Credit Rating Services

Presented by: Dhaval Navadiya Nemik Shah Viren Chaudhari Hemant Patel (14) (21) (23) (24)

Meaning & Definition: An assessment of the credit worthiness of individuals and corporations, It is based upon the history of borrowing and repayment, as well as the availability of assets and extent of liabilities. Rating is an opinion regarding the timely repayment of principal and interest thereon; It is expressed by assigning symbols, which have definite meaning. It is important to emphasize that credit ratings are not recommendations to invest. It has to be noted that there is no private of contract between an investor and a rating agency and the investor is not protected by the opinion of the rating agency.

Origin of concept of CR: Originated in the US in 1909 AD when the founder of Moodys Investor Service, John Moody, rated the US Rail Road Bonds. the relevance of this concept was realized only after the great depression when investors lost all their money. Lack of symmetric information and high costs of collecting information increased the popularity of credit rating agencies. Moodys and S&P have been rating bonds since 1916 and have captured the lions share. These agencies have grown so powerful that even sovereign governments are worry of getting a poor rating from them. India was first among the developing world to set up a credit rating agency Credit Rating Information Services of India Limited (CRISIL) in 1988.

Credit Rating can be for: -

Need For CR: Growing number of cases of defaults in payment of interest and repayment of principal sum borrowed byway of fixed deposits, issue of debentures or preference shares or commercial papers. Maintenance of investors confidence, since defaults shatter the confidence of investors in corporate instruments. Protect the interest of investors who cannot into merits of the debt instruments of a company. Motivate savers to invest in industry and trade.

Objectives: To provide superior and low cost information to investors for taking a decision regarding risk return trade off. To Improve a healthy discipline on borrowers To help merchant bankers, brokers, regulatory authorities, etc., in discharging their functions related to debt issues To encourage greater information disclosure, better accounting standards, and improved financial information (helps in investors protection)

Importance: Credit rating helps in the development of financial markets. Credit rating agencies play a key role in the infrastructure of the modern financial system. It saves the investors time and enables him to take quick decisions and provides him better choices available investment opportunities. Issuers with a high credit rating can raise funds at a cheaper rate thereby lowering their cost of capital.

Advantages For: Investors

Safeguard against bankruptcy Easy understandability Savings of resources Quick investment decision Choice of investment Benefit of surveillance

Rated Companies
Low cost of borrowing Increase in investors population Rating as a marketing tool Encourages financial discipline Motivation for growth Merchants job became easy

Brokers & Financial Intermediaries.

Saves time, money, energy & manpower for convincing clients about investment. Less effort in studying companies credit position to convince their clients Easy to select profitable investment security

Disadvantages: Biased rating & misinterpretation. Static Study. Concealment of material information. No guarantee for soundness of the company. Reflection of temporary and adverse conditions. Present rating may change (down grade).

Classification of CR agencies: -

International agencies: Moodys Credit Rating Agency: Moody's is an essential component of the global capital markets, providing credit ratings, research, tools and analysis that contribute to transparent and integrated financial markets. Moody's Corporation (NYSE: MCO) is the parent company of Moody's Investors Service. The Corporation, which reported revenue of $2 billion in 2010, employs approximately 4,500 people worldwide and maintains a presence in 26 countries.

International agencies: Standard & Poors: In 1906, Luther Lee Blake founded the Standard Statistics Bureau, with the view to providing financial information on non-railroad companies. In 1941, Poor and Standard Statistics merged to become Standard & Poor's Corp. In 1966, the company was acquired by The McGraw-Hill Companies, and now encompasses the Financial Services division.
Fitch IBCA: -

Fitch Ratings positions itself as a global rating agency dedicated to providing value beyond the rating through independent and prospective credit opinions, research and data. Fitch Ratings was one of the three Nationally Recognized Statistical Rating Organizations (NRSRO) designated by the U.S. Securities and Exchange Commission in 1975, together with Moody's and Standard & Poor's. It is one of the "Big Three credit rating agencies"

