VIVEK SINGH

B.COM (H)
ROLL – 263
SEMESTER - VI
RESEARCH GUIDE-PROF.S.SAHA
ACCOUNTING & FINANCE
DEPARTMENT OF COMMERCE
ST.XAVIERS COLLEGE, KOLKATA.
2006 - 2009

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Sometimes words fall short to show gratitude, the same happened with me
during this project. The immense help and support received from my
institution overwhelmed me during the project.

The content and accuracy of this project are the responsibility of the various
books used and information available on the net.

I am extremely grateful to my faculty guide Dr.S.Shah, Department of

Commerce, St.Xaviers College, Kolkata who have shared his expertise and
knowledge with me and without whom the completion of this project would
have been virtually impossible.
My sincere gratitude to all who provided me with the necessary
information with valuable suggestion and comments on bringing out this
report in the best possible way.

I also very thankful to my friends who helped me in completion of the

project. I am thankful to that power that always inspires me to take right step
in the journey of success in my life.

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The research presented here describes the study of Credit Rating of a firm by
Credit Rating Information Services of India Ltd. (CRISIL). Credit rating of a firm
is a very important issue in the field of finance. The use of credit ratings
originated in the U.S. during the 19th-century but they are now spreading
around the globe. This paper also examines how the financial risk of a
company affect credit ratings and to what extent credit ratings directly affect
the capital structure decisions of a firm.
This research will provide the fundamental understanding of the credit risk
analysis process and various aspects of financial statement analysis to help in
managing better credit-related issues.

This study is not meant to take decisions for the prospective investors and to
make subsequent investments. The research is only a study and not the
guidelines to make necessary investments.

TABLE OF CONTENTS

CHAPTER I.............................................................................................6
1. INTRODUCTION OF THE STUDY....................................................................6
1.1 BRIEF IDEA OF THE STUDY............................................................................................6
1.2 RESEARCH PROBLEMS..................................................................................................7
1.3 LITERATURE REVIEW....................................................................................................8
1.4 OBJECTIVE OF THE STUDY............................................................................................8
1.5 METHODOLOGY............................................................................................................8
SCHEME OF WORK .............................................................................................................9
1.8 LIMITATIONS OF THE STUDY.........................................................................................9

CHAPTER II............................................................................................9
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 2. THEORETICAL ASPECTS OF THE STUDY.......................................................10
2.1. Evolution of Credit Ratings........................................................................................10
2.2. Meaning of Credit Ratings.........................................................................................11
2.3. Credit Information.....................................................................................................12

Information commonly used to assess the

creditworthiness of a firm includes the following:..................................12
2.4. Five C’s of Credit.......................................................................................................13
2.6 Overview of CRISIL.....................................................................................................17
2.6.1 CRISIL Ratings .....................................................................................................18
2.6.3 CRISIL Approach...................................................................................................19
2.6.4 CRISIL Rating Process..............................................................................................20
2.6.5.1 Interpretation & Evaluation............................................................................22
2.6.6 CRISIL Rating Scale..............................................................................................22
2.6.7 Long Term Rating Scale.......................................................................................23
2.6.7.1 Investment Grade Ratings.............................................................................23
2.6.7.2 Speculative Grade Ratings.............................................................................23
2.6.8. Short Term Rating Scale......................................................................................24
2.6.10 Time Frame for Credit Rating.............................................................................25
2.6.11 Recommendations to the Investors....................................................................26
2.7 Capital Structure and its Sources...............................................................................26
.........................................................................................................................................26
2.8 Financial Leverage......................................................................................................27

CHAPTER III..........................................................................................28
3. COLLECTION OF DATA & DATA PRESENTATION............................................28
3.1 Primary Data..............................................................................................................28
3.2 Secondary Data..........................................................................................................28
3.3 Data Presentation: Tabulation....................................................................................29
ANNEXURE 1.................................................................................................................29
3.4 Data Analysis & Interpretation....................................................................................31
3.4.1 Effect of Financial Leverage on Credit Rating ......................................................31

