies. CREDIT RATING : RATING METHODOLOGY CARE undertakes rating exercise based on information provided by the company, inhouse database and data from other sources that CARE considers reliable. CARE does not undertake unsolicited ratings. The primary focus of the rating exercise is to assess future cash generation capability and their adequacy to meet debt obligations in adverse conditions. The analysis therefore attempts to determine the long-term fundamentals and the probabilities of change in these fundamentals, which could affect the credit-worthiness of the borrower. The analytical framework of CARE's rating methodology is divided into two interdependent segments. The first deals with the operational characteristics and the second with the financial characteristics. Besides quantitative 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 vary with the type of issuer. Rating determination is a matter of experienced and holistic judgement, based on the relevant quantitative and qualitative factors affecting the credit quality of the issuer. Key parameters considered in the rating exercise for industrial companies include the following : Economy and Industry Risks

42

CARE's rating analysis begins by assessing the characteristics of the industry/industries in which the borrower operates. Some important factors are: 1) Effect of economic cycles on the industry. 2) Business cycles in the industry and their severity. 3) Tariff structure, threat from imports, price competitiveness of the domestic industry, and pace of technological change. 4) Basis of competition and key success factors.

5) Structure of the industry; entry and exit barriers. 6) Environmental and political factors.

Business Risks Against the backdrop of the issuer's industry, CARE then assesses the issuer's strengths and weaknesses vis-a-vis its competitors. Factors considered include: 1) 2) 3) 4) . 5) 6) Diversification of income sources. Technology. Size of the company and market share. Locational advantages and disadvantages. Supply of raw materials and marketing arrangements. Bargaining power of the issuer's suppliers and customers

Financial Risk 1) Financial management philosophy and track record (capital structure, profitability, liquidity position, financial flexibility and cash flow adequacy). 2) Financial projections (with particular emphasis on achievability of sales targets, the components of cash flow and ability to meet debt obligations as and when they fall due). 3) Free cash flows and their sensitivity to various economic, industrial and business risks over the term of the instrument. 4) 5) Inter-firm comparison of the financial structure and profitability margins. Accounting policies and practices.

43

Management Assessment 1) 2) 3) 4) Background and history of the issuer. Corporate strategy and philosophy. Quality of management and management capabilities under stress. Organizational structure, personnel policies including succession planning .

Instrument Terms Rating may vary according to such factors as: 1) Maturity of instrument.

2) Nature of security - secured or unsecured, senior or subordinated, covenants and other provisions that may reduce the amount of recovery in case of default. 3) 4) 5) 6) . The criteria discussed above are specific to industrial companies. Credit rating methodology for banks, financial institutions and non-banking finance companies, in addition to some factors discussed above, focuses on the CRAMEL model: Capital adequacy Resource raising ability Asset quality Management quality Earnings quality Liquidity Repayment terms - moratorium period, repayment in instalments or bullet repayment etc. Coupon rates - floating, fixed, zero coupon etc. Options - conversion into equity, put and call options etc. Credit Reinforcements through guarantees or the backing of financial assets

