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    Credit Ratings

    What is Credit Rating?

     

    Credit Rating is an opinion of the credit rating agency on the relative ability of person upon fulfilling the financial commitments or debt service obligations when they arise on the basis of the available information at the particular point of time. Credit rating establishes a link between the return & risk.

     

    Credit rating is usually expressed by alphabetical or symbols which are simple and easily understandable. Normally, the credit rating agencies publish the explanations for the symbols mentioned as well as rationale for the ratings assigned.

     

    Why Credit Rating?

     

    With the increasing market changes in the Indian Economy, investors value systematic assessment of two types of risk namely “Business Risk”&“Payment Risk” arising out of linkages between money, capital, and foreign exchange markets.

     

    With a view to protect small investors, who are the main targets for the unlisted corporate debt in the form of fixed deposits credit ratings are made mandatory.

     

    India was perhaps the first amongst developing countries to setup a credit rating agency in 1988. The function of credit rating was institutionalised when RBI made it mandatory for the issue of Commercial Paper (CP) and subsequently by SEBI, when it made credit rating compulsory for certain categories of debentures and debt instruments.

     

    Objective of Credit Rating:

     

    By definition, the main objective of credit rating is an opinion on issuer’s capacity in servicing the debt.

     

    So, therefore, the credit rating agencies conventionally does not rate equity as the servicing period is not known.

     

    Credit Rating Agencies:

     

    Credit rating Agencies are the companies that assign credit ratings on the ability of the debtor on fulfilling the financial commitments. An agency may rate the instruments, debt repaying obligations for short term & long term of the individuals/ company/ firm, etc.

     

    The Credit Rating Agency in India must be a company and is regulated by SEBI and registration with SEBI is mandatory for rating the business.

     

     

     

     

     

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    SBS Interns' Digest                                                                                                                          www.sbsandco.com/digest

     

    Types of Credit Rating Agencies in India:

     

    There are four standardised credit rating agencies in India:

     

    1. CRISIL (Credit Rating Information Services of India Limited)

     

    1. ICRA (Formerly called Investment Information Credit Rating Agency of India Limited)
    2. CARE
    3. ONICRA Credit Rating Agency Pvt. Ltd

     

    Process of Credit Rating by the Credit Rating Agencies:

     

    1. Pre-Analysis and document collection

     

    1. Finalization of assignment and detailed questionnaire is prepared
    2. Customer and referral feedback is collected
    3. In-depth analysis of the business unit
    4. Site visit scheduled and data collected
    5. Draft Report and rating proposal
    6. Report evaluation by rating committee
    7. Final evaluation is made and rating is given to the business unit

     

     

    How the ratings are given?

     

    ITEM

    RATIO-RANGE

    PARAMETERS

     

     

     

    Current Ratio

    Over 1.50

    20

     

    1.33 to 1.50

    16

     

    1.20 to 1.33

    12

     

    1.10 to 1.20

    8

     

    1.00 to 1.20

    4

     

    Below 1.00

    0

     

     

     

    TOL/TNW

    Above 4.5

    40

     

    4.25 to 4.50

    8

     

    4.00 to 4.25

    12

     

    3.50 to 4.00

    16

     

    1 to 3.50

    20

     

    Below 3.00

    0

     

     

     

     

     

     

     

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    Credit Ratings

     

     

    SBS Interns' Digest                                                                                                                          www.sbsandco.com/digest

     

     

    PBIT/Interest

     

    Over 3.00

     

     

     

     

     

     

     

     

    2.50 to 3.00

     

    10

     

     

     

     

     

    2.00 to 2.50

     

    8

     

     

     

     

     

     

    1.75 to 2.00

     

    6

     

     

     

     

     

     

    1.50 to 1.75

     

    4

     

     

     

     

     

     

    Below 1.50

     

    20

     

     

     

     

     

     

     

     

     

     

     

     

    PAT/ Net sales

     

    Above 15%

     

    10

     

     

     

     

     

    13-15%

     

    8

     

     

     

     

     

     

    11-12%

     

    6

     

     

     

     

     

     

    9-10%

     

     

    4

     

     

     

     

     

     

    7-8%

     

     

    2

     

     

     

     

     

     

    Less than 6%

     

    0

     

     

     

     

     

     

     

     

     

     

     

     

     

    ROCE

     

    20%

     

     

    10

     

     

     

     

     

    Below 10%

     

    0

     

     

     

     

     

     

     

     

     

     

     

     

    Current Asset Holding

    120 days

     

    15

     

     

     

     

     

    Above 185 days

    0

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    S.NO.