CHAPTER VI..........................................................................................33
4. DATA ANALYSIS.........................................................................................33
4.1 By Using Statistical Tools............................................................................................33
4.2 By using computer assistance....................................................................................33

CHAPTER V...........................................................................................34
5. Summary .................................................................................................34
5.1 Findings .....................................................................................................................34
5.2 Final Conclusion..........................................................................................................35
5.3 Areas of Further Research..........................................................................................35
REFERENCE & BIBLIOGRAPHY.........................................................................36

Figure 1...............................................................................................29
Figure 2...............................................................................................30
Figure 3...............................................................................................30
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CHART 1..............................................................................................31

List of Abbreviations

1. SEBI – Securities & Exchange Board of India

2. CRISIL- Credit Rating Information Services of India Ltd.

3. ICRA - Investment Information and Credit Rating Agency of India Limited

4. CARE: - Credit analysis and Research Limited

5. ICSI - Institute of Companies Secretary of India.

6. CR- Credit Ratings

7. FL – Financial Leverage.

8. APP – Approximated figure.

9. F.Y – Financial Year

10.PBIT- Profit Before Interest & Text

11.PBT – Profit Before Tax

12.Contd - continued

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 CHAPTER I

1. INTRODUCTION OF THE STUDY

1.1 BRIEF IDEA OF THE STUDY

Credit Ratings are a symbolic indication of the current

opinion regarding the relative capability of a corporate entity to service its
debt obligations in time with reference to the instrument being rated. Credit
ratings are judgments about firms financial and business prospects. Credit
rating is defined ‘as a process by which a statistical service prepares various
ratings identified by symbols which are indicators of the investment quality of
the credit rated’. The credit may be a debt instrument or equity. In case of
debt, ratings are given while in the case of shares grading is done.

It is an independent assessment of the creditworthiness

of a bond (note or any security of any indebtness) by a credit rating agency. It
measures the probability of the timely repayment of principal and interest of a
bond. Generally, a higher credit rating would lead to a more favorable effect
on the marketability of a bond. The credit rating symbols (long term) are

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generally assigned with “triple A” as the highest and “triple B” as the lowest
in investment grade. Anything below “triple B” is commonly known as a ‘junk
bond’.

With the help of credit ratings, the lenders can evaluate the potential risk
posed by lending money to companies and to mitigate losses due to bad debt.
Since, credit rating acts to extend loans from financial institutions, companies
will strive to maintain and improve their ratings. Credit rating agencies play a
key role in financial markets by helping to reduce the informative asymmetry
between lenders, on one side, and borrowers on the other side, about the
creditworthiness of a firm.

Rating is usually assigned to a specific instrument rather than the

company as a whole. In the Indian context, the rating is done at the instance
of the issuer, which pays rating fees for this service. If it is unsatisfied with the
rating assigned to its proposed instrument, it is at liberty not to disclose the
rating given to it.

1.2 RESEARCH PROBLEMS

To present the whole Overview of the Project in a summarized form is quite a

difficult task, but in spite of it, sincere efforts has been put to present the
whole thing in a brief manner.
The debt instrument companies often do not provide the ratings of their
creditworthiness obtained from the agencies in the websites. So there arrived
a difficulty in analyzing and critically examine the worthiness of the
companies to that extent.

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The study more or less comes under the securities market line incorporated
with securities laws and compliances issued under the SEBI guidelines. So the
workings required expert knowledge in the field of regulatory framework
concerning Capital Market of India.
Thus due to small time frame the detailed knowledge to that effect was quite
impossible. Again there were lack of sufficient articles and journals regarding
the research.

Despite all the problems it was tried to overcome the same as maximum as it
was possible.

1.3 LITERATURE REVIEW

The study presented here is brought up with the help of some well known
literatures. Some of them were India credit rating is raised by S&P, By Justin
Huggler, The State of Credit Rating in India; Ragunathan V Varma & Jayant R.
S&P downgrades Tata Motors’ credit rating By Joe Leahy in Mumbai.

