CREDIT RATING AGENCIES

SUBPRIME MORTGAGE CRISIS

GREEK CRISIS
K A N I S H K A M E H R O T R A A N D P R A B H AT B A H L

WHAT IS CREDIT RATING AGENCY ?

Anindependentcompanythat evaluates thefinancial conditionof
issuers ofdebt instrumentsand thenassignsaratingthat reflects
itsassessmentof theissuer'sabilityto make thedebtpayments.
Potentialinvestors,customers,employeesandbusiness
partnersrely upon thedataandobjectiveanalysisof credit rating
agencies in determining the overallstrengthandstabilityof a
company.
Examples : Moodys, Fitch Group, Standard & Poors etc..

WHAT DOES CREDIT RATING CONVEY?

A credit rating is an opinion on the creditworthiness or the relative
degree of risk of timely payment of interest and principal on a debt
instrument.
Most rating agencies adopt some variation of this definition for their
credit ratings.
The ratings are a comment on the relative likelihood of default in
comparison to other rated instruments.
In other words, a rating indicates the probability of default of the
rated instrument and therefore provides a benchmark for
measuring and pricing credit risk.

RATING RELATED PRODUCTS

CRAs rate a large number of financial products:
1. Bonds/ debentures- [the main product]
2. Commercial paper
3. Structured finance products
4. Bank loans
5. Fixed deposits and bank certificate of deposits
6. Mutual fund debt schemes
7. Initial Public Offers (IPOs)
and many more

ADVANTAGES

DISADVANTAGES

They Help Good Institutions Get

Better Rates

Evaluation Is Highly
Controversial

They Warn Investors of Risky

Companies

There Can Be Conflict of

Interest

They Provide a Fair Risk-Return

Ratio

Ratings Arent Always

Accurate

They Give Institutions an

Incentive to Improve

NON-RATING RELATED ACTIVITIES

CRAs often undertake a variety of non rating related activities. These include the following:
Economy and Company Research: Some Indian CRAs have set up research arms to
complement their rating activities. These arms carry out research on the economy, industries and
specific companies, and make the same available to external subscribers for a fee.
Risk consulting: The risk consulting groups of credit rating agencies would leverage the
agencies understanding of credit risk to develop and provide the tools and data that banks would
require. The products in this area include tools for internal ratings, operational risk evaluation, and
overall capital calculation.
Funds research: Some CRAs have diversified from mutual fund ratings into mutual fund
research. The services that are available under this head include fund rankings, performance
attribution tools (to help users understand the reasons for funds performance), desktop tools, and
fixed income research.
Advisory services: CRAs offer various kinds of advisory services, usually through dedicated
advisory arms. Most of this is in the nature of developing policy frameworks, bid process
management, public private partnership consulting, and creating an enabling environment for
business in India and globally.

ANALYTICAL FRAMEWORK USED BY CRA

The analytical framework involves the analysis of business risk,
technology risk, operational risk, industry risk, market risk, financial
risk and management risk.
Business risk analysis covers industry analysis, operating
efficiency, market position of the company whereas
Financial risk covers accounting quality, existing financial position,
cash flows and financial flexibility.
Under management risk analysis an assessment is made of the
competence and risk appetite of the management.

SEBI CODE OF CONDUCT FOR CRAS

SEBIs code of conduct for CRAs addresses some of the basic issues relating to conflicts of interest.
The Code of Conduct is designed to ensure transparent and independent functioning of CRAs. Some
of the salient provisions of the Code of Conduct are:
A CRA shall make all efforts to protect the interests of investors.
A CRA shall at all times exercise due diligence, ensure proper care and exercise independent
professional judgment in order to achieve and maintain objectivity and independence in the
rating process.
A CRA shall have in place a rating process that reflects consistent and international rating
standards.
A CRA shall keep track of all important changes relating to the client companies and shall
develop efficient and responsive systems to yield timely and accurate ratings. Further a CRA shall
also monitor closely all relevant factors that might affect the creditworthiness of the issuers.
A CRA shall disclose its rating methodology to clients, users and the public.
A CRA shall not make any exaggerated statement, whether oral or written, to the client either
about its qualification or its capability to render certain services or its achievements with regard to
the services rendered to other clients.

TOP CRAS GLOBAL AND INDIA

Type

Subsidiary

Industry

Bond credit ratings

Predecessor

Moody's Analyses Publishing Company

Founded

1909

Headquarters

7 World Trade Center

New York City,United States

Parent

Moody's Corporation

Website

www.moodys.com/researchandratings

Type

SubsidiaryofMcGraw Hill Financial,limited

liability company

Industry

Financial services

Founded

1860, present corporation status in 1941

Founder

Henry Varnum Poor

Headquarters

New York City,United States

Key people

Douglas L. Peterson(President)

Revenue

$2.61billion US$ (2009)

Number of employees

10,000 (approximate)

Parent

McGraw Hill Financial

Website

standardandpoors.comspratings.com

Type

Subsidiary

Industry

Financial services

Founded

1914

Founder

John Knowles Fitch

Headquarters

New York City,United States,

andLondon,United Kingdom

Key people

Paul Taylor
President & CEO

Revenue

$732.5 Million (2011)

Owner

Hearst Corporationand FIMALACSA

Number of employees

2,000 (approximate)

