UNIVERSITY OF THE PUNJAB

CREDIT RISK MANAGEMENT AND CREDIT RATING

SUBMITTED TO: Ms. Sahar Butt SUBMITTED BY: Group: Sana Javaid (BC09-070) Saira Khan (BC09-067) Sadia Khalid (BC09-069) Sana Afzal (BC09-065) Rabia Pervaiz (BC09-068) Haffsa Idrees (BC09-061)

Class: B.Com. (Hons.) Semester: 7 Section: A (Morning)

Subject Code: F2

Table of Contents
INTRODUCTION ....................................................................................................................... 3 Credit risk Management: .............................................................................................. 3 Credit Rating: ............................................................................................................... 3

CREDIT RISK MANAGEMENT .................................................................................................. 3 Credit Risk .............................................................................................................................. 3 Types of Credit Risk ............................................................................................................ 4 Impact and Probability of Credit Risk .................................................................................. 4 Principles of Effective Credit Risk Management ..................................................................... 5 Credit Risk Management Process .......................................................................................... 6 CREDIT ANALYSIS................................................................................................................ 7 Debt Service Coverage Ratio .............................................................................................. 7 CREDIT RISK ANALYSIS METRICS...................................................................................... 8 The Five Cs of Credit Analysis ............................................................................................ 8 BASIC TERMINOLOGIES ...................................................................................................... 9 CREDIT ASSESSMENT ..................................................................................................... 9 CREDIT CRUNCH .............................................................................................................. 9 CREDIT EXPOSURE .......................................................................................................... 9 Credit rating ..............................................................................................................................10 Credit Rating Scale................................................................................................................10 Investment Grade ..............................................................................................................11 Speculative grade ..............................................................................................................11 International Short-term Credit Ratings..................................................................................13 Credit Report ............................................................................................................................15 Credit Reporting ....................................................................................................................15 Working Of Credit Reporting Companies ...............................................................................15 Credit Rating Agency.............................................................................................................16 International Credit Rating Agencies ..................................................................................16 Local and International Credit Rating Agencies ..................................................................16 TOP 4 INTERNATIONAL CRS .............................................................................................18 1. MOODYS ...................................................................................................................18

2 2. Standard & Poors ..........................................................................................................19 3. Fitch ...............................................................................................................................20 4. DBRS ..........................................................................................................................21 PACRA ..................................................................................................................................24 INTRODUCTION ...............................................................................................................24 PRODUCTS OFFERED: ....................................................................................................24 RATING MATRIX ...............................................................................................................25 RESEARCH .......................................................................................................................25 PACRAS RATING .............................................................................................................26 FUND STABILITY RATINGS .............................................................................................27

CREDIT RISK MANAGEMENT AND CREDIT RATING

INTRODUCTION
Every day, among the millions of businesses that operate in every corner of the world, billions of dollars in cash are loaned, and goods and services worth billions more are provided on credit. While financial institutions have faced difficulties over the years for a multitude of reasons, the major cause of serious financial problems continues to be directly related to lax credit standards for borrowers and counterparties, poor portfolio risk management, or a lack of attention to changes in economic or other circumstances that can lead to a deterioration in the credit standing of institutions counterparties. Commercial lending continues to present significant challenges with respect to the effective measurement, monitoring, and control of credit risk exposures. In addition to this, to keep this high level of commercial activity moving smoothly, companies must have a commonly accepted method for evaluating the creditworthiness of commercial enterprises. It is impossible for individual companies to make credit determinations on every trading partner. The solution is to use effective Credit Risk Management and Business Credit Ratings. Credit risk Management: Credit Risk Management is a tool to control the risk level and to reduce the risk/return ratio in the credit portfolio. Credit risk management is done on two levels: basic and advanced. i Credit Rating: A credit rating evaluates the credit worthiness of a debtor, especially a business (company) or a government. It is an evaluation made by a credit rating agency of the debtor's ability to pay back the debt and the likelihood of default. These are determined by credit rating agencies.ii

CREDIT RISK MANAGEMENT

The goal of credit risk management is to maximize an institutions risk -adjusted rate of return by maintaining credit risk exposure within acceptable parameters. Financial institutions need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credits or transactions. They should also consider the relationships between credit risk and other risks. The effective management of credit risk is a critical component of a comprehensive approach to risk management and essential to the long-term success of any organization.

Credit Risk

4 It is a risk of loss of principle or loss of financial reward arising from a borrowers failure to repay a loan or meet a contractual obligation. Credit risk is most simply defined as the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms. Types of Credit Risk iii There are two main types of credit risk: 1) Credit spread risk: Credit spread risk is exhibited by portfolios for which the credit spread is traded marked-to-market. Changes in observed credit spreads impact the value of these portfolios. Credit spread risk is the risk of financial loss owing to changes in the level of credit spreads used in the mark-to-market of a product.

Credit default risk: Credit default risk is the risk that an obligor is unable to meet its financial obligations. In the event of a default of an obligor, a firm generally incurs a loss equal to the amount owed by the obligor less a recovery amount which the firm recovers as a result of foreclosure, liquidation or restructuring of the defaulted obligor. All portfolios of exposures exhibit credit default risk, as the default of an obligor results in a loss. Impact and Probability of Credit Risk In assessing credit risk from a single counterparty, an institution must consider three issues:
iv Default probability: What is the likelihood that the counterparty will default on its obligation either over the life of the obligation or over some specified horizon, such as a year? Calculated for a one-year horizon, this may be called the expected default frequency.