1.4 OBJECTIVE OF THE STUDY

The objective of this research is to provide the understanding of how credit

rating helps the INVESTORS in making the risk and return analysis and
thereby helping the company to grow and maintain its success. The study also
aims to represent the overall effect of financial leverage of a company on its
credit ratings in the market.
1.5 METHODOLOGY

The study is accompanied with simple data gathered from various books. The
data are very relevant to the study which are lucidly explained with the help
of some tables and chart. Since the time frame was small and due to lack of
resources available the primary data could not be collected. The study is

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solely based on secondary data like internet, books, journals, magazines and
various articles. In addition to this, quantitative research is used to analyze
the data.

SCHEME OF WORK

The work is divided into 5 chapters.

1.8 LIMITATIONS OF THE STUDY

The procedures and knowledge on credit ratings was limited only to one
rating agency, CRISIL. The rating processes, criteria and functioning of other
rating agencies like ICRA, CARE and Fitch Ratings India Private Limited were
not considered.

The research is limited to the secondary data only. Primary data could not be
incorporated due to time constraint. Lastly, credit ratings are on the verge of
rapid growth worldwide. The rating agencies are looking for fresh ways to
drive growth, such as introducing ratings for hospitals, educational
institutions, builders, state governments and even film projects. So these
aspects could not be taken into consideration due to the time limitation and
word limitation. Again further research on other case studies could not be
carried out due to the time factor.

CHAPTER II

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2. THEORETICAL ASPECTS OF THE STUDY

2.1. Evolution of Credit Ratings

The concept of Credit Rating originated in the United States. The

first Credit Ratings were published by John Moody during 1909 in his analysis
or rail road investments. This evolved into the rating company, Moody’s
Investors Services Inc, a division of Dun and Bradstreet Inc.

Moody was followed by Poor’s publishing Company in 1916 and the

Standard Statistics Company in 1922, which merged, into Poor to become the
largest bond rating concern, Standard and Poor’s corporation, a subsidiary of
Mc Graw Hill, Inc. The third is Fitch publishing company of New York, which
was established in 1924. The fourth agency is Duff & Phelps of Chicago, which
was recognized by Securities and Exchange Commission in 1982. It acquired
Crisanti and Maffei Inc. of New York in 1991. These four security rating
agencies are the only ones with Securities and Exchange Commission
recognition as national bond rating agencies. There are other services that
rate securities especially stock, like Value Line Investment Survey.

The recognition of rating agency by Securities and Exchange

Commission in U.S.A does not constitute approval. Actually, such recognition
is not necessary to enter the security rating business. SEC uses the ratings of
recognized agencies for evaluation of bong assets of brokers and dealers
registered with it.

In India there are 4 credit rating agencies. First, Credit Rating Information
Services of India Limited (CRISIL) set up by ICICI AND UTI in 1988. Secondly
Investment Information and Credit Rating Agency of India limited (ICRA) set
up by IFCI in 1991. Thirdly, Credit Analysis and Research Limited (CARE)

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promoted by IDBI in 1993 in association with financial institutions. Fourthly,
Duff and Phelps Credit Rating India Private Limited (DCR India) for rating non-
banking financial companies for fixed deposits.

2.2. Meaning of Credit Ratings

"Credit rating agency" is a commercial concern engaged in the

business of credit rating of any debt obligation or of any project or program
requiring finance, whether in the form of debt or otherwise, and includes
credit rating of any financial obligation, instrument or security, which has the
purpose of providing a potential investor or any other person any information
pertaining to the relative safety to timely payment of interest or principal.1
Credit ratings are judgments about firms financial and business
prospects. Credit rating is defined ‘…as a process by which a statistical
service prepares various ratings identified by symbols which are indicators of
the investment quality of the credit rated’. The credit may be a debt
instrument or equity. In case of debt, ratings are given while in the case of
shares grading is done.
It is an independent assessment of the creditworthiness of a bond
(note or any security of any indebtness) by a credit rating agency. It measures
the probability of the timely repayment of principal and interest of a bond.
Generally, a higher credit rating would lead to a more favorable effect on the
marketability of a bond. The credit rating symbols (long term) are generally
assigned with “triple A” as the highest and “triple B” as the lowest in
investment grade. Anything below “triple B” is commonly known as a ‘junk
bond’.