Interpretation

Moodys
Long-term Shortterm

Standard & Poors

Long-term Shortterm

Fitch
Longterm AAA AA+ AA AAA+ A ABBB+ BBB BBBBB+ BB BBB+ B BCC+ CCC CCCCC C,D Shortterm

Investment-grade ratings
Highest credit quality High credit quality Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca,C AAA AA+ AA AAA+ A ABBB+ BBB BBBBB+ BB BBB+ B BCCC+ CCC CCCCC C,D

Prime-1

A1+

F1

strong payment capacity Adequate payment capacity Last rating in investment -grade

Prime-2

A1 A2 A3

Prime-3

F2 F3

Speculative-grade rating
Speculative Credit risk developing due to economic changes Highly speculative credit risk present with limited margin safety high default risk, capacity depending on sustains favorable conditions Default, Although Prospect of partial recovery B B

Not Prime

Indian Credit Rating System: -

Registration of Credit Rating Agencies : Registration with the SEBI is mandatory for carrying on the rating business. The application for the grant of certificate of registration should be made to the SEBI and accompanied by a non-refundable fee of Rs 50,000. A credit rating agency means a body corporate. engaged/proposed to be engaged in the business of rating of securities offered by way of public/rights issues.

Indian Credit Rating Agencies : Credit Rating and Information Services of India Ltd. (CRISIL): CRISIL is the largest credit rating agency in India. CRISIL pioneered ratings in India more than 20 years ago, and is today the undisputed business leader, with the largest number of rated entities and rating products: CRISIL's rating experience covers more than 41,738 entities, including 20,000 small and medium enterprises (SMEs). As on June 30, 2011, CRISIL had more than 13,787 ratings (including over 6,800 SMEs) outstanding

Indian Credit Rating Agencies : Credit Analysis & Research Ltd. (CARE): Credit Analysis & Research Ltd is a full service rating company that offers a wide range of rating and grading services across sectors. CARE Ratings has completed over 9844 rating assignments having aggregate value of about Rs.31190 bn (as at March, 2011).

Investment Information and Credit Rating Agency of India (ICRA): ICRA Limited, was established in 1991, and was originally named Investment Information and Credit Rating Agency of India Limited (IICRA India). The company changed its name to ICRA Limited, and went public on 13 April 1997, with a listing on the BSE and the NSE. Moody's continues to be the largest single shareholder in ICRA. ONICRA Credit Rating Agency of India Ltd : Onicra was established in 1993, by Mr. Sonu Mirchandani, who at the time, promoted consumer durables major, Onida. Unlike the West, India did not have a credible system to screen financial profiles. Operations began with one office that conducted 10 cases per month. network of over 148 branches, covering more than 500 locations panIndia, and touches over 30,000 unique case every day.

Rating Methodology: Business Analysis: Industry risk (demand/supply, number of firms and potential entrants in the industry, government policies relating to the industry, the performance of the industry, its future potentiality etc.). Market position in the industry (marketing strengths and weaknesses of the firm vis--vis its competitors). Operating efficiency (production processes of the firm, its cost structure, locational advantages, labour relationships, input availability).

Legal position. Financial Analysis: Accounting quality (method of income recognition, inventory valuation, depreciation policies, auditors remarks, and off-balance liabilities.) earnings, among others.) Adequacy of Cash flows (future cash flows, working capital needs, and capital budgets.) Financial Flexibility (whether alternative financing plans have been developed and the feasibility of such plans)

Earning protection (profitability ratios, earnings growth, and projected

 Management Evaluation: This includes a study of the track record of the management, the managements capacity to overcome adverse situation, goals, philosophy, and strategies.

Fundamental Analysis: Liquidity Management (capital structure, matching of assets and liabilities, liquid assets, maturing deposits, among others.)

