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.

In India there are 5 credit rating agencies. First, Credit Rating InformationServices Of India Limited (CRISIL) set up by ICICI AND UTI in 1988. Secondly InvestmentInformation and Credit Rating Agency of India limited (ICRA) set up by IFCI in 1991. Thirdly,Credit Analysis and Research Limited (CARE) promoted by IDBI in 1993 in association withfinancial institutions. Fourthly, Duff and Phelps Credit Rating India Private Limited (DCR India) for rating non-banking financial companies for fixed deposits

TYPES OF CREDIT RATINGS
Two type of credit rating has been noticed :
1) Traditional debt rating (TDR)
2) Private placement rating (PPR)

Traditional debt ratings (TDR):
Traditional debt ratings are a symbolic prediction about the debtsecurity probability resulting in a default in timely payment of interest and principal. In other words,traditional debt rating reflects the current opinion of a credit rating agency of the relative capabilityand willingness of an issuer of a debt instrument to service the debt obligation as per the term of contract .Traditional debt rating is specific to specific to a debt instrument in term of credit risk associated with such instrument .Traditional debt rating enable an investor to establish a link between risk and return and provide a symbolic yardstick to identify the risk level associated withthe instrument and the return it offers to match with his preferences with expectations

Private placement rating (PPR):
Privately rating is newly introduced credit rating system finding in the literature generated by standard & poor on credit rating , private placement rating is not much different to traditional debt rating but it goes one step ahead to traditional debt rating ,ie. Apart fromevaluating a risk of default in timely payment it also evaluates the likelihood of loss to an investor in the vent of default according on the investment . Never the less, either or both of the two types of rating can be used for new issues of debt securitiesor structured obligations.

RATING SYMBOLS

Rating agencies use symbols such as AAA, AA, BBB, B, C, D, to convey the safetygrade to the investor. Ratings are classified into three grades: High investment grades, investmentgrades and speculative grades. In all ratings is classified into 14 or 15 categories. Signs “+” or “-”are used to show the certainty of timely payment. The suffix + or – may be used to indicate thecomparative position of the instrument within the group covered by the symbol. Thus FAA- lies onenotch above FA+. To provide finer gradations, rating industry attach + or – to their ratings. Therating symbols for different instruments of the same company need not necessarily be the same.

High Investment Grades AAA: - Triple A denotes highest safety in terms of timely payment of interest and principal. The issuer is fundamentally strong and any adverse changes are not going to affect it.

AA: - Double A denotes high safety in terms of timely payment of interest and principal. The issuer differs in safety from AAA issue only marginally.

Investment Grades A: - denotes adequate safety in terms of timely payment of interest and principal. Changes in circumstances can adversely affect such issues.

BB: - Triple B denotes moderate safety in terms of timely payment of interest and principal speculative grades.

Speculative Grades BB: - Double B denotes inadequate safety terms of timely payment of interest and principal. Uncertain changes can lead to inadequate financial capacity to make timely paymentsin the immediate future.

B: - denotes high risk. Adverse changes could lead to inability or unwillingness to pay timely payment.

C: - denotes substantial risk. Issue rated is vulnerable to default.

D: - denoted default in terms of timely payment of interest and principal.These symbols are just a current opinion of an agency and they are not recommendations toinvest or not to invest. The rating assigned applies to a particular instrument of the company and is not a general evaluation of the company.

Rating Fees: -In the credit rating business, the users of rating service, such as investors, financialintermediaries and other end- users, do not pay for it. The issuer of the financial instrument pays feesto the credit rating industry and this is the major source of revenue to the rating agency.

FUNCTIONS OF CREDIT RATING AGENCIES

1. Superior information 2. Low cost information 3. Basis for proper risk, return and trade off 4. Healthy discipline on corporate borrowers 5. Formulation of public policy guidelineson institutional investment.

CREDIT RATING INFORMATION SERVICES LTD.
The first creditagency floated on january 1, 1988. It was jointly started by ICICI and UTI with an equity capital of 4 crores. CRISIL is india’s leading rating agency, and is the fourth largest in the world.
The principle objective if CRISIL is to rate the debt obligations of indian companies. Its rating guides the investorsabout the risk of timely payment of interest and principal on particular debt instrument.
Debenture rating symbols:
High investment grades: - AAA,AA
Investment grades: - A, BBB
Speculative grades: - BB, B, C, D

INVESTMENT INFORMATION AND CREDIT RATING AGENCY OF INDIA
ICRA Limited ( an associateof moody’s investor service) was incorporated in 1991 as an independent and professional company. ICRA is a leading provider of investment information and credit rating services in india. ICRA’s major shareholders include moody’s investor service and leading indian financial institutions and banks.
Services provided by ICRA: - 1. Rating services information 2. Grading and research services 3. Advisory services 4. Economic research outsourcing