CR is the process of assigning standard scores which summarize the

probability of the issuer being able to meet its repayment obligations for a
particular debt instrument in a timely manner. Credit rating is integral to debt
1
Ministryoffinance,GOI
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markets as it helps market participants to arrive at quick estimates and
opinions about various instruments. In this manner it facilitates trading in debt
and money market instruments especially in instruments other than
Government of India Securities. Credit rating is not a recommendation to buy,
hold or sell.
Rating is usually assigned to a specific instrument rather
than the company as a whole. In the Indian context, the rating is done at the
instance of the issuer, which pays rating fees for this service. If it is
unsatisfied with the rating assigned to its proposed instrument, it is at liberty
not to disclose the rating given to it. There are 4 rating agencies in India.
These are as follows:
CR is a dynamic concept and all the rating companies are
constantly reviewing the companies rated by them with a view to changing
(either upgrading or downgrading) the rating. They also have a system
whereby they keep ratings for particular companies on "rating watch" in case
of major events, which may lead to change in rating in the near future.
Ratings are made public through periodic newsletters issued by rating
companies, which also elucidate briefly the rationale for particular ratings. In
addition, they issue press releases to all major newspapers and wire services
about rating events on a regular basis.

2.3. Credit Information

Information commonly used to assess the

creditworthiness of a firm includes the following:
 Credit Reports: Many organizations sell information on the credit
strength of business firms. The best-known and largest firm of this type is
Dun & Bradstreet, which provides subscribers with a credit-reference book
and credit reports on individual firms.

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  Financial Statements: Financial statements contain a wealth of
information. A searching analysis of the firm’s financial statements can
provide useful insights into the creditworthiness of the firm.
 The firm’s payment history: The most obvious way to obtain an
estimate of a firm’s probability on nonpayment is whether it has paid
previous bills or not. A study of the promptness of past payments is very
useful.
 Bank References: The bankers of the firm may be another source of
information. To ensure a higher degree of candour, the firm’s banker may
be approached indirectly through the bank granting credit. 2

2.4. Five C’s of Credit

A credit rating assesses the creditworthiness of a firm in terms of the “five C’s
of credit”.

 Character: It refers to the firm’s willingness to honour its obligations. The

credit manager should judge whether the firm will make honest efforts to
honour its credit obligation.
 Condition: It refers to the prevailing economic and other conditions which
may affect the firm’s ability to pay. Adverse economic conditions can affect
the ability or willingness of the firm to pay.
 Capacity: It refers to the firm’s ablity to meet credit obligations. The
ability to pay can be judged by assessing the firm’s capital and assets
which it may offer as security. Capacity is evaluated by the financial
position of the firm.
 Capital: It is the financial reserves of the firm. If the firm has problems in
meeting credit obligations from operating cash flow, the focus shifts to its
capital.

2
Corporatefinance,WesterfieldRoss&Jaffe
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 Collateral: It refers to the security offered by the firm in the form of
pledged assets.3

