CREDIT RATING ASPECTS

Kamaljit Behera (0921415)

Leelesh Jain (0921416)
Pawan Pathak (0921421)
Saurabh Singh (0921427)
Suyash Jain (0921433)
Maria Varghese (0921446)
 What is CREDIT RATING ?
• A credit rating estimates the credit
worthiness of an individual,
corporation, or even a country.
• It is an evaluation made by an agency
(bureaus) of a borrower’s overall credit
history.
• A credit rating is also known as an
evaluation of a potential borrower's
ability to repay debt, prepared by an
agency at the request of the lender.
• A poor credit rating indicates a high risk
of defaulting on a loan, and thus leads
to high interest rates, or the refusal of
• Credit ratings are calculated from
financial history and current
assets and liabilities.
• Typically, a credit rating tells a lender
or investor the probability of the
subject being able to pay back a
loan.
• In recent years, credit ratings have also
been used to adjust insurance
premiums, determine
employment eligibility, and
 What it is and what it is
not ?
 What a rating is:
• A current opinion on the relative
creditworthiness of debt
• An issue specific evaluation
• Aimed at differentiating credit quality


 What a rating is not:

• Not an audit of the issuing company
• Not a one time assessment of
creditworthiness of the issuer
• Not a general purpose certification of
goodness of a company
• Not a recommendation to buy, hold or sell
 When CREDIT RATING
started ?
• The initial rating exercise was started by
Henry Poor who published financial
statistics of Railroad companies in
1860.
• In addition to his publishing business, John
Moody (Moody’s Investors Services)
started publishing ratings for railroad
bonds from the year1909.
• The rating activity got a boost post Great
Depression of 1933 when US
Government Controller of Currency
directed the banks in USA to purchase
bonds rated BBB and above and the rest
came to be known as ‘junk’ bonds. At
present in US markets all commercial
 What can be CREDIT
• INDIVIDUAL
RATED ?
 An individual's credit score, along with his or
her credit report, affects his or her ability to
borrow money through financial institutions such
as banks.
• CORPORATE
 The credit rating of a corporation is a financial
indicator to potential investors of debt securities
such as bonds.
• SOVEREIGN
 A sovereign credit rating is the credit rating of a
sovereign entity, i.e. a country. The sovereign
credit rating indicates the risk level of the
investing environment of a country and is used by
 FINANCIAL INSTRUMENTS
q Bonds
q Bank Deposits
q Commercial Paper
q Term Loans
q Preference Shares
q Secured Debt
q Unsecured Debt
q Mortgage Backed Securities
q Asset Backed Securities
q Structured Obligations

 These can be issued by Sovereigns,
Manufacturing/ Service Companies
,Statutory Bodies/Public Sector
Companies, Financial Institutions &
Banks, Finance Companies, Credit
Unions, Holding Companies, Insurance
Companies and Mutual Funds
•
 Where is CREDIT RATING
emerging ?
• Equity Research
• Banking Sector
• Insurance Sector
• New Instruments viz. Floating Rate
Notes
• Intermediary in Financial Sector
• Indian Corporate raising funds
overseas
 Who uses CREDIT RATING ?
Investors
 1. Eases risk identification and diversification
 2. Risk based pricing of Investments
 3. Greater depth of research, being locally
based
Issuers

 1. A proactive step towards transparency

 2. An independent, unbiased assessment
 3. Enhances credibility & acceptability
 4. Increases access to funding
 5. Encourages financial discipline
Regulatory authorities

 1. Investor protection
 2. Market discipline
Intermediaries

 1. Fixing coupon rates

 2. A second opinion
 What is a CREDIT RATING
AGENCY ?
• 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.
 Which are the CRA in
INDIA ?
• Credit Rating Information Services of
India Limited (CRISIL)
• Investment Information and Credit
Rating Agency of India (ICRA)
• Credit Analysis & Research Limited
(CARE)
• Duff & Phelps Credit Rating India
Private Ltd. (DCR India)
• ONICRA Credit Rating Agency of India
Ltd.
 What CRA should comply
with ?
• The Securities and Exchange Board of
India (Credit Rating Agencies)
Regulations, 1999 offers various
guidelines with regard to the registration
and functioning of the credit rating
agencies in India.
• The registration procedure includes
application for the establishment of a
credit rating agency, matching the
eligibility criteria and providing all the
details required.
• They are required to prepare internal
procedures, abidance with circulars.
What is process of CREDIT
RATING ?
 Why are financial instruments
rated ?
• Developments in the financial markets
have focused attention on the need to
have proper understanding of the
terms of financial instruments, before
selecting them for investment.
• Even sophisticated investors, in both
domestic as well as international markets,
are complaining about investing in an
inappropriate instrument without fully
comprehending the risks involved.
• Rapid developments in financial markets
aided by technology, requires an investor
to have proper understanding of
features of instruments, especially the
more sophisticated ones, before investing
 What is the criteria for
instruments ?
• CERTAINTY OF RATE OF RETURN
• PRE-MATURE REDEMPTION
• NUMBER OF PARTIES INVOLVED
IN THE TRANSACTION
• FAMILIARITY OF CAPITAL MARKET
WITH THE INSTRUMENT