Credit exposure/ Impact: In the event of a default, how large will the outstanding obligation be when the default occurs? Recovery rate: In the event of a default, what fraction of the exposure may be recovered through bankruptcy proceedings or some other form of settlement? o o Low probability and impact indicate a Low-level risk. High probability and low impact indicate a Medium-level risk. Low probability and high impact indicate a High-level risk. High probability and high impact indicate a Critical Risk.
Figure 1

Principles of Effective Credit Risk Managementv

The following are what are considered to be the nine principle components necessary to conduct safe and sound lending activities and to ensure for an effective credit risk management program: 1. Credit Risk Appetite - Establishing a well-defined credit risk appetite for your institution is the critical first step toward an effective lending and credit risk management program. 2. Underwriting Criteria - Establishing equally well-defined underwriting criteria which includes both quantitative (objective) and qualitative (subjective) factors and provides the foundation upon which the institution can build a quality loan portfolio consistent with its risk appetite. 3. Credit Analysis - Conducting a thorough and appropriate (i.e., CRE vs. C&I) analysis of credit risk at the approval phase and throughout the life of a loan is critical to ensuring that lending decisions are made according to the institutions risk appetite and underwriting criteria. The analysis should include both quantitative (objective) and qualitative (subjective) factors. 4. Credit Risk Rating Methodology - Adopting a clear and concise credit risk rating methodology which similarly includes both quantitative (objective) and qualitative (subjective) factors provides for the effective grading of credit risk across the loan portfolio. It is also the basis upon which proactive and effective measurement, monitoring, and control of credit risk exposure can be built. 5. Loan Review - In order to ensure that loans have been appropriately risk rated, a periodic assessment of the credit risk of each loan should be performed. This review should be independent from the lending area and be conducted with an appropriate scope of coverage (in terms of both number of loans and outstanding balances) and frequency. 6. Loan Monitoring/Management - Once a loan has been originated it becomes a living, breathing organism of credit risk which must be proactively and appropriately monitored throughout its life. Receipt and analysis of updated financial information on the borrower and guarantors (if any), as well as the periodic assessment of collateral coverage, is key for ensuring that the level of credit risk is effectively measured, monitored, and controlled from origination through maturity. 7. Portfolio Monitoring and Reporting - Similarly to the measurement, monitoring, and management of credit risk at the individual loan level, doing so at the portfolio level provides for an aggregate perspective on overall credit risk across the portfolio, particularly in terms of concentrations by loan, borrower, industry type, product/commodity type, and/or geographical location, as well as the aggregate level of exposure to related borrowers.

6 8. Stress Testing - As the loan portfolio grows in terms of both number and variety, stress testing on both a loan-by-loan basis and at the portfolio level becomes increasingly important to measure the overall credit risk exposure inherent in the loan portfolio and the potential increase or decrease due to changes in key factors (i.e., interest rates, cap rates, net operating income, etc.). 9. Allowance for Loan and Lease Losses (ALLL) - A clearly defined loan loss reserve methodology that is consistent with applicable regulatory guidelines and Generally Accepted Accounting Principles (GAAP) is critical towards protecting the institution from credit losses. All of the above components should be incorporated into a comprehensive set of policies and procedures covering all aspects of the lending and credit risk management program.

Credit Risk Management Process

It involves four major steps: 1) Risk Identification: It can be done by gathering data from a) Balance sheets (Non-performing loans, capital, reserves, etc) b) Call and thrift financial reports/ income statements 2) Risk Assessment: It can be done in three waysvi: a) Quantitative Analysis: Ratio, peer and trend analysis b) Qualitative Analysis: It can be done by analyzing i) Holding company and systematic support

ii) Balance sheet and loan composition iii) Ratings iv) Stock price performance c) Recent Developments: Review i) Recent enforcement actions

ii) Management changes iii) Acquisitions iv) New market entries

7 3) Risk Response Development: Decide on the available and applicable control measures and hierarchy of control. The available measures for credit risk management could be to: a) Eliminate b) Mitigate c) Transfer d) Share e) Accept f) Contingency plan

4) Risk Response Control: Implement the control measure that has been decided upon according to the nature, impact and probability of the credit risk.

CREDIT ANALYSISvii
Credit analysis is the method by which one calculates the credit-worthiness of a business or organization. The audited financial statements of a large company might be analyzed when it issues or has issued bonds or; a bank may analyze the financial statements of a small business before making or renewing a commercial loan. The term refers to either case, whether the business is large or small. Credit analysis involves a wide variety of financial analysis techniques, including: Ratio and trend analysis Creation of projections Detailed analysis of cash flows Examination of collateral and other sources of repayment Examination of credit history and management ability

Analysts attempt to predict the probability that a borrower will default on its debts, and also the severity of losses in the event of default. Debt Service Coverage Ratio Before approving a commercial loan, a bank will look at all of these factors with the primary emphasis being the cash flow of the borrower. A typical measurement of repayment ability is the debt service coverage ratio. A credit analyst at a bank will measure the cash generated by a business (before interest expense and excluding depreciation and any other non-cash or extraordinary expenses). The debt service coverage ratio divides this cash flow

8 amount by the debt service (both principal and interest payments on all loans) that will be required to be met. Commercial Bankers like to see debt service coverage of at least 120 percent. In other words, the debt service coverage ratio should be 1.2 or higher to show that an extra cushion exists and that the business can afford its debt requirements.