2.5 Utility of Ratings

2.5.1 INVESTORS PROTECTION

The main purpose of credit rating is to communicate to the investors the

relative ranking of the default loss probability for a given fixed income
investment, in comparison with other related instruments.4 Investors have
always received credit ratings with enthusiasm. But issuers do not share the
enthusiasm since they have to share their securities at higher yields if their
issue gets inferior rating.
Credit rating gives an investor a simple and easy indicator to
the credit quality of the debt instrument, the risks and likely returns, thus
providing a yardstick against which the risk inherent in an instrument can be
measured. An investor uses the rating to assess the risk level and compares
the offered rate of return, which is expected rate of return (for the given level
of risk) to optimize his risk return trade- off. Ratings also provide a
comparative framework, which allows the investor to compare investment
opportunities.
The advantages of credit rating data for investors are obvious:
 Savings in research costs.
 Ratings represent the informed opinion of a neutral third party.
 Certainty about the financial strength of the issuer.
 Identification of the risk involved in the debt instrument.
3
FinancialManagement,Pandey.I.M financialManagement,ChandraPrasanna
4
securitieslaws&compliances,ICSI
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 Guidance in making an investment decision by being presented with a
wide variety of safe choices.
 Constant monitoring and surveillance by the agency on the debt
instrument leading to effective risk management strategies.5
Spending too much on credit risk research
diminishes the return on investment. In addition, unlike underwriters and
main banks, credit rating agencies are valued for their neutral viewpoint and
expertise in credit risk analysis. For these reasons, investors rely heavily on
credit rating data.
Credit rating also benefits the issuer. If a public offer is contemplated, the
financial manager must bear in mind the rating while determining the
appropriate leverage. Additional debt may lower the rating from an
investment to a speculative grade category, thus rendering the security
ineligible for investment by many institutional investors. It may well be that
the advantages of debt outweigh the disadvantages of the lower credit rating.
Junk bonds, for instance, are a high risk and a high yield (16 to
25% in USA) instruments. Investment may be limited in such instrument to
what an investor can afford to lose.
Ratings will also affect the pricing of the issue. Actually pricing
should reflect the rating. The marketability of a relatively unknown issuer who
is competent is enhanced and the role of name recognition in an investment
decision is minimized.
In actual practice ratings are reflected in prices. There is no
difference between the interest rates that are paid on the fixed deposits of
two companies even if they are rated differently. Same is true of long dated
debentures. But in commercial paper market where banks are major players’
differentials in ratings are reflected in pricing. A reliance CP would be cheaper
than of a company, which is not rated well.

5
Legalpundits.com
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 Ratings are used by brokers for opinions and as a service for
their customers. Insurance companies and mutual funds use them in the
purchase of securities even though their own staff prepares investment
analysis. Portfolio managers also use them in security management. Banks
depend on them for their investment in commercial paper. Individual
investors depend on them for their decisions to place fixed deposits. Ratings
are bound to assume greater importance with the institutionalization of
investors in the form of unit trusts, mutual funds, pension and provident
funds. The debt has shown considerable buoyancy in 1996 not only at the
wholesale level (institutional investors) but also at retail level in view of poor
offerings of equity in the primary market. This has come about largely on
account of the availability of ratings on debt instruments, which boosted
investor confidence.

2.5.2 SEBI Regulations for Credit Rating Agencies

SEBI issued regulations for credit rating agencies in 1999. These

regulations are called as 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 10 % stake in them.

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 Rating agencies cannot rate a security issued by an entity, which is (a) a
borrower of its promoter. (b) a subsidiary of its promoter. (c) An associate of
its promoter, if (i) there is common chairman, directors between credit rating
agency and these entities (ii) there are common employees (iii) there are
common chairman, directors, and employees on the rating committee.
 Rating agencies cannot rate a security issued by its associated 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 the condition or contravenes any of the provisions of the Act.6

2.6 Overview of CRISIL

CRISIL is India's leading Ratings, Research, Risk and Policy Advisory

Company. At the core of CRISIL are its unimpeachable credibility and
unmatched analytical rigor. CRISIL offers domestic and international
customers a unique combination of local insights and global perspectives,
delivering independent information, opinions and solutions that help them
make better-informed business decisions and improve the efficiency of
markets and market participants and help shape infrastructure policy and
projects.