CREDIT RATING : RATING SYMBOLS AND DEFINITION

44

CARE'S

RATING

DEFINITIONS

A. Long Term & Medium Term Instruments Symbols Definition

Instruments carrying this rating are considered to be of the best CARE AAA quality, carrying negligible investment risk. Debt service payments CARE AAA are protected by stable cash flows with good margin. While the (FD)/(CD)/(SO)/ underlying assumptions may change, such changes as can be (CPS)/(RPS) visualized are most unlikely to impair the strong position of such instruments. Instruments carrying this rating are judged to be of high quality by all CARE AA standards. They are also classified as high investment grade. They are CARE AA rated lower than CARE AAA securities because of somewhat lower (FD)/(CD)/(SO)/ margins of protection. Changes in assumptions may have a greater (CPS)/(RPS) impact or the long-term risks may be somewhat larger. Overall, the difference with CARE AAA rated securities is marginal. Instruments with this rating are considered upper medium grade CARE A instruments and have many favorable investment attributes. Safety for CARE A principal and interest are considered adequate. Assumptions that do (FD)/(CD)/(SO)/ not materialise may have a greater impact as compared to the (CPS)/(RPS) instruments rated higher. Such instruments are considered to be of investment grade. They CARE BBB indicate sufficient safety for payment of interest and principal, at the CARE BBB time of rating. However, adverse changes in assumptions are more (FD)/(CD)/(SO)/ likely to weaken the debt servicing capability compared to the higher (CPS)/(RPS) rated instruments. CARE BB Such instruments are considered to be speculative, with inadequate CARE BB protection for interest and principal payments. (FD)/(CD)/(SO)/ CARE B Instruments with such rating are generally classified susceptible to CARE B default. While interest and principal payments are being met, adverse (FD)/(CD)/(SO)/ changes in business conditions are likely to lead to default. (CPS)/(RPS) CARE C Such instruments carry high investment risk with likelihood of default CARE C in the payment of interest and principal. (FD)/(CD)/(SO)/ (CPS)/(RPS) CARE D Such instruments are of the lowest category. They are either in default CARE D or are likely to be in default soon. (FD)/(CD)/(SO)/ (CPS)/(RPS) FD Fixed Deposit

45

CD SO CPS RPS

Certificate of Structured Convertible Preference Redeemable Preference Shares

Deposit Obligations Shares

B. Short Term Instruments Symbols PR 1 Definition Instruments would have superior capacity for repayment of short-term promissory obligations. Issuers of such instruments will normally be characterized by leading market positions in established industries, high rates of return on funds employed etc. Instruments would have strong capacity for repayment of short- term promissory obligations. Issuers would have most of the characteristics as for those with PR-1 instruments but to a lesser degree. Instruments have an adequate capacity for repayment of short- term promissory obligations. The effect of industry characteristics and market composition may be more pronounced. Variability in earnings and profitability may result in changes in the level of debt protection. Instruments have minimal degree of safety regarding timely payment of short-term promissory obligations and the safety is likely to be adversely affected by short-term adversity or less favorable conditions. The instrument is in default or is likely to be in default on maturity.

PR 2

PR 3

PR 4 PR 5

C. Credit Analysis Rating Symbols CARE 1 CARE 2 Definition Excellent debt management capability. Such companies will normally be characterized as leaders in the respective industries. Very good debt management capability. Such companies would be regarded as close to those rated CARE-1, but with a lower capability to withstand changes in assumptions. Good capability for debt management. Such companies are considered medium grade; assumptions that do not materialize may impair debt management capability in future. Barely satisfactory capability for debt management. The capacity to meet obligations is likely to be adversely affected by short- term adversity or less favorable conditions. Poor capability for debt management. Such companies are in default or are likely to default in meeting their debt obligations.

CARE 3

CARE 4 CARE 5

46

D. Long Term Loans Symbols Definition

Loans carrying this rating are considered to be of the best quality, carrying negligible investment risk. Debt service payments are protected by stable cash flows with good margin. While the CARE AAA (L) underlying assumptions may change, such changes as can be visualised are most unlikely to impair the strong position of such loans. Loans carrying this rating are judged to be of high quality by all standards. They are also classified as high investment grade. They are rated lower than CARE AAA loans because of somewhat lower CARE AA (L) margins of protection. Changes in assumptions may have a greater impact or the long-term risks may be somewhat larger. Overall, the difference with CARE AAA rated loans is marginal. Loans with this rating are considered upper medium grade and have many favourable investment attributes. Safety for principal and CARE A (L) interest are considered adequate. Assumptions that do not materialise may have a greater impact as compared to the loans rated higher. Such loans are considered to be of investment grade. They indicate sufficient safety for payment of interest and principal, at the time of CARE BBB (L) rating. However, adverse changes in assumptions are more likely to weaken the debt servicing capability compared to the higher rated loans. Such loans are considered to be speculative, with inadequate CARE BB (L) protection for interest and principal payments. CARE B (L) Loans with such rating are generally classified susceptible to default. While interest and principal payments are being met, adverse changes in business conditions are likely to lead to default. Such loans carry high investment risk with likelihood of default in the CARE C (L) payment of interest and principal. Such loans are of the lowest category. They are either in default or are CARE D (L) likely to be in default soon.