CREDIT RISK ANALYSIS METRICSviii

The Five Cs of Credit Analysis The preliminary credit investigation is a fairly standard process. By standardizing the steps taken to investigate a new or existing account and determine its desirability, the credit department minimizes the potential for slow payments and/or bad debt losses involving that customer. The key qualitative and quantitative measures examined in a credit analysis are known as the "C's of Credit" are: Character, Capacity Capital Conditions of the times Collateral

Character: This involves a customer's willingness to pay obligations; its reliability, integrity,
trustworthiness, and quality of management: assess individual's business character based on their success, payment record, and information from current suppliers.

Capacity to pay: Business's ability to operate successfully and pay when a debt is due;
applicant's ability to generate cash flows. One way to evaluate capacity is to determine if the customer generates sufficient cash flow necessary to pay debts as they come due.

Capital: Credit applicant's equity or net worth; signifies the financial strength as a credit risk
and customer's ability to pay its obligations; business that shows increasing sales, profits, and net worth, and favorable trends of operations.

Conditions: Analysis of how current and expected general economic situations may affect the
applicant's business; may include past and current political history, recent economic events and currency issues.

Collateral: Collateral, such as property or other assets, helps to secure payment if those
assets are pledged to the creditor. Specific assets, such as accounts receivable or inventories can be pledged to creditors.

9 How Credit Risk Analysis Informs Lending Practices? The importance of each metric can vary considerably from applicant to applicant. Not only do they help a lender decide whether or not to issue credit, they also influence payment terms, credit limit, and if there are additional assurances that need to be made.

BASIC TERMINOLOGIES
Certain terminologies must be considered before studying the credit risk management concept. Some of them are as follows:
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Credit assessment Credit crunch Credit exposure

CREDIT ASSESSMENT Your credit is calculated as 'Good', 'Fair' or 'Needs Improvement'. A good credit assessment means you should be able to qualify, within the limits of your income, for most loans. You are also much more likely to receive the best interest rates available. If your credit is fair, you will probably not have trouble qualifying for a loan, but you may not receive the best available interest rate. If your credit rating needs improvement, you may have issues that could limit your ability to qualify for many loans.
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CREDIT CRUNCH It is an economic condition in which investment capital is difficult to obtain. Banks and investors become wary of lending funds to corporations, which drives up the price of debt products for borrowers. Credit crunches are usually considered to be an extension of recessions. A credit crunch makes it nearly impossible for companies to borrow because lenders are scared of bankruptcies or defaults, which results in higher rates. The consequence is a prolonged recession (or slower recovery), which occurs as a result of the shrinking credit supply.
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CREDIT EXPOSURE The total amount of credit extended to a borrower by a lender. The magnitude of credit exposure indicates the extent to which the lender is exposed to the risk of loss in the event of the borrower's default. For example, if a bank has made short-term and long-term loans totaling $100 million to company A, its credit exposure to company A is $100 million. In general, a bank will seek to have greater credit exposure to its customers with the highest credit rating, and less exposure to clients with a lower credit rating. If a customer encounters unexpected financial problems, the bank may seek to reduce its credit exposure in order to mitigate the risk of loss arising from a potential default.

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Credit rating
A credit rating evaluates the credit worthiness of a debtor, especially a business (company) or a government. It is an evaluation made by a credit rating agency of the debtor's ability to pay back the debt and the likelihood of default.[3] Credit ratings are determined by credit ratings agencies. The credit rating represents the credit rating agency's evaluation of qualitative and quantitative information for a company or government; including non-public information obtained by the credit rating agencies analysts. Credit ratings are not based on mathematical formulas. Instead, credit rating agencies use their judgment and experience in determining what public and private information should be considered in giving a rating to a particular company or government. The credit rating is used by individuals and entities that purchase the bonds issued by companies and governments to determine the likelihood that the government will pay its bond obligations. A poor credit rating indicates a credit rating agency's opinion that the company or government has a high risk of defaulting, based on the agency's analysis of the entity's history and analysis of long term economic prospects.

Credit score
A credit score is a numerical expression based on a statistical analysis of a person's credit files, to represent the creditworthiness of that person. A credit score is primarily based on credit report information typically sourced from credit bureaus. Lenders, such as banks and credit card companies, use credit scores to evaluate the potential risk posed by lending money to consumers and to mitigate losses due to bad debt. Lenders use credit scores to determine who qualifies for a loan, at what interest rate, and what credit limits. Lenders also use credit scores to determine which customers are likely to bring in the most revenue. The use of credit or identity scoring prior to authorizing access or granting credit is an implementation of a trusted system. Credit scoring is not limited to banks. Other organizations, such as mobile phone companies, insurance companies, landlords, and government departments employ the same techniques. Credit scoring also has a lot of overlap with data mining, which uses many similar techniques.