Asset quality (companys credit management, policies for monitoring

credit, composition of assets, and sector risk.) Profitability (profitability ratios, spreads, reserves, and non-business income.) Interest and tax sensitivity (exposure to interest rate charges, hedge against interest rate, tax provisions, and impact of tax law changes)

 Rating Fees: In the credit rating business, the users of rating services, such as investors, financial intermediaries and other end-users, do not pay for it. The issuer of the financial instrument pays fees to the credit rating agency. Today, issuers fees constitute 95 percent of the total revenues of rating agencies. In India, rating agencies charge 0.1 percent of instrument size as rating fees. They also charge an annual surveillance fees at a rate of 0.03 percent to monitor the instrument during its life.

Comparisons of Indian Credit Rating Agencies Rating Symbols: Particular CRISIL CARE ICRA
Long Term Instruments Highest Safety High Safety Adequate Safety Moderate Safety Moderate Risk High Risk Very High Risk Default CRISIL AAA CRISIL AA CRISIL A CRISIL BBB CRISIL BB CRISIL B CRISIL C CRISIL D CARE MLD AAA CARE MLD AA CARE MLD A CARE MLD BBB CARE MLD BB CARE MLD B CARE MLD C CARE MLD D LAAA LAA LA LBBB LBB LB LC LD

Short Term Instruments Lowest Credit Risk (CRISIL)A1 CARE MLD PR-1 (ICRA)A1

Low Credit Risk High Adequate credit Risk High Risk Susceptible of default
Default

(CRISIL)A2 (CRISIL)A3 (CRISIL)A4

(CRISIL)D

CARE MLD PR-2 CARE MLD PR-3 CARE MLD PR-4

CARE MLD PR-5

(ICRA)A2 (ICRA)A3 (ICRA)A4

(ICRA)D

 Securities and Exchange Board of India (Credit Rating Agencies) Regulations, 1999. 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 are required to have a minimum net worth of Rs 5 crore. Rating agencies cannot assess financial instruments of their promoters who have more than 10 percent stake in them. They 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, and employees on the rating committee. 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. A 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.

SEBI regulations for CR agencies: -

Growth of CR agencies in India: Indian agencies came 2nd, after the US in terms of number of ratings issued and in the number of agencies. Between the four rating agencies in India, over 5,000 ratings have been issued for around 1,400 issuers. In 1992, for the first time, the Reserve Bank introduced the requirement of rating for commercial paper. The SEBI followed up by introducing mandatory rating of bonds. in the private placements, rating is not mandatory but banks and mutual funds ask for a rating. In 1997, the penetration of rating, that is, the number of rated issues out of the total number of issues was 35 percent. In the year 2002, it was 97 percent. Between fiscal 1997 and 2001, rated debt volumes increased from Rs 13,743 crore to Rs 52,746 crore, which is 84 percent of the total issuance.

Recent changes of CR: CRISIL upgraded 605 ratings and downgraded 269 ratings in 2010-11 (refers to financial year, April 1 to March 31) on a base of around 6200 ratings as on March 31, 2011.

Recent changes of CR: Improvement in CRISILs modified credit ratio (MCR, and indicator of the relative frequency of upgrades and downgrades) to 1.10 times in 2010-11 from 0.93 times in 2009-10. While the upgrades have been broad-based, across rating categories and industries, the downgrades have been largely concentrated in the low rating categories of BB and lower. Upgrades outnumbered downgrades in 2010-11, driven largely by healthy demand conditions and a favorable funding environment. The proportion of ratings with positive outlooks has increased to 4.5 percent as on March 31, 2011 and is higher than the precrisis. The proportion of ratings with negative outlooks has reduced from a year ago.

While the upgrade rate has increased to 6.3 percent in H2 2010-11, there is a moderation in the pace of improvement. CRISIL believes that the credit quality of Indias corporates is peaking and further improvement in credit quality is unlikely from these levels.

Movement in Overall Annual Default Rates since Inception: Since CRISIL's inception in 1988, there have been 239 defaults by issuers carrying a long-term rating. The statistics indicate a steady decline in default rates from 1998 to 2007, increase in 2008 and 2009 due to the economic slowdown, and a decrease in 2010. Default rates have to be both low and stable, over a given time horizon, to be usefully factored for the pricing of debt.

Thank You !