Website

www.fitchratings.com

 CRISIL or Credit Rating Information Services of India Limited is a

global analytical company providing ratings, research, and risk and
policy advisory services.
Stock price:CRISIL(NSE)Rs.1,976.00+51.70 (+2.69%)
20 Aug, 3:29 PM IST
CEO:Roopa Kudva
Founded:1987
Headquarters:Mumbai,Maharashtra,India,Mumbai,India
Subsidiaries:Irevna,CRISIL Risk & Infrastructure Solutions
Ltd,CRISIL MarketWire Ltd,Gas Strategies Group Ltd

 Commercial banking company

ICRA Limited is an Indian independent and professional investment
information and credit rating agency. It was established in 1991,
and was originally named Investment Information and Credit Rating
Agency of India Limited.
Stock price:ICRA(NSE)Rs.4,101.00-96.10 (-2.29%)
20 Aug, 3:29 PM IST
Headquarters:Gurgaon,India
Founded:1991

 Full service credit rating agency exclusively set up for micro, small
and medium enterprises (MSME) in India and has grown to rate
SME, mid & large corporate.
Type - Public
Founded - 2005
Headquarters - Mumbai, Maharashtra, India
Key people - Mr. Sankar Chakraborti, CEO
Services - Ratings, Research and Policy Advisory

FINANCIAL CRISIS OF 2008

(SUBPRIME MORTGAGE CRISIS)

HOW IT ALL STARTED

Small loans
distributed at high
rate of interest

Large Loan given at

low rate of interest

Money is Invested

HIGH profits
FINANCIAL INSTITUTUION/
INVESTMENT BANK

ABOUT THE CRISIS

Post 2001, the US government had encouraged US banks to lend money to
people, to encourage spending & investing mainly for the purpose of buying
houses
These banks granted loans to large number of borrowers despite having
lower income levels, unsure employment status, unscrupulous credit history,
etc.
Huge number of borrowers availed of bank credit without evaluating their
repayment capacities. The economy was flush with liquidity & stock markets
were booming

CONTINUED..
A silent storm brewed in international financial markets with origins
in the US housing market, which witnessed an unprecedented boom
since 2001
The boom was led by rising housing prices, low interest rates.
Housing prices in USA began to drop in 2006. Rising interest rates
& falling housing prices led to rise in sub prime mortgage
delinquencies & resultant foreclosure
Result: The housing bubble burst in Aug 2006

SEQUENCE OF EVENTS

CONTINUED.. (HOUSING BUBBLE)

Up until 2006, the housing market in the United States was
flourishing due to the fact that it was so easy to get a home loan.
Individuals were taking on subprime mortgages, with the
expectations that the price of their home would continue to rise and
that they would be able to refinance their home before the higher
interest rates were to go into effect. 2005 was the peak of the
subprime boom. At this time, 1 in 5 mortgages was subprime.
However, the housing bubble burst and housing prices had
reached their peak. They were now on a decline.

BUBBLE BURST

CONTINUED.
Home prices reached their peak in the second quarter of 2006.
They did not fall drastically at first.
Home prices fell by less than 2 percent from the 2nd quarter of
2006 to the 4th quarter of 2006.
The foreclosure start rates increased by 43 percent over these two
quarters, and increased by 75 percent in 2007 compared to 2006.
This implies that mortgage default rates began to rise as soon as
home prices began to fall.

CONTINUED.

The increase in foreclosures added to the inventory of homes available

for sale.

This further decreased home prices, putting more homeowners into a

negative equity position and leading to more foreclosures.
The increase in foreclosures also decreased the value of mortgagebacked securities.
This made it difficult for investment banks to issue new mortgagebacked securities, eliminating a major source of financing for new
mortgage loans and contributing to the continuing decline in home
prices.

IMPACTS ON FINANCIAL SYSTEM

Large losses were incurred by the following groups:
I. Mortgage lenders: One thirds of top 30 mortgage lenders have
either been acquired or have filed for bankruptcy or have been
liquidated.
II. Investment banks: Since the housing bubble burst, the five largest
U.S. investment banks have either filed for bankruptcy (Lehman
Brothers), been acquired by other Firms or become commercial
banks subject to greater Regulation.
III. Foreign investors (mainly banks and governments) who had
invested in mortgage backed securities.
IV. Insurance companies: (e.g., AIG) who had sold credit default swaps.
Credit default swaps are a type of contract that insures against the
mortgage-backed securities.

IMPACT ON INDIA
Year

Growth Rate

2005-06

9.5

2006-07

9.6

2007-08

9.3

2008-09

6.8

2009-10

8.0

2010-11

8.6

BSE SENSEX PERFORMANCE IN 2008

Month

Open

High

Low

Close

January

20325.27

21,206.77

15,332.42

17468.71

February

17820.67

18,895.34

16,457.74

17578.72

March

17227.56

17,227.56

14,677.24

15644.44

April

15771.72

17,480.74

15,297.96

17287.31

May

17560.15

17,735.70

16,196.02

16415.57

June

16591.46

16,632.72

13,405.54

13461.60

July

13480.02

15,130.09

12,514.02

14355.75

August

14064.26

15,579.78

14,002.43

14564.53

September

14412.99

15,107.01

12,153.55

12860.43

October

13006.72

13,203.86

7,697.39

9788.06

November

10209.37

10,945.41

8,316.39

9092.72

December

9162.94

10,188.54

8,467.43

9647.31

FALL OF INR
Dec 30th 08 : 1USD =48INR
Jan 1st 08 : 1USD =39INR

Dec 1st 08 : 1USD=50INR

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