Credit Rating Scale

The credit rating of a corporation is a financial indicator to potential investors of debt securities such as bonds. Credit rating is usually of a financial instrument such as a bond, rather than the whole corporation. These are assigned by credit rating agencies such as A. M. Best, Dun & Bradstreet, Standard & Poor's, Moody's or Fitch Ratings and have letter designations such as A, B, C. The Standard & Poor's rating scale is as follows, from excellent to poor: AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-, BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, CC, C, D. Anything lower than a BBB- rating is considered a speculative or junk bond.

11 International long-term credit ratings International Long-Term Credit Ratings (LTCR) may also be referred to as Long-Term Ratings. When assigned to most issuers, it is used as a benchmark measure of probability of default and is formally described as an Issuer Default Rating (IDR). When applied to issues or securities, the LTCR may be higher or lower than the issuer rating (IDR) to reflect relative differences in recovery expectations. The following rating scale applies to foreign currency and local currency ratings: Investment Grade AAA Highest credit quality. 'AAA' ratings denote the lowest expectation of credit risk. They are assigned only in case of exceptionally strong capacity for payment of financial commitments. This capacity is highly unlikely to be adversely affected by foreseeable events. AA Very high credit quality. 'AA' ratings denote expectations of very low credit risk. They indicate very strong capacity for payment of financial commitments. This capacity is not significantly vulnerable to foreseeable events. A High credit quality. 'A' ratings denote expectations of low credit risk. The capacity for payment of financial commitments is considered strong. This capacity may, nevertheless, be more vulnerable to changes in circumstances or in economic conditions than is the case for higher ratings. BBB Good credit quality. 'BBB' ratings indicate that there is currently expectation of low credit risk. The capacity for payment of financial commitments is considered adequate but adverse changes in circumstances and economic conditions are more likely to impair this capacity. This is the lowest investment grade category.

Speculative grade BB Speculative 'BB' ratings indicate that there is a possibility of credit risk developing, particularly as the result of adverse economic change over time; however, business or financial alternatives may be available to allow financial commitments to be met. Securities rated in this category are not investment grade. B Highly speculative for issuers and performing obligations, 'B' ratings indicate that significant credit risk is present, but a limited margin of safety remains. Financial commitments are currently being met; however, capacity for continued payment is contingent upon a sustained, favorable business and economic environment. For individual obligations, may indicate distressed or defaulted obligations with potential for extremely high recoveries. Such obligations would possess a Recovery Rating of 'R1' (outstanding).

12 CCC For issuers and performing obligations, default is a real possibility. Capacity for meeting financial commitments is solely reliant upon sustained, favorable business or economic conditions. For individual obligations, may indicate distressed or defaulted obligations with potential for average to superior levels of recovery. Differences in credit quality may be denoted by plus/minus distinctions. Such obligations typically would possess a Recovery Rating of 'R2' (superior), or 'R3' (good) or 'R4' (average). CC For issuers and performing obligations, default of some kind appears probable. For individual obligations, may indicate distressed or defaulted obligations with a Recovery Rating of 'R4' (average) or 'R5' (below average).

Grade C For issuers and performing obligations, default is imminent. For individual obligations, may indicate distressed or defaulted obligations with potential for below-average to poor recoveries. Such obligations would possess a Recovery Rating of 'R6' (poor).

RD Indicates an entity that has failed to make due payments (within the applicable grace period) on some but not all material financial obligations, but continues to honor other classes of obligations.

D It indicates an entity or sovereign that has defaulted on all of its financial obligations. Default generally is defined as one of the following: Failure of an obligor to make timely payment of principal and/or interest under the contractual terms of any financial obligation; The bankruptcy filings, administration, receivership, liquidation or other winding up or cessation of business of an obligor; or The distressed or other coercive exchange of an obligation, where creditors were offered securities with diminished structural or economic terms compared with the existing obligation.

Default ratings are not assigned prospectively; within this context, non-payment on an instrument that contains a deferral feature or grace period will not be considered a default until after the expiration of the deferral or grace period. Issuers will be rated 'D' upon a default. Defaulted and distressed obligations typically are rated along the continuum of 'C' to 'B' ratings categories, depending upon

13 their recovery prospects and other relevant characteristics. Additionally, in structured finance transactions, where analysis indicates that an instrument is irrevocably impaired such that it is not expected to meet pay interest and/or principal in full in accordance with the terms of the obligation's documentation during the life of the transaction, but where no payment default in accordance with the terms of the documentation is imminent, the obligation may be rated in the 'B' or 'CCC-C' categories. Default is determined by reference to the terms of the obligations' documentation. Fitch will assign default ratings where it has reasonably determined that payment has not been made on a material obligation in accordance with the requirements of the obligation's documentation, or where it believes that default ratings consistent with Fitch's published definition of default are the most appropriate ratings to assign.

International Short-term Credit Ratings

The following ratings scale applies to foreign currency and local currency ratings. A Short-term rating has a time horizon of less than 13 months for most obligations, or up to three years for US public finance, in line with industry standards, to reflect unique risk characteristics of bond, tax, and revenue anticipation notes that are commonly issued with terms up to three years. Short-term ratings thus place greater emphasis on the liquidity necessary to meet financial commitments in a timely manner. F1 Highest credit quality. Indicates the strongest capacity for timely payment of financial commitments; may have an added "+" to denote any exceptionally strong credit feature. F2 Good credit quality. A satisfactory capacity for timely payment of financial commitments, but the margin of safety is not as great as in the case of the higher ratings. F3 Fair credit quality. The capacity for timely payment of financial commitments is adequate; however, near term adverse changes could result in a reduction to non investment grade. B Speculative. Minimal capacity for timely payment of financial commitments, plus vulnerability to near term adverse changes in financial and economic conditions. C High default risk. Default is a real possibility. Capacity for meeting financial commitments is solely reliant upon a sustained, favorable business and economic environment. RD Indicates an entity that has defaulted on one or more of its financial commitments, although it continues to meet other obligations. D Indicates an entity or sovereign that has defaulted on all of its financial obligations.