ICRA was set up byindustrial finance corporation of india on 16th jan 1991. It is a public limited company with an authorized share capital of 10 crores. The initial paid up capital was subscibed by IFC, UTI. LIC, GIC, SBI and others.
Debenture and preference rating symbols:
LAAA, LAA, LA, LBBB, LBB, LB, LC, LD

CREDIT ANALYSIS AND RESEARCH ON EQUITY
CARE was promoted in 1993 jointly with investment companies, banks and finance companies. Services offered by CARE are credit rating, information service, equity reasearch etc.
Long term debt rating symbols;
CARE AAA
CARE AA
CARE A
CARE BB
CARE B
Medium term instruments:
CARE AAA, CARE AA, CARE A, CARE BB, CARE C

CREDIT RATING: THE PROCESS

Lesson Objectives
· To understand the process of credit rating, mechanism of credit rating,
Credit Rating Process
The rating process begins with the receipt of formal request from a company desirous of having its issue obligations rated by credit rating agency. A credit rating agency constantly monitors all ratings with reference to new political, economic and financial developments and industry trends. The process/procedure followed by all the major credit rating agencies in the country is almost similar and usually comprises of the following steps.
1. Receipt of the request: The rating process begins, with the receipt of formal request for rating from a company desirous of having its issue obligations under proposed instrument rated by credit rating agencies. An agreement is entered into between the rating agency and the issuer company. The agreement spells out the terms of the rating assignment and covers the following aspects: * It requires the CRA (Credit Rating Agency) to keep the * information confidential. * It gives right to the issuer company to accept or not to * accept the rating. * It requires the issuer company to provide all material * information to the CRA for rating and subsequent * surveillance.
2. Assignment to analytical team: On receipt of the above request, the CRA assigns the job to an analytical team. The team usually comprises of two members/analysts who have expertise in the relevant business area and are responsible for carrying out the rating assignments.
3. Obtaining information:. The analytical team obtains the requisite information from the client company. Issuers are usually provided a list of information requirements and broad framework for discussions. These requirements are derived from the experience of the issuers business and broadly confirms to all the aspects which have a bearing on the rating. The analytical team analyses the information relating to its financial statements, cash flow projections and other relevant information.
4. Plant visits and meeting with management: To obtain classification and better understanding of the client’s operations, the team visits and interacts with the company’s executives. Plants visits facilitate understanding of the production process, assess the state of equipment and main facilities, evaluate the quality of technical personnel and form an opinion on the key variables that influence level, quality and cost of production. Direct dialogue is maintained with the issuer company as this enables the CRAs to incorporate non-public information in a rating decision and also enables the rating’ to be forward looking. The topics discussed during the management meeting are wide ranging including competitive position, strategies, financial policies, historical performance, risk profile and strategies in addition to reviewing financial data.
5. Presentation of findings: After completing the analysis, the findings are discussed at length in the Internal Committee, comprising senior analysts of the credit rating agency. All the issue having a bearing on rating are identified. An opinion on the rating is also formed. The findings of the team are finally presented to Rating Committee.
6. Rating committee meeting: This is the final authority for assigning ratings. The rating committee meeting is the only aspect of the process in which the issuer does not participate directly. The rating is arrived at after composite assessment of all the factors concerning the issuer, with the key issues getting greater attention.
7. Communication of decision: The assigned rating grade is communicated finally to the issuer along with reasons or rationale supporting the rating. The ratings which are not accepted are either rejected or reviewed in the light of additional facts provided by the issuer. The rejected ratings are not disclosed and complete confidentiality is maintained.
8. Dissemination to the public: Once the issuer accepts the rating, the credit rating agencies disseminate it through printed reports to the public.
9. Monitoring for possible change: Once the company has decided to use the rating, CRAs are obliged to monitor the accepted ratings over the life of the instrument. The CRA constantly monitors all ratings with reference to new political, economic and financial developments and industry trends. All this information is reviewed regularly to find companies for ,major rating changes. Any changes in the rating are made public through published reports by CRAs.

