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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.
Performs isolated function of credit risk evaluation Rating is an issue specific view Useful in differentiation of credit quality
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The process of assigning a symbol with specific reference to the instrument being rated, that acts as an indicator of the current opinion on relative capability on the issuer to service its debt obligation in a timely fashion
The
relative ranking of the default- loss probability for a given fixed income investment, in comparison with other rated instruments
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Moodys a rating is an opinion on the future ability and legal obligation of the issuer to make timely payments of principal & interest on a specific fixed income security. The rating measures the probability that the issuer will default on the security over its life, which depending on the instrument, may be a matter of days to 30 years or more. In addition, long term ratings incorporate an assessment of the expected monetary loss, should a default occur.
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The Rating agency must do all it can to preserve its credibility and integrity in the market place. As a primary ingredient of credibility, the agency must maintain independence from all interested market forces, including issuers, security underwriters, or government. Credit rating is a simple and easy to understand symbolic indicator of the opinion of a credit rating agency about the risk involved in a borrowing programme of an issuer with reference to the capability of the issuer to repay the debt as per terms of issue.
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General purpose evaluation of issuer Audit of the issuing company One time assessment valid over life of the instrument A recommendation to purchase, sell, or hold a security Predictors of default Guarantees against losses
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1. 2. 3.
Rating is based on information Many factors affect rating Rating by more than one agency Publication of ratings Right of appeal against assigned rating Rating of rating agencies Rating is for instrument and not for the issuer Rating not applicable to equity shares Credit v/s financial analysis Time taken in rating process
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The following factors generally influence the ratings to be assigned by a credit rating agency: The security issuers ability to service ratings Factors affecting assignedits debt - they calculate the past and likely future cash flows and compare with fixed interest obligations of the issuer.
1.
2. The volume and composition of outstanding debt. 3. The stability of the future cash flows and earning capacity of company. 4. The interest coverage ratio i.e. how many number of times the issuer is able to meet its fixed interest obligations. 5. Ratio of current assets to current liabilities (i.e. current ratio (CR)) is calculated to assess the liquidity position of the issuing firm.
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6. The value of assets pledged as collateral security and the securitys priority of claim against the issuing firms assets. 7. Market position of the company products is judged by the Factors affecting assigned ratings demand for the products, competitors market share, distribution channels etc. 8. Operational efficiency is judged by capacity utilisation, prospects of expansion, modernisation and diversification, availability of raw material etc. 9. Track record of promoters, directors and expertise of staff also affect the rating of a company.
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has no vested interest in an issue unlike brokers, financial intermediaries. own reputation is at stake.
Its
2. Provides quality and dependable information:. A credit rating agency is in a position to provide quality information on credit risk which is more authenticate and reliable because:
It
has highly trained and professional staff who has better ability to assess risk.
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3. Provides information at low cost: Most of the investors rely on the ratings assigned by the ratings agencies while taking investment decisions. These ratings are published in the form of reports and are available easily on the payment of negligible price. It is not possible for the investors to assess the creditworthiness of the companies on their own. 4. Provide easy to understand information: Rating agencies first of all gather information, then analyse the same. At last these interpret and summarise complex information in a simple and readily understood formal manner. Thus in other words, information supplied by rating agencies can be easily understood by the investors. They need not go into details of the financial statements.
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5. Provide basis for investment: An investment rated by a credit rating enjoys higher confidence from investors. Investors can make an estimate of the risk and return associated with a particular rated issue while investing money in them. 6. Healthy discipline on corporate borrowers: Higher credit rating to any credit investment enhances corporate image and builds up goodwill and hence it induces a healthy/ discipline on corporate. 7. Formation of public policy: Once the debt securities are rated professionally, it would be easier to formulate public
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Benefits to investors:
1. 2. 3. 4. 5. 6. 7. 8.
Safety of investments Recognition of risk and returns Freedom of investment decisions Wider choice of investments Dependable credibility of issuer Easy understanding of investment proposals Relief from botheration to know company Advantages of continuous monitoring
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Easy to raise resources Reduced cost of borrowing Reduced cost of public issues. Rating builds up image Rating facilitate growth Recognition to unknown companies
Benefits to intermediaries:
1.
Less efforts in persuading their clients to select an investment proposal. Saves time, efforts, costs and manpower in convincing 5/24/12
2.