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Credit Reportxii
A report containing detailed information on a person's credit history, including identifying information, credit accounts and loans, bankruptcies and late payments, and recent inquiries. It can be obtained by prospective lenders with the borrower's permission, to determine his or her credit worthiness

Credit Reporting
Credit reporting is the process that credit reporting agencies, also called credit bureaus, use to inform banks and other businesses about your payment and spending habits via your credit report. Your credit report is maintained by companies known as credit reporting agencies or credit bureaus. There are three major credit reporting agencies in the United States Equifax, Experian, and TransUnion. Periodically, the companies you do business with send updates to the credit reporting agencies to let them know how youre doing on your financial obligations. For example, your credit card issuer will update your account to include your account balance, credit limit, monthly payment, recent payment history, and current status of your account.

Working Of Credit Reporting Companiesxiii

A credit report is such an important piece of information that every person who has received credit is entitled to a free one each year. But what exactly is this document that wields so much power? The credit reporting companies Trans Union, Equifax and Experian are the three major companies that maintain credit reports. The credit reporting companies issue credit reports to creditors, insurers and others as permitted under law. Here's an example of how the system works: When you apply for a new credit card, the creditor requests a copy of your financial history, or credit report, from one or more of the credit reporting companies. The creditor may use your credit report, a score, and other information you provide (such as income or debt information) to determine whether to approve your application and what rates to offer. If you are issued a card, the creditor reports that account to the credit reporting companies, and then updates it, including your balance and payment activity, about every 30 days. The credit reporting companies update your credit report as they receive new information from creditors or lenders. Your credit profile change based on your financial activity. The next time you apply for a credit card or loan, the process repeats.

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Credit Rating Agencyxiv

A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. In some cases, the servicers of the underlying debt are also given ratings. In most cases, the issuers of securities are companies, special purpose entities, state and local governments, non-profit organizations, or national governments issuing debt-like securities (i.e., bonds) that can be traded on a secondary market. A credit rating for an issuer takes into consideration the issuer's credit worthiness (i.e., its ability to pay back a loan), and affects the interest rate applied to the particular security being issued. A company that issues credit scores for individual credit-worthiness is generally called a credit bureau (US) or consumer credit reporting agency (UK). ESMA is exclusively responsible for the registration and supervision of Credit Rating Agencies in the European Union. A full list of all CRA's currently registered in the EU, can be found via the menu. In addition, ESMA also carries out policy work to prepare future legislation, such as regulatory technical standards, and guidelines. This work is undertaken through the CRA technical committee, which has representatives from all the national competent authorities. International Credit Rating Agencies Canadian bond rating service(BRS) Dominion bond rating service(DBRS) Duff and Phelps credit rating agency Fitch IBCA Ital rating DCR SPA Japan credit rating agency(JCRA) Japan rating and investment information Mikuni and co. Moodys investor service Standard and poors rating service Thompson bank watch Local and International Credit Rating Agencies M. Best (U.S.) Baycorp Advantage (Australia) Bulgarian Credit Rating Agency (Bulgaria, European Union) Capital Intelligence (Cyprus) Capital Standards Rating (Kuwait) CARE Ratings (India) Credo line (Ukraine) Credit Rating Information and Services Limited(CRISL), (Bangladesh) CRISIL (India)

17 Dagong Global Credit Rating (People's Republic of China) Dominion Bond Rating Service (Canada) Duportl (UK) Egan-Jones Rating Company (U.S.) First Afghan Credit Risk Ratings (Afghanistan)FACRR First Report, (UK) Fitch Ratings (Dual-headquartered U.S./UK), 80% of which is owned by FIMALAC, a French firm. Global Credit Ratings Co. (Africa) HR Ratings (Mexico) ICRA Limited (India) SMERA (India) Japan Credit Rating Agency, Ltd. (Japan) Kroll Bond Rating Agency (U.S.) Moody's Investors Service (U.S.) Muros Ratings (Russia alternative rating agency) Rapid Ratings International (U.S.) Pakistan Credit Rating Agency Limited (Pakistan) Standard & Poor's (U.S.) UK Credit Info (U.K.) Weiss Ratings (U.S.) Onicra Credit Rating Agency of India Ltd (India)

The Big Three credit rating agencies are Standard & Poor's, Moody's Investor Service, and Fitch Ratings. Moody's and S&P each control about 40 percent of the market. Third-ranked Fitch Ratings, which has about a 14 percent market share, sometimes is used as an alternative to one of the other majors.