E. Short Term Loans Symbols PL 1 PL 2 Definition Superior capacity for repayment of interest and principal on the loan. Strong capacity for repayment of interest and principal on the loan. They are rated lower than PL-1 because of somewhat lower margins of protection. Changes in assumptions may have a greater impact.

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PL 3

PL 4 PL 5

Adequate capacity for repayment of interest and principal on the loan. Variability in earnings and profitability may result in significant changes in the level of debt servicing capability. The effect of industry characteristics may be more pronounced. Minimal degree of safety regarding timely payment of interest & principal and the safety is likely to be adversely affected by short-term adversity or less favourable conditions. The loan is in default or is likely to be in default on maturity.

As instruments characteristics/loan characteristics or debt management capability could cover a wide range of possible attributes whereas rating is expressed only in limited number of symbols, CARE assigns '+' or '-' signs to be shown after the assigned rating (wherever necessary) to indicate the relative position within the band covered by the rating symbol. F : Performance Rating of Parallel Marketers These ratings are on a scale of 1 to 4 1-Good 2-Satisfactory 3-Low Risk 4-High Risk G : Collective Investment Schemes Symbols CARE 1 (CIS) Definition Schemes carrying this rating are considered to be very strong, with high likelihood of achieving their objectives and meeting the obligations to investors. Schemes carrying this rating are considered to be strong, with adequate likelihood of achieving their objectives and meeting the obligations to investors. They are rated lower than CARE 1 (CIS) rated schemes because of relativesly higher risk. Such schemes are considered to have adequate strengths for achieving their objectives and meeting the obligations to investors. They are considered to be investment grade. Schemes carrying this rating are considered to have inadequate capability to achieve their objectives and meet the obligations to investors. They are considered to be speculative grade. Such schemes are considered weak and are unlikely to achieve their objectives and meet their obligations to investors. They have either failed or are likely to do so in the near future.

as

notified

by

Govt.

of

India.

CARE 2 (CIS)

CARE 3 (CIS)

CARE 4 (CIS)

CARE 5 (CIS)

CREDIT RATING : RATING PROCESS

48

The rating process takes about three to four weeks, depending on the complexity of the assignment and the flow of information from the client. Rating decisions are made by the Rating Committee. Client Requests for rating Submits information and detailed schedules Care 1. Assigns rating team 2. The team analyses the information.

Interacts with the team, responds to queries 3. The team interacts with clients, raised and provides any additional data undertakes site visits, and analyses data necessary for the analysis submitted by the client 4. Internal committee previews analysis. 5. RATING COMMITTEE awards rating to client Accepts rating * , ** 6. Notification in press 7. Periodic Surveillance * : Client may ask for a review of the rating assigned and furnish additional information for the purpose. ** : Client has option not to accept the final rating in which case, CARE will not publish the rating or monitor it.

NEW CONCEPT AND OVERVIEW OF INDIAN CREDIT RATING AGENCY ( SMEs RATING)

SMERA

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SMERA is the country's first rating agency that focuses primarily on the Indian SME segment. SMERA's primary objective is to provide ratings that are comprehensive, transparent and reliable. This would facilitate greater and easier flow of credit from the banking sector to SMEs. SME Rating Agency of India Limited (SMERA) is a joint initiative by SIDBI (www.sidbi.in), Dun & Bradstreet Information Services India Private Limited (D&B) (www.dnb.co.in), Credit Information Bureau (India) Limited (CIBIL) (www.cibil.com) MEANING :
1)

2)

3) 4) 5)

SMERA Rating is an independent third-party comprehensive assessment of the overall condition of the SME, conducted by SME Rating Agency of India Limited It takes into account the financial condition and several qualitative factors that have bearing on credit worthiness of the SME SMERA Rating consists of 2 parts,a Composite Appraisal/Condition indicator and a size indicator SMERA Rating categorises SMEs based on size, so as to enable fair evaluation of each SME amongst its peers An SME unit having SMERA Rating would enhance its market standing amongst trading partners and prospective customers

SMERA FEATURES : SMERA is the only rating agency dedicated to SMEs and its rating model takes into consideration financial and non-financial factors for assigning rating to a SME unit. SMERA ratings will also factor-in payment score obtained from CIBIL indicating the payment track record of the SME unit being rated. Dun & Bradstreets expertise on rating SME units is also an important factor that distinguishes SMERA rating from any other ratings

ELIGIBILITY OF SMEs All types of SMEs including manufacturing, service sector, trading etc can approach SMERA directly or through the banks for a rating from SMERA. However, NBFCs/finance companies/Nidhis/chit funds etc., are not rated by SMERA.