Non- disclosure of significant information Static study Rating is no certificate of soundness Rating may be biased Rating under unfavourable conditions Difference in rating grades
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Rating process
1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Mandate Assign Rating Team Receive initial information Secondary data Meetings and visits Preview Meeting Surveillance Committee meeting Rating communication Rating reviews
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Mandate Assign Rating Team Receive initial information conduct basic research Meetings and visits Analysis and preparation of report Preview meeting Rating meeting Assign rating Communicate the rating and rationale Acceptance Surveillance
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FINANCIAL RISK
MANAGEMENT EVALUATION
BUSINESS RISK
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FINANCIAL RISK
PROJECT RISK
MANAGEME NT EVALUATIO N
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Industry Risk
Industry Structure
Determinants Entry
Extent of Competition
Nature Threat
Presence
Market Position
Market share Competitive advantages
Brand
equity flexibility
Pricing
of exports
Operating Efficiency
Cost structure Manufacturing efficiency Production flexibility Technology risk Raw material sourcing Location factors
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recognition capitalization and inventory valuation policies income sheet and contingent liabilities
Expense
Depreciation Off-balance
Non-operating
Sustainability
Earnings Protection
Profitability Interest Capital Debt
measures
service coverage on capital employed to raise equity and debt funds in times of stress
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Working Return
Financial Flexibility
Ability Alternatives Liquid
assets available
Management Evaluation
Strength of linkage to parent/ group
implementation record
1) Nature of industry 2) Market position 3) Efficiency of operation 4) Project risk 5) Protective factors 6) Quality of management
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1) Financing policies 2) Flexibility of financial structure 3) Past financial performance 4) Quality of accounting policy 5) Financial performance indicators a) Profitability b) Gearing or level of leveraging c) Coverage ratios d) Liquidity position
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AA+ AA AA -
S&P and others BBB+ Adequate payment capacity BBB Adequate payment capacity BBB - Adequate payment capacity
CCC-
As above
Ca
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ICRA Limited was incorporated on January 16, 1991 and launched its services on August 31, 1991. It is an independent and professional company providing investment information and credit rating services. ICRA has broad based its services to the corporate and financial sectors, both in India and overseas, and presently provides its services under three banners:
Information Advisory
LAAA
High safety
Profile Indicates fundamentally strong position Risk factors are negligible Visualization of any circumstances adversely affecting the degree of safety Timely payment of principal and interest as per terms will not be affected Modest & slightly varying risk factors Strong protective factors
LA+ LA LA-
Adequate safety Risk factors are more variable & greater in periods of economic stress Protective factors are average Any adverse change in circumstances although could be visualized, may alter the fundamental strength and affect the timely payment of principal & interest as per terms Moderate safety Considerable variability in risk factors Protective factors are below average Adverse changes in business/
LB+ LB LB-
Risk prone
LC+ LC LC-
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Risk factors indicate that the obligations may not be met when due Adverse changes in business/ economic conditions could result in inability/ unwillingness to service debts on time as per terms Substantial risk Presence of inherent elements of risk & timely servicing of debts/ obligations could be possible only in case of continued existence of favorable circumstances
MA+ MA MA5/24/12
Adequate safety
MC+ MC MC-
Risk prone
MD
Default
high susceptibility to default adverse changes in business/economic conditions could result in inability/ unwillingness to service debts on time & as per terms either already in default or expected to default
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To assist investors in making investment decisions. To assist issuers in raising funds from a wider investor base. To provide a marketing tool to entities placing debt with clients. To provide regulators with a market driven system for bringing about the development of the capital markets. To institutionalize a viable and market- driven system of credit rating in India.
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4.
5.
Creating awareness of the concept amongst all market participants. Winning credibility, confidence and trust of participants. Generating ratings business that would increase in size as a system of market driven interest rates into play.
2. 3.
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CRISIL ( CREDIT RATING & INFORMATION SERVICES OF INDIA LTD.) 1) Debenture Rating Symbols
Symbol AAA ( Triple A) AA ( Double A) A BBB ( Triple B) BB ( Double B) B C D
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Indicator Highest safety High safety Adequate safety Moderate safety Inadequate safety High risk Substantial risk Default
NOTE: 1) CRISIL may apply + or - signs for ratings from AA to C to reflect comparative standing within the category. 2) The contents within parentheses are a guide to the pronunciation of the rating symbols. 3) Preference share rating symbols are identical to debenture rating symbols except that the letters pf are prefixed to the raring symbols, e.g., pfAAA.
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Indicator Highest Safety High Safety Adequate Safety High risk Default
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Sector
Rating
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ERA 2
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ERB 1
Earning prospects over the medium- term are of the highest grade changes in business / economic circumstances, as may be visualized, are unlikely to significantly impair the underlying fundamentals
ERB 2
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Good earning Earning prospects over prospects & the medium- term are of moderate risk a high grade changes in business / economic circumstances, as may be visualized, may adversely affect the
ERC 1
Moderate Earning prospects over the earning medium- term are moderate prospects & changes in business / low risk economic circumstances, as may be visualized, are unlikely to significantly impair the underlying fundamentals Moderate Earning prospects over the earning medium- term are moderate prospects & changes in business / moderate economic circumstances, as risk may be visualized, may adversely affect the underlying fundamentals Moderate Earning prospects over the earning medium- term are moderate prospects & changes in business /
ERC 2
ERC 3
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ERD 1
Earning prospects over the Poor earning medium- term are low prospects & changes in business / low risk economic circumstances, as may be visualized, are unlikely to significantly impair the underlying fundamentals
ERD 2
ERD 3
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Earning prospects over the Poor earning medium- term are low prospects & changes in business / moderate economic circumstances, as risk may be visualized, may adversely affect the underlying fundamentals Earning prospects over the Poor earning medium- term are low prospects & changes in business /
of ratings is questionable
may lead to herding behaviour thereby increasing the volatility of the capital flows agencies are unable to constantly monitor developments agencies need to maintain expert professional staff lawyers, CAs, CS, MBA, finance analysts, bankers, etc.
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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 . Rating agencies cannot assess financial instruments of their promoters who have more than 10 % stake in them. Rating agencies are required to have a minimum net worth of Rs. 5 crores.
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Rating
agencies cannot rate a security issued by an entity which is a borrower of its promoter or a subsidiary of its promoter or an associate of its promoter, if (1) there are common chairmen, directors between credit rating agency and these entities (2) there are common employees (3) there are common chairmen, directors, employees on the rating committee
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Rating
agencies cannot rate a security issued by its associate 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 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 any condition or contravenes any of the provisions of the act
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CRAs
will keep a record of discussion summary with issuer, management and auditors.
- CRAs will also be required to maintain records of voting details of the rating committee for five years after the maturity of the instrument . - CRAs will formulate policies for conflict of interests. - Individuals in the credit rating process will not be allowed to hold shares of the issuer. - CRAs will be required to disclose methodology of
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SEBI
has made it compulsory for CRAs to have internal audits conducted on a half-yearly basis, that would cover all aspects of CRAs operations and procedures, including investor grievance redressal mechanism.
At present, there are five registered CRAs in India, including CARE, Icra, Fitch, Crisil and Brickwork Ratings India.
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