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TOP 4 INTERNATIONAL CRS

Here is the list of Top 4 international Credit Rating Agencies of the world. These agencies are Nationally Recognized Statistical Rating Organizations by the U.S. Securities and Exchange Commission. 1. MOODYSxv

Moodys is the oldest credit rating agency. It is also the first rating agency to be recognized by NRSRO in 1975. The company became public in 2000. It has been earning huge profits. Average profit margin was 53% from 2000 to 2007. Structured finance products were its top source of revenue by 2000. MOODY'S RATING PROCESS Meeting with management The Moody's analyst will discuss the meeting agenda with the issuer in advance of the meeting, to ensure the issuer is aware of the type of information Moody's typically receives at such a meeting. The discussion at the rating meeting will generally focus on the subjects like Background and history of the company/entity , Industry/sector trends ,Management structure , Basic operating and competitive position , Corporate strategy and philosophy, Debt structure, Financial position and sources of liquidity. Moody's Rating Committee The role of the Moody's rating committee is to introduce as much objectivity into the process as possible by bringing an understanding of the relevant risk factors and viewpoints to each and every analysis. Factors considered in determining the make-up of a rating committee may include the size of the issue, the complexity of the credit, and the introduction of a new instrument. Rating Process Timeline Moody's rating process, from the time of the preliminary discussion to the public release of the rating, takes approximately 60-90 days. However, Moody's is sensitive to issuers' needs and timing concerns, and will be as flexible and responsive as possible in order to accommodate tighter financing schedules and other requirements.

19 Rating Dissemination and Publication Once the rating committee has made its decision, the issuer will be informed of the rating and Moody's rationale. For a public rating, the new rating is distributed by press release simultaneously to the major financial media worldwide. External Rating Appeals There may be instances in which the issuer has new or additional information that was not available to Moodys for consideration by the rating committee in reaching its not-yetpublished credit rating decision. In these circumstances, issuers may request that Moodys reconsider its decision based on this new or additional information, a process that is commonly referred to as an external appeal. Right of Refusal of the Moody's Rating in Asia Pacific Moody's provides first-time rating applicants with the ability to determine whether their ratings will be made public, subject to certain limitations, in the event of a debt issuance by the applicant in any of the international capital markets at a later date. If applicants choose not to have their rating published, then both Moody's and the applicant will keep the rating confidential. Companies will not be permitted to disclose their Moody's rating on a selective basis. Treatment of Confidential Information Moody's recognizes that an issuer's trust in the confidential nature of the rating relationship is an essential component of the rating process. Confidential information will not be publicly disclosed, but, if relevant, will be used in the formulation of the public rating opinion. On-Going Relationship The Moody's analyst will maintain regular contact with the issuer both electronically and via the telephone, and will be available at all times to respond to an issuer's needs or questions 2. Standard & Poorsxvi

The agency is owned by Mc Graw-Hill Inc. It has been published any stock indices of the world, most famous being S&P 500 index which is the most watched index in the world. McGraw-Hill reported a net profit margin of 12.6 percent for 2008. It has following rating processes:

20 1) Rating Issuers & Issues 2) Typical Process for a New Corporate or Government Rating Contract Pre evaluation. Management meeting.. Analysis. Rating committee. Notification. Publication

3) Rating Corporate and Government Issuers & Issues

5)

Request The Initial Rating Process The Analytical Team & Rating Committee Pre evaluation Management meeting. Analysis Committee evaluation Notification of issuer Publication.

Process for Rating Structured Finance Instruments - Key Differences Highlighted Request Pre evaluation Analysis Rating Committees

3. Fitchxvii

Fitch is smallest among the top three agencies. It is a part of Fitch Group. It Was the third agency to become an NRSRO in 1975. From 1975 to 1992, four other agencies were recognized as NRSROs and all subsequently merged with Fitch. Analytical Team Input from Rated Entities The Committee Process Criteria Development Differences of Opinion

21 Access to Confidential Information Surveillance of Ratings Rating Dissemination Product Range Timing of the Process Fees
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4. DBRS

DBRS is privately owned Canadian ratings agency has been the top ratings agency in Canada for 30 years. It became the fourth NRSRO in 2003. DBRS believes that it can compete with the big three but is not favored by authorities. The Rating Process Corporate and Structured Finance are: CORPORATE RATING PROCESS Initial Contact

In most cases, the organization is contacted by the issuer directly or by its investment banker or dealer and requested to conduct a corporate rating.
Letter of Engagement

In order to formalize the rating assignment, the terms of the engagement are confirmed.
Information on the Issuer

Relevant information about the issuer is obtained, and may be received from a variety of sources including third parties, for the purposes of conducting the rating analysis.
Meeting with Management

An extensive meeting or series of meetings is generally conducted with management regarding all relevant aspects of the issuers business.