TIME VALIDITY OF RATING

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The rating certificate issued by SMERA is based on the latest financial statement available, the site visit report and management interview carried out as on a recent date. Thus, the validity of SMERA rating of an SME unit is as on a given date and based on the assumption of a going concern.

SMERA RATING METHODOLOGY & RATING SCALE

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LIMITATIONS OF CREDIT RATING - RATING DOWNGRADES

Rating agencies all across the world have often been accused of not being able to predict future problems. In part, the problem lies in the rating process itself, 52

which relies heavily on past numerical data and standard ratios with relatively lower usage of judgment and understanding of the underlying business or the country economics. Data does not always capture all aspects of the situation especially in the complex financial world of today. An excellent example of the meaningless over reliance on numbers is the poor country rating given to India. Major rating agencies site one of the reasons for this as the low ratio Indias exports to foreign currency indebtedness. This completely ignores two issues firstly, India gets a very high quantum of foreign currency earnings through remittances from Indians working abroad and also services exports in the form of software exports which are not counted as "merchandise" exports. These two flows along with other "invisible" earnings accounted for almost US$11bn in FY 99. Secondly, since India has tight control on foreign currency transactions, there is very little error possible in the foreign currency borrowing figure. As against this, for a country like Korea, the figure for foreign currency borrowing increased by US$50bn after the exchange crisis began. This was on account of hidden forward liabilities through swaps and other derivative products. In general, Indian rating agencies have lost some amount of their credibility in the last two years due to their inability to predict defaults in many companies, which they had rated quite highly. Sometimes, some of the agencies had an investment grade rating in place when the company in question had already defaulted to some of the fixed deposit holders. Further, rating agencies resorted to mass downgrading of 50-100 companies as a reaction to public criticism, which further eroded their credibility. The major reasons for these downgrades are as follows : 1) Biased raiting and misrepresentation: In the absence of quality ratings , credit rating is a curse for capital market industry. To avoid biased rating ,the expert in rating agency ,carrying out detaild analysisi of the company , should have no links with the company or the persons intersete din the company so that they can make their report impartial and judicious recommendation for rating committee. 2) Static study : Rating is done on the present and the past historical data of the company and this is only a sttsic study . prediction of the company health through rating is momentary and anything can happen after assignment of rating sybols to the company .dependence for the future result on the rating,therefore defeat the vary purpose of the risk indicative of the rating. 3) Concealment of material information : Rating company might conceal material information from the investigating team of the credit rating company, in such cases quality of rating suffer and renders the rating reliable.

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4) Rating is no guarantee for soundness of the company : Rating is done for a particular instrument to assess the credit risk but it should not be considered as a certificate for matching quality of the company or its management. 5) Human bias :

Finding of the investigation team at times may suffer from with the human bias for unavoidable personal weakness of the staff and might effect the rating . 6) Down grade:

Once the company has been rated and if it is not able to maintain its working result and performance ,credit rating agency would review the grade or downgrade the rating resulting into impairing the image of the company . 7) Validity of rating

Validity of the rating ends with the maturity of a debt instrument and its no longer subsequently benefits the issuer company becsuse the rating is valid for the life time of the debt instrument being rated .

8)

Difference in rating of two agencies:

Rating done by two different credit rating agencies for the same instrument of the same issuer company in many cases would not be identical. Such difference is likely to occur because of the because of the value judgment differences on qualitative aspect of the analysis in two different rating agencies whereas quantitative analysis might be the same and identical .