     

    RATING

     

    SYMBOL

     

    COMPANY SCORE

     

     

     

     

     

     

     

     

     

     

    1

     

     

    Highest Safety

     

    A+

     

    Above 90

     

     

     

     

     

     

     

     

     

     

    2

     

     

    High Safety

     

    A

     

    Between 80 & 90

     

     

     

     

     

     

     

     

     

     

    3

     

     

    Fairly High Safety

     

    A-

     

    Between 70 & 80

     

     

     

     

     

     

     

     

     

     

    4

     

     

    Moderate Safety

     

    B

     

    Between 60 & 70

     

     

     

     

     

     

     

     

     

     

    5

     

     

    Low Safety

     

    C

     

    Between 50 & 60

     

     

     

     

     

     

     

     

     

     

    6

     

     

    Very Poor

     

    D

     

    Below 50

     

     

     

     

     

     

     

     

     

     

     

     

     

     

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    Credit Ratings

     

     

    SBS Interns' Digest                                                                                                                          www.sbsandco.com/digest

     

    Credit Rating Agencies globally:

     

    The “Big Three” credit rating agencies controlling around 95% of the rating business are as follows;

     

    • Moody’s Investor Service

     

    • Standard & Poor (S&P)
    • Fitch Ratings

     

    Credit Ratings:

     

     

    MOODY’S

    S&P

    FITCH

     

    MEANING

     

    Aaa

    AAA

    AAA

     

    High Quality, Extremely strong capacity to meet its financial

     

     

    commitments.

     

     

     

     

     

     

    Aa1

    AA+

    AA+

     

    High  Quality,  Very  Strong  Capacity  to  meet  financial

     

    Aa2

    AA

    AA

     

    obligations with very low credit risk, but susceptibility to long-

     

    Aa3

    AA-

    AA-

     

    term risks appears somewhat greater.

     

    A1

    A+

    A+

     

    High Quality, Strong Capacity to meet financial obligations but

     

    A2

    A

    A

     

    is somewhat susceptible to the adverse effects/ economic

     

    A3

    A-

    A-

     

    conditions are likely to weaken the obligor's capacity.

     

    Baa1

    BBB+

    BBB+

     

    Medium grade, Adequate capacity to meet the financial

     

     

    obligations

     

     

     

     

     

     

    Baa2

    BBB

    BBB

     

    Adverse conditions on changing the circumstances.

     

    Baa3

    BBB-

    BBB-

     

    Likely to lead weekend the obligor’s capacity on adverse

     

     

    conditions.

     

     

     

     

     

     

    Ba1

    BB+

    BB+

     

    Lower medium grade, Less vulnerable but faces major

     

    Ba2

    BB

    BB

     

    ongoing  uncertainties  exposure  which  would  lead  to

     

    Ba3

    BB-

    BB-

     

    inadequate capacity to meet financial commitments.

     

    B1

    B+

    B+

     

    Lower medium grade, More vulnerable but faces major

     

    B2

    B

    B

     

    ongoing uncertainties exposure will likely weaken to meet

     

    B3

    B-

    B-

     

    financial commitments.

     

    Caa

    CCC

    CCC

     

    Poor  Quality,  Currently  vulnerable  depending  on  the

     

     

    favorable conditions

     

     

     

     

     

     

    Ca

    CC

    CC

     

    Poor Quality, Currently highly vulnerable

     

     

    C

    C

     

    Currently highly vulnerable for non-payment

     

    C

    D

    D

     

    Failed to pay or more of its financial obligations

     

     

     

     

     

     

     

    Types of Credit Rating:

     

    • Corporate Ratings

     

    • Sovereign Ratings
    • Instrument Ratings

     

    Corporate Credit Ratings:The opinion of an independent agency regarding the likelihood that a corporation will fully meet its financial obligations as they come due is known as corporate credit rating.

     

     

     

     

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    Credit Ratings

     

     

    SBS Interns' Digest                                                                                                                          www.sbsandco.com/digest

     

    Sovereign Credit Rating:The sovereign credit rating indicates the risk level of the investing environment of a country and is used by investors looking to invest abroad.

     

    Instrument Credit Rating: The Credit Rating done on the credit worthiness of corporate or government bonds are called instrument credit rating.

     

    Users of The Credit Rating:

     

    • Investors

     

    • Borrowers
    • Lenders

     

    Benefits of Credit Rating:

     

    To Company:

     

    1. Motivation for Growth in their own efforts

     

    1. Lower Cost of Borrowings from Banks & Financial Institutions
    2. A company with the higher credit rating can attract the investors of different strata of the society and the degree of the timely payment of principal and interest.

     

    1. Reduction in costof public issue and debt t.

     

    To Investors:

     

    1. Assurance of Safety

     

    1. Helps in Investment decisions
    2. Regular review of the ratings of a particular instrument
    3. Easy understandability of the investment proposal

     

    Demerits of Credit Rating:

     

    1. Possibility of Biased Rating and Misrepresentations by the rating committee

     

    1. Highly rated instruments may not disclose the material facts
    2. Ratings are given depending on the given past and present known facts of the company but it is difficult to predict the future in case of changes in the environment in the business by way of political, government, legal, social, technology, etc.

     

    1. Problems for new companies as there is no existing data available for rating the company.

    Downgrading of credit ratings of a particular instrument in case the expectations set is not reached by the company.

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