22 Draft Rating Report

Following analysis of the information obtained, typically a draft rating report is prepared.
Rating Committee

The analysis and draft rating report, if prepared and proposed rating is submitted to the Rating Committee, who will determine the rating.
Review by the Issuer

Rating Committee reviews the report to ensure that the factual information is correct and that these materials do not contain any confidential information.
Publishing

Except for private ratings, internal assessments and for certain private placement transactions, the final rating report is externally published, accompanied by the press release.
Surveillance

Ongoing surveillance of all its ratings (including public and certain private ratings and internal assessments) is performed.
STRUCTURED FINANCE RATING PROCESS Initial Contact

An initial meeting with the sponsor, usually the financial institution which will be structuring transactions for third party clients or selling assets directly into the special purpose vehicle (SPV), will be held to discuss the structure of the SPV.
Letter of Engagement

In order to formalize the rating assignment, the terms of the engagement are confirmed.
Information on the Sponsor

The organization evaluates the sponsors financial and operational capabilities

23 Structural and Legal Review

The sponsor will provide constituting documents to allow review to ensure that the legal structure is consistent with the described purpose of the SPV.
Draft Rating Report

A pre-sale or rating report is typically drafted by the lead analyst that focuses on rating rationale and the structural features of the transaction, the roles performed by various parties as well as the structural risk mitigants or flexibilities that exist within the transaction.
Rating Committee

The analysis, draft rating report, and proposed rating are submitted to the Rating Committee, who will determine the rating.
Review by the Sponsor

Once Rating Committee approval is received, the sponsor is provided with a copy of the press release and draft rating report, if prepared, to review to ensure that the factual information is correct.
Publishing

Except for private ratings, internal assessments and for certain private placement transactions, the press release and final rating report, if prepared, is externally published.
Surveillance

Each sponsor of a SPV structure is generally required to provide periodic performance reports, which provides an overview of the performance of the pool of receivables and the transaction and, if relevant, prompt notification of any covenant trigger and a proposed course of action to remedy the situation.

24

PACRA
INTRODUCTION PACRA seeks to be an agent of change, developing insightful risk solutions, transforming both the rating business and the industry in line with the best practices. Being the first rating agency in Pakistan, PACRA carries the onus of leadership. PACRA is in the business to evaluate the capacity and willingness of an obligor to honor its financial obligations. Its credit rating opinion reflects an independent, professional and impartial assessment of the credit risk associated with a particular debt instrument or an entity. By providing a measurement of risk, this facilitates investors in making prudent investment decisions. T.E.A.M - Together Everyone Achieves More. The Board of Directors of PACRA comprises seven professionals drawn from diverse fields. All Directors, except the Managing Director, are Non-Executive, while three of them are Independent. PACRA was established in 1994 as a joint venture. PRODUCTS OFFERED: ENTITY RATING: Entity rating signifies the level of investment risk and the capacity and/or willingness of an entity to meet its debt obligations. The risk level is indicated by the long and short term ratings. INSTRUMENT RATING: Instrument rating covers all non-equity instruments including TFCs (long and short term), Sukuks, and bonds. By indicating the risk profile of the instrument, the assigned rating helps the issuer in deciding the terms of the instrument while guiding the potential investors in investment decision. INSURER FINANCIAL STRENGHT: The insurer financial strength (IFS) rating represents an opinion of an issuers financial strength and business continuity from a policy holder's prospective. IFS rating captures the relative ability of the insurer to meet policy holders' obligations. However, the rating provides no guarantee against default but offers a well researched opinion as to the likelihood of the issuer to fail to fulfill its obligations towards policy holders. PROJECT GRADING: The Project Grading (PG) is an opinion on a specific project being managed by any real estate entity. ASSET MANAGER RATING: AM Rating differs fundamentally from credit ratings, which refer to the ability to meet debt obligations. The focus of AM rating is to gauge the fund management capability of the asset manager, as reflected from its operating platform, human resource base and the infrastructure that it has erected. AM rating gives a view on whether the asset

25 manager meets or exceeds the overall investment management best practices, the benchmarks and standards in all criteria under review. RATING MATRIX

RATING MATRIX Rating Matrix is a set of standardized methodologies and policies. These govern the evolution of the rating opinion from start to finish and lend consistency to PACRAs ratings. Rating Matrix is periodically updated

PACRAS POLICIES PACRAs Rating Policies are comprehensive and detailed descriptions of PACRAs rating practices and procedure

PACRAS METHODOLIGIES. PACRA bases its ratings analysis and opinions upon established criteria and methodologies and applies them in a uniform and consistent manner

RESEARCH Gathering facts and figures, examining with a critical eye and drawing insights from the entire activity with the objective of forming a view research forms an integral part of PACRAs rating process. The primary outcome of research is a sector study report. PACRA adds value by identifying specific array of factors that lead to credit risk in a particular industry.

26

SECTOR STUDIES

PACRA sector studies provide a detailed insight into the dynamics of a sector. These studies are distinct in that they exclusively focus upon the risk drivers and their mitigants, if any, operating within the sector.

PACRAS PUBLICATIONS

PACRA has a proprietary industry communiqu called PACRA Insight. PACRA Insight is a bi-annual publication disseminated through PACRA website. PACRA Insight lays out in detail the rating portfolio composition and credit trends of Pakistans rating industry.

PACRAS CONTRIBUTIONS.

PACRA, carrying the onus of leadership, strives to contribute to industry growth and development by educating the users of ratings.