Limitations cont
Corporate earnings fell very sharply due to persistent recessionary conditions prevailing in the economy. Many of the corporate are in commodity sectors where fluctuations in selling prices of products can be very sharp - leading to complete erosion of profitability. 54

This problem was compounded by the Asian crisis, which led to increased competition from cheap imports in many product categories. Rating agencies substantially overestimated financial flexibility of corporate especially from traditional corporate houses. Much of the financial flexibility was implicit on raising money from new issues from the capital market, which has been impossible in the last 3 years. In the case of finance companies, widespread defaults like CRB and tightening of regulations made it virtually impossible for them to raise money in any form. These finance companies had been in the habit of investing in longer term, illiquid assets by borrowing shorter term fixed deposits. When the flow of credit stopped, they faced liquidity problems. These were further compounded by defaults by some of the companies to which they had on lent money. The experience is no different from the international scenario where reputed and highly experienced rating agencies like Standard & Poor (S&P) and Moodys were unable to predict the Asian crisis and had to face the embarrassment of seeing the credit rating of South Korea as a country go from A+ to BB+ in a short span of 3 months. By and large, the rating is a very good estimate of the actual creditworthiness of the company; however, it is not able to predict extreme situations such as the ones described above, which are unlikely to have been predicted by most investors in any case. Investors should realize that a credit rating is not sacrosanct and that one has to do ones own due diligence and investigation before investing in any instrument. They should use the rating as a reference and a base point for their own effort. One good way of doing this is examining the behavior of the stock price in case the stock is listed. As a collective, the market is far smarter at predicting problems than any credit rating agency. Witness the sharp erosion in stock prices of companies much before their credit ratings were downgraded. Witness also the fact that foreign currency bonds from Indian issuers trade at yields lower than countries which have been rated higher by rating agencies.

Code of Ethics to be followed by Rating Agencies

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Member Credit Rating Agencies shall put in place systems and procedures to ensure the following : 1) The proceedings of a credit rating board / rating committee, are kept confidential at all times, and not revealed to any external parties or agencies. If any records of the proceedings are made, credit rating agencies must take steps to keep such records properly safeguarded, except where required to be disclosed by the provisions of laws or regulations. 2) When the credit rating board decides on a rating, it shall be announced as a joint decision and the individual votes shall be kept confidential, even if recorded. This requirement of confidentiality shall apply to rating board members for their own votes as well.

Member Credit Rating Agencies shall put in place systems and procedures to ensure the following : 1) When and after a credit rating board / rating committee member or credit rating agency employee terminates his/her employment or work association with the rating agency, the requirement of confidentiality with respect to the information received during the period of work association shall continue as information held in trust. 2) A credit rating board / rating committee member does not take undue material advantage of any confidential information received through his or her participation in a credit rating process. Persons involved in the ratings process should also be made vigilant to prevent abuse of prior knowledge of ratings changes.

FREQUENTLY ASKED QUESTIONS

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1) What is credit rating? Credit rating is, essentially, the opinion of the rating agency on the relative ability and willingness of the issuer of a debt instrument to meet the debt service obligations as and when they arise.

2) Why do rating agencies use symbols like AAA, AA, rather than give marks or descriptive credit opinion? The great advantage of rating symbols is their simplicity, which facilitates universal understanding. Rating companies also publish explanations for their symbols used as well as the rationale for the ratings assigned by them, to facilitate deeper understanding.

3) Why is credit rating necessary at all? Credit rating is an opinion expressed by an independent professional organisation, after making a detailed study of all relevant factors. Such an opinion will be of great assistance to investors in making investment decisions. It also helps the issuers of debt instruments to price their issues correctly and to reach out to new investors. Regulators like Reserve Bank of India (RBI) and Securities & Exchange Board of India (SEBI) often use credit rating to determine eligibility criteria for some instruments. For example, the RBI has stipulated a minimum credit rating by an approved agency for issue of Commerce Paper. In general, credit rating is expected to improve quality consciousness in the market and establish, over a period of time, a more meaningful relationship between the quality of debt and the yield from it. Credit Rating is also a valuable input in establishing business relationships of various types.