 What is the complexity in
financial instruments ?
 Instruments are classified into three
categories based on the complexity
involved in the comprehension of these
instruments.
• SIMPLE
 These are generally, instruments with
a fixed rate of return with a pre-
determined repayment period. They do
not have any prepayment risk and
number of counter parties is only one.
Capital market participants are very
familiar with the instrument.
• COMPLEX
 These are generally, instruments with
a variable rate of return. While the
repayment period may be fixed, there is
a risk of pre-payment and number of
counter parties may be more than one.
Capital market participants may be only
moderately familiar with the
instrument.
• HIGHLY-COMPLEX
 They generally have a variable return
and maturity profile. Number of
counterparties involved may be more
than one. Capital market participants
are not very familiar with the
instrument.
 COMPLEXITY v/s CREDIT
RISK
• Classification of instruments based on
complexity should not be
misconstrued as an indicator of
inherent credit risk of the
instrument.
• Even instruments classified as Simple
may have a higher credit risk
comparable to those classified as
Complex or Highly Complex.
• For example, while Fixed Deposits,
which are unsecured in nature, are
simple instruments to transact, the
credit risk may be higher than that of
Highly Complex instrument like Asset
 What is the methodology of
CREDIT RATING ?
 Various Credit Rating Agencies use
various methods. The general
methods are –
The first method :

• Business Analysis – Industry risk,

market position and operating
efficiency of the company, legal
position.
• Financial Analysis – Accounting
quality, earnings position,
adequacy of cash flows, and
• Management Evaluation – Goals,
philosophy, strategies, ability to
overcome adverse situations,
managerial talents and succession
plans, commitment, consistency
and credibility.
• Regulatory and Competitive
Environment -
• Fundamental Analysis – Liquidity
management, assets quality,
profitability and financial position,
interest and tax sensitivity.
In this method all these factors are

analyzed and
The second method :

 The rating methodology comprises

the study of industry as well as the
company’s SWOT analysis.
• Marketing strategies
• Competitive edge
• Level of technological development
• Operational efficiency
• Competence and effectiveness of
management
• HRD policies and practices
• Hedging of risks
• Cash flow trends and potential
• Liquidity
• Financial flexibility
• Asset quality and past record of
servicing debts and obligations
• Government policies and status
affecting the industry
•
 What are the symbols
used ?
• Various agencies uses various symbols for
denoting the ratings.
• The rating scales are generally AAA, AA, A, BBB,
BB,……D..etc
• The prefixes are added so as to denote the type
of instrument. They are:
q Pref. shares: “Pf”
q Fixed Deposits: “F”
q Short Term Instruments: “P”
• Also prefixes are also used to denote whether
they are long /medium/short term.
q Long: “L”
q Medium: “M”

• AAA/AA are considered High
Investment Grades.
• A/BBB are considered Investment
Grades.
• BB/B/C/D are considered speculative
grades.
• Additionally, (+) or (-) signs are used to
denote higher or lower safety
within the grade (AA+, AA- etc.)
• Generally for short term - A1, A2, A3,
A4, A5 are used for rating.
• Some agencies use “P” instead of “A”
• The symbols can also be called as the
 What are the Short term
symbols ?
• The short term include money
market instruments like
commercial papers etc.
qA-1/P-1: Highest Safety
qA-2/P-2: High Safety
qA-3/P-3: Adequate Safety
qA-4/P-4: Risk prone
qA-5/P-5: Default (which give no
return or will definitely default)
 What are the medium term
symbols?
• The medium term instruments include
instruments ranging 2 to 5 years,
generally like certificate of deposits
and fixed deposits.
qMAAA: Highest Safety
qMAA: High Safety
qMA : Adequate Safety
qMB : Inadequate Safety
qMC : Risk prone
qMD : Default

 What are the long term
symbols ?
• The long term sources include long term
Debentures, Bonds, Preference shares and
equities.
q LAAA : Highest Safety
q LAA : High Safety
q LA : Adequate Safety
q LBBB : Moderate Safety
q LBB : Inadequate Safety
q LB : Risk prone
q LC : Substantial Risk
q LD : Default, Extremely speculative
Why are CR/CRA criticized ?
• Credit rating agencies do not downgrade
companies promptly enough.
 For example, Enron's rating remained at
investment grade four days before the
company went bankrupt, despite the fact
that credit rating agencies had been aware
of the company's problems for months.
• Large corporate rating agencies have been
criticized for having too familiar a
relationship with company
management, possibly opening
themselves to undue influence or the
vulnerability of being misled.
• The lowering of a credit score by a CRA
can create a vicious cycle, as not
only interest rates for that company
would go up, but other contracts
with financial institutions may be
affected adversely, causing an
increase in expenses and ensuing
decrease in credit worthiness.
• Credit Rating Agencies have made
errors of judgment in rating
structured products, particularly in
assigning AAA ratings to structured
debt, which in a large number of
cases has subsequently been
downgraded or defaulted.
• Rating agency business is itself
reputation-based and the finance
 THANK YOU
 BIBLIOGRAPHY:
• www.wikipedia.com
• www.crisil.com
• www.icra.com
• www.care.com
• www.blogspot.com
• www.googole.co.in