Rating Methodology
Rating methodology used by the major Indian credit rating agencies is more or less the same. The rating methodology involves an analysis of all the factors affecting the creditworthiness of an issuer company e.g. business, financial and industry characteristics, operational efficiency, management quality, competitive position of the issuer and commitment to new projects etc. A detailed analysis of the past financial statements is made to assess the performance and to estimate the future earnings. The company’s ability to service the debt obligations over the tenure of the instrument being rated is also evaluated.
MANAGEMENT OF FINANCIAL SERVICES obligations that determine the rating. While assessing the instrument, the following are the main factors that are analysed into detail by the credit rating agencies.
1. Business Risk Analysis
2. Financial Analysis
3. Management Evaluation
4. Geographical Analysis
5. Regulatory and Competitive Environment
6. Fundamental Analysis
These are explained as under:
I. Business Risk Analysis: - Business risk analysis aims at analysing the industry risk, market position of the company, operating efficiency and legal position of the company. This includes an analysis of industry risk, market position of the company, operating efficiency of the company and legal position of the company. a. Industry risk: The rating agencies evaluates the industry risk by taking into consideration various factors like strength of the industry prospect, nature and basis of competition, demand and supply position, structure of industry, pattern of business cycle etc. Industries compete with each other on the basis of price, product quality, distribution capabilities etc. Industries with stable growth in demand and flexibility in the timing of capital outlays are in a stronger position and therefore enjoy better credit rating. b. Market position of the company: Rating agencies evaluate the market standing of a company taking into account: * Percentage of market share * Marketing infrastructure * Competitive advantages * Selling and distribution channel * Diversity of products * Customers base * Research and development projects undertaken to * identify obsolete products * Quality Improvement programs etc. c. Operating efficiency: Favorable locational advantages, management and labor relationships, cost structure, availability of raw-material, labor, compliance to pollution control programs, level of capital employed and technological advantages etc. affect the operating efficiency of every issuer company and hence the credit rating. d. Legal position: Legal position of a debt instrument is assessed by letter of offer containing terms of issue, trustees and their responsibilities, mode of payment of interest and principal in time, provision for protection against fraud etc. e. Size of business: The size of business of a company is a relevant factor in the rating decision. Smaller companies are more prone to risk due to business cycle changes as compared to larger companies. Smaller companies operations are limited in terms of product, geographical area and number of customers. Whereas large companies enjoy the benefits of diversification owing to wide range of products, customers spread over larger geographical area. Thus, business analysis covers all the important factors related to the business operations over an issuer company under credit assessment.

II. Financial Analysis
Financial analysis aims at determining the financial strength of the issuer company through ratio analysis, cash flow analysis and study of the existing capital structure. This includes an analysis of four important factors namely:
a. Accounting quality
b. Earnings potential/profitability
c. Cash flows analysis
d. Financial flexibility
Financial analysis aims at determining the financial strength of the issuer company through quantitative means such as ratio analysis. Both past and current performance is evaluated to comment the future performance of a company. The areas considered are explained as follows.
a. Accounting quality: As credit rating agencies rely on the audited financial statements, the analysis of statements begins with the study of accounting quality. For the purpose, qualification of auditors, overstatement/understatement of profits, methods adopted for recognising income, valuation of stock and charging depreciation on fixed assets are studied.
b. Earnings potential/profitability: Profits indicate company’s ability to meet its fixed interest obligation in time. A business with stable earnings can withstand any adverse conditions and also generate capital resources internally. Profitability ratios like operating profit and net profit ratios to sales are calculated and compared with last 5 years figures or compared with the similar other companies carrying on same business. As a rating is a forward-looking exercise, more emphasis is laid on the future rather than the past earning capacity of the issuer.
c. Cash flow analysis: Cash flow analysis is undertaken in relation to debt and fixed and working capital requirements of the company. It indicates the usage of cash for different purposes and the extent of cash available for meeting fixed interest obligations. Cash flows analysis facilitates credit rating of a company as it better indicates the issuer’s debt servicing capability compared to reported earnings.
d. Financial flexibility: Existing Capital structure of a company is studied to find the debt/equity ratio, alternative means of financing used to raise funds, ability to raise funds, asset deployment potential etc. The future debt claims on the issuer’s as well as the issuer’s ability to raise capital is determined in order to find issuer’s financial flexibility.

III. Management Evaluation: - Any company’s performance is significantly affected by the management goals, plans and strategies, capacity to overcome unfavorable conditions, staff’s own experience and skills, planning and control system etc. Rating of a debt instrument requires evaluation of the management strengths and weaknesses.

IV. Geographical Analysis
Geographical analysis is undertaken to determine the locational advantages enjoyed by the issuer company. An issuer company having its business spread over large geographical area enjoys the benefits of diversification and hence gets better credit rating.
A company located in backward area may enjoy subsidies from government thus enjoying the benefit of lower cost of operation. Thus geographical analysis is undertaken to determine the locational advantages enjoyed by the issuer company.

V. Regulatory and Competitive Environment
Credit rating agencies evaluate structure and regulatory framework of the financial system in which it works. While assigning the rating symbols, CRAs evaluate the impact of regulation/deregulation on the issuer company

VI. Fundamental Analysis
Fundamental analysis includes an analysis of liquidity management, profitability and financial position, interest and tax rates sensitivity of the company. This includes an analysis of liquidity management, profitability and financial position, interest and tax rates sensitivity of the company. * Liquidity management involves study of capital structure, availability of liquid assets corresponding to financing commitments and maturing deposits, matching of assets and liabilities. * Asset quality covers factors like quality of company’s credit risk management, exposure to individual borrowers and management of problem credits etc. * Profitability and financial position covers aspects like past profits, funds deployment, revenues on non-fund based activities, addition to reserves. * Interest and tax sensitivity reflects sensitivity of company following the changes in interest rates and changes in tax law.