4) Does credit rating constitute an advice to the investors to buy? It does not. The reason is that some factors, which are of significance to an investor in arriving at an investment decision, are not taken into account by rating agencies. These

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include reasonableness of the issue price or the coupon rate, secondary market liquidity and pre-payment risk. Further, different investors have different views regarding the level of risk to be taken and rating agencies can only express their views on the relative risk.

5) What kind of responsibility or accountability will attach to a rating agency if an investor, who makes his investment decision on the basis of its rating, incurs a loss on the investment? A credit rating is a professional opinion given after studying all available information at a particular point of time. Nevertheless, such opinions may prove wrong in the context of subsequent events. Further, there is no privity of contract between an investor and a rating agency and the investor is free to accept or reject the opinion of the agency. Nevertheless, rating is essentially an investor service and a rating agency is expected to maintain the highest possible level of analytical competence and integrity. In the long run, the credibility of a rating agency has to be built, brick by brick, on the quality of its services.

6) Do rating companies undertake unsolicited ratings? Not in India, at least not yet. There is however, a good case for undertaking unsolicited ratings. It will be relevant to mention here that 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. Co-operation from the issuers as well as their willingness to share even confidential information are important prerequisites. On its part, the rating agency has a great responsibility to ensure confidentiality of the sensitive information that comes into its possession during the rating process.

7) How reliable and consistent is the rating process? How do rating agencies eliminate the subjective element in rating? To answer the second question first, it is neither possible nor even desirable, to totally eliminate the subjective element. Rating does not come out of a pre-determined

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mathematical formula, which fixes the relevant variables as well as the weights attached to each one of them. Rating agencies do a great amount of number crunching, but the final outcome also takes into account factors like 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 professionals with impeccable credentials. Rating agencies also ensure that the rating process is insulated from any possible conflicts of interest.

8) Is it customary to have the same issue rated by more than one rating agency? Do the ratings for the same instrument vary from agency to agency? The answer to both the questions is yes. 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 the opinions given by two or more agencies will vary, in some cases. But it will be very unusual if such differences are very wide. For example, a debt issue may be rated DOUBLE A PLUS by one agency and DOUBLE A or DOUBLE A MINUS by another. It will indeed be unusual if one agency assigns a rating of DOUBLE A while another gives a TRIPLE B.

9) Why do rating agencies monitor the issues already rated? A rating is an opinion given on the basis of information available at a particular point of time. As time goes by, many things change, affecting the debt servicing capabilities of the issuer, one way or the other. It is, therefore, essential that as a part of their investor service, rating agencies monitor all outstanding debt issues rated by them. In the context of emerging developments, the rating agencies often put issues under creditwatch and upgrade or downgrade the ratings as and when necessary. Normally, such action is taken after intensive interaction with the issuers.

10) Are all ratings published? In India, ratings are undertaken only at the request of the issuers and only those ratings, which are accepted by the issuers, are published. But there is a view that the rating agencies should publish all ratings, even those found unacceptable by the issuers. This is

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a matter for further discussion, so that a generally acceptable industry practice emerges. Once a rating is accepted, it will be 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.

11) Do issuers have a right of appeal against a rating assigned? Yes. In a situation where an issuer is unhappy with the rating assigned, he may request for a review, furnishing additional information, if any, considered relevant. The rating agency will, then, undertake a review and thereafter indicate its final decision. Unless the rating agency had overlooked critical information at the first stage, (which is unlikely), chances of the rating being changed on appeal are rare.

12) How much time does rating take? 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 and a rating agency may take six to eight weeks or more to arrive at a decision. The time taken may be somewhat less say, three or four weeks, for rating short term instruments like commercial paper, as the focus will be more on short term liquidity rather than on long term fundamentals. It is of paramount importance to rating companies to ensure that they do not, in any way, compromise on the quality of their analysis, under pressure from issuers for quick results. Issuers would also be well advised to approach the rating agencies sufficiently in advance so that issue schedules can be adhered to.

13) Is it possible that not satisfied with the rating assigned by one rating agency, an issuer approaches another, in the hope of getting a better result? It is possible, but rating companies do not and should not indulge in competitive generosity. Any attempt by issuers to play one agency against another will have to be

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discouraged by all the rating companies. It may, however, be pointed out here that two rating companies may, and often do, arrive at different conclusions on the same issue. This is only natural, as perceptions differ.