PACRAS RATING No. Industry Ratin Entity g type JS GLOBA L CAPITA L LIMITE D Brokerag e Entity

Dissemina tion date 28 dec2012

LT ratin g AA

ST ratin g A1+

Action

Outlo ok Stable

Maintain

Press releas e view

Histor y history

Interpretation: JS GLOBAL CAPITAL LIMITED is a brokerage entity; it has maintained its rating as for evidence history can be viewed. JCR-VIS Credit Rating Co. Ltd: JCR-VIS Credit Rating Co. Ltd. (JCR-VIS), approved by Securities & Exchange Commission of Pakistan and State Bank of Pakistan, is operating as a Full Service rating agency providing independent rating services in Pakistan. JCR-VIS is a joint venture between Japan Credit Rating Agency, Ltd. (JCR) - Japan's premier rating agency, Vital Information Services (Pvt.) Limited (VIS) Pakistans only independent financial research organization, Karachi Stock Exchange and Islamabad Stock Exchange. In January 2001 JCR and VIS entered into a Joint Venture Agreement whereby JCR acquired 15% share in DCR-VIS Credit Rating Co. Ltd. of Pakistan. As a result of this agreement, the name of the company changed from DCR-VIS Credit Rating Co. Ltd. to JCR-VIS Credit Rating Co. Ltd. (JCR-VIS).

27 FUND STABILITY RATINGS JCR-VIS has revised its Fund Stability criteria. The key change in the methodology pertains to interest rate sensitivity of a fund at different rating grades. RATING METHODOLOGY: Fund Stability Ratings (FSRs) measure the sensitivity of a funds Net Asset Value (NAV) and total return to changing market conditions, with particular emphasis on downside risk. Credit Risk Criteria Asset Allocation % of NAV** FSR Issue / Issuer Rating AA A A A+ A+ Min. 85% Max. 15% Min. 50% Max. 30%* Min. 25% Max.15%* MAX 10% AA--

AAA AA+ AA AA-

DURATION CRITERIA / MATURITY CRITERIA Fund Rating Wtd. Avg. Duration AAA 45 DAYS AA+ 60 DAYS AA 90 DAYS AA180 DAYS A BAND 1 YEAR For example, JCR-VIS shows rating like this:

Recent Announcements

Ratings/Action

Jubilee General Insurance Company Limited 12/28/2012 IFS Press Release / History OUTLOOK Interpretation:

AA+ Stable

Upgrade

Press release shows detailed publication on insurer financial strength. History shows its history regarding financial strength, which is in above scenario is upgraded. AA+ =60 days of maturity.

28 SERVICES OFFERED Entity Ratings of Corporations, NBFIs & FIs Credit Ratings of Term Finance Certificates and long term issues Bank Finance Ratings Commercial Paper Ratings Lease, Housing Finance, Credit Card and other Corporate/ Consumer Finance Receivables Securitization Ratings Equity Ratings including initial public Offerings and Right Offerings Insurer Financial Strength Ratings Project Finance Ratings Mutual Funds Ratings Musharaka/Modaraba issues Ratings Grading of Construction Projects JCR-VIS RATING PROCESS Issuer/Client JCR-VIS Issuer/Client 1.Signs agreement for an initial rating 2.Submits preliminary information materials 3. Conducts a preliminary study 4. Submits a detailed questionnaire to the issuer/client 5. Provides detailed information in response to detailed questionnaire 6. Conducts pre due diligence meeting analysis 7. Conducts due diligence meetings (4-5 weeks) 8. Conducts post due diligence analysis 9. Brief for internal rating committee meetings is prepared 10. Sub Committee recommends preliminary/initial rating 11. Rating Committee decides the preliminary/initial rating 12. Discusses the rating rationales and rating issues with client 13. Notifies issuer of the preliminary/initial rating, deliberates on appeals by client, if any 14. Consents to release of preliminary/initial rating to the public in case of non-mandatory ratings 15. Releases the preliminary/initial rating to the press ( 2-3 weeks)

JCR-VIS

Issuer/Client JCR-VIS

29 REFERENCES
i

http://www.creditriskmanager.com/glossary/business-credit-ratings http://www.risk.no/credrisk.htm Principles for the Management of Credit Risk (by Basel Committee on banking Supervision) Basel 2000 ii Credit Rating and the Impact on Capital Structure by Christian Kronwald (2009) iii + Credit Risk A Credit Risk Management Framework by CREDIT SUISE|FIRST BOSTON iv http://www.riskglossary.com/link/credit_risk.htm v 9 COMPONENTS OF AN EFFECTIVE LENDING AND CREDIT RISK MANAGEMENT PROGRAM by James C. Lacovara, MS, Managing Director, Credit Risk Management (ICS RISK ADVISORS) vi http://www.pmanetwork.com/investmentmanagement/creditriskmanagement/
vii

&
ix

viii

http://en.wikipedia.org/wiki/Credit_analysis http://www.bankrate.com/calculators/smart-spending/credit-risk-assessment-test-calculator.aspx x http://www.investopedia.com/terms/c/creditcrunch.asp#ixzz2G9Oimgil xi http://www.investopedia.com/terms/c/credit-exposure.asp#ixzz2G9PfLW2v xii http://www.investorwords.com/5490/credit_report.html#ixzz2G4nrwmpn xiii http://unctad.org/en/Docs/osgdp20081_en.pdf

xiv

http://en.wikipedia.org/wiki/Credit_rating_agency#List_of_credit_rating_agencies

xv

http://www.moodys.com/ratings-process/How-to-Get-Rated/002001

xvi

http://www.standardandpoors.com/aboutcreditratings/

xvii

http://www.globalclearinghouse.org/infradev/assets%5C10/documents/Fitch%20%20The%20Rating%20Process%20(2006).pdf xviii http://www.dbrs.com/research/236737/the-rating-process-corporate-and-structured-finance.pdf