14) Who rates the rating companies? Informed public opinion will be the touchstone on which the rating companies have to be assessed and the success of a rating agency should be measured by the quality of the services offered, consistency and integrity.

15) Is the rating assigned for an instrument or for the Issuer Company? The rating is for a particular issue and not for a company. It is, therefore, 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 carry the highest rating even as the long term debt of the same issuer may be assigned a rating several levels below the highest rating. This is only natural, as the risk profile changes very dramatically for longer maturities. It is, however, not unusual for lenders and business counterparties to consider the long term bond rating as a rating of the issuer.

16) Why are equity shares not rated? 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 in the conventional sense does not apply to equity shares.

17) In what way is a credit rating different from an analysis by any financial analyst? Credit rating is essentially, business analysis, which has a much broader connotation than financial analysis. One significant factor, which adds value to the analysis of a rating

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agency, is that the rating is normally done at the request of and with the active cooperation of the issuer. So, 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. The rating agencies also make necessary adjustments to published accounts for the purpose of their analysis and juxtapose the issuer against the backdrop of the industry in question and the general economic environment. And, at the culmination of this detailed process, the rating emerges as the well considered view of a dozen or more highly qualified and experienced professionals. The rating agencies zealously safeguard their independence and scrupulously avoid any conflict of interest with the various players in the capital market. If any analyst or group of analysts is able to ensure all these, we probably have another rating agency in the making.

18) Are rating standards specific for each country? If CARE gives AAA and if S&P assigns AAA, are they at the same level? CARE rates only Rupee denominated debt while S&P rates debt of any currency. A CARE AAA rating indicates that the companys rupee debt stands in good comparison to debt issued by the Government of India (considered safest relatively) and is considered to be of the best quality. The sovereign ceiling, if any, does not apply. However, all S&P ratings will have a cap in the form of the rating ceiling for a particular currency denominated debt.

19) If a rating is downgraded, how would it "benefit" (or compensate ) the investor? A credit rating is a professional opinion on the ability and willingness of an issuer to meet debt-servicing obligations. It is an opinion on future debt servicing capabilities given on the basis, inter-alia, of past performance and all available information (from audited financial statements, company management, banks and financial institutions, statutory auditors, etc.) at a particular time. While rating agencies make all possible efforts to project corporate business prospects, industry trends and management capabilities, many events are unpredictable. Hence, such opinions may prove wrong in the context of subsequent events. On the occurrence of such an event, a rating agency can only review and make appropriate changes in the rating. Moreover, when there are recessionary trends in certain segments of the economy, companies in such segments or with large exposures to such segments are adversely affected and their credit ratings get downgraded. Such downgradations are a natural consequence of the recessionary trends. In other words, credit quality (and credit rating) is dynamic, not static and all rating agencies review their ratings periodically and make changes, wherever considered appropriate. Such changes are reported widely through the media. It is the experience of all rating agencies that

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some instruments initially rated as investment grade fall below investment grade or go into default, over a period of time. Further, it must be noted that there is no privity of contract between an investor or a lender and a rating agency and the investor is free to accept or reject the opinion of the agency. A credit rating is not an advice to buy, sell or hold securities or investments and investors are expected to take their investment decisions after considering all relevant factors and their own policies and priorities. A credit rating is not a guarantee against future losses. Please also note that credit ratings do not take into account many aspects which influence investment decisions. They do not, for example, evaluate the reasonableness of the issue price, possibilities for capital gains or take into account the liquidity in the secondary market. Ratings also do not take into account the risk of prepayment by issuer, or interest or exchange risks. Although these are often related to the credit risk, the rating essentially is an opinion on the relative quality of the credit risk, based on the information available at a given point of time.

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CONCLUSION
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 to 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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BIBLIOGRAPHY
BOOKS 1) CREDIT RATING DR. JC VERMA.

WEBSITES
1) www.crisil.com 2) www.icra.com 3) www.careratings.com

NEWS PAPER1) ECOMICTIMES 2) BUSINESS STANDARD

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