6
www. Sebi.gov.in

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www.crisilonline.com/images
37
CRISIL's majority shareholder is Standard & Poor's, the world's foremost
provider of independent credit ratings, indices, risk evaluation, investment
research and data. CRISIL's association with Standard & Poor's, a division of
The McGraw-Hill Companies, dates back to 1996 when both companies
started working together on rating methodologies and joint projects.8

2.6.1 CRISIL Ratings

A CRISIL rating is CRISIL's opinion on the relative degree of risk associated

with timely payment of interest and repayment of principal on a specified
bank facility. CRISIL assigns rating on the long-term and short-term rating
scales. Ratings can be used by banks to determine risk weights for their loan
exposures, in keeping with the Reserve Bank of India's (RBI's) April 2007
Guidelines for Implementation of the New Capital Adequacy Framework. The
new framework mandates that the amount of capital provided by a bank
against any loan and facility will be based on the credit rating assigned to the
loan issue by an external rating agency. This means that a loan and a facility
with a higher credit will attract a lower risk weight than one with a lower
credit rating. 9

2.6.2. Benefits of CRISIL Ratings

 For Bank: The new guidelines from RBI create an incentive for banks to
use ratings, by giving significant relief in the capital that banks must hold
against their corporate loan exposures. The highest relief of 80 per cent is
available for 'AAA' and 'P1+' rated exposures, but there is substantial

8
www.crisil.com/about-crisil.html
www.iloveindia.com/finance/encyclopedia/crisil.html

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crisilrating,journal
37
 relief for exposures that are rated below the highest category as well. For
instance, both 'A' category-rated long-term loans and 'P2' category-rated
short-term facilities provide 50 per cent relief. Ratings will also be a key
input for appropriate pricing of credit risk by banks.

 For Borrowers: A CRISIL’s rating will help borrowers obtain more precise
risk-based pricing on bank loans. Borrowers may also benefit when the
capital savings that the banks enjoy are reflected in loan pricing. In the
long run, as many lower rated borrowers obtain ratings, and the market
understands the risk associated with such lower ratings, access to
markets for lower rated corporate is likely to improve significantly.

 For the Debt Market: Ratings will help develop a secondary market for
loans, and will provide a uniform scale for analyzing credit risk of bank
loans. 10

2.6.3 CRISIL Approach

CRISIL’s framework for assessing credit quality covers the four broad areas of
business risk, financial risk, management risk and project risk.

o Business risk analysis covers the business fundamentals of the rated

company, the characteristics of the industry in which it operates, its
competitive market position in the industry and operational efficiencies.
o Financial risk analysis includes an assessment of the company’s past
financial performance, its future performance and its financial flexibility
with particular emphasis on its balance sheet.

10
http://www.crisil.com/credit-ratings-risk-assessment/bank-loan-ratings.jsp

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 o An evaluation of the company’s management, its philosophies, strategies
and risk appetite is undertaken in assessing management risk.

o If the company is implementing any large project, the risks associated

with the project’s implementation, its funding and marketing risks are also
evaluated. 11

2.6.4 CRISIL Rating Process

CRISIL employs a multi-layered decision making process in assigning a rating.

It has structured its rating processes as well as its rating committee to ensure
that all assigned ratings are based on the highest standards of independence
and analytical rigor. CRISIL strongly believes that the interest of investors is
best served if open dialogue is maintained with the issuer. Engaging the
issuer in a direct dialogue not only enables it to incorporate non-public
information in a rating report, but also makes it forward looking.
CRISIL's analysis on each credit is carried out by a team of at least two
analysts who interact with the company’s management. The analysis is based
on information obtained from the issuer, and on an understanding of the
business environment in which the issuer operates and it is carried out within
the framework of clearly spelt-out rating criteria. The analysis is then
presented to a rating committee comprising members who have the
professional competence to meaningfully assess the credit, and have no
interest in the entity being rated. The rating committee determines the rating
to be assigned. 12

11
Journal, ‘Ratings Methodology for Manufacturing Firms ’
12
book, Corporate Finance by Vishwanath S.R. and the site, http://www.crisil.com/credit-
ratings-risk-assessment/rating-process.htm
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2.6.5 DIAGRAMATIC VIEW ON THE PROCESS

13

13
www.crisil.com
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2.6.5.1 Interpretation & Evaluation

Specific process safeguards that ensure independence from organizational

bias include:

∗ Multi-member rating teams

∗ Multi-tier rating process
∗ All rating decisions taken by a rating committee comprising
experienced, competent and reputed professionals
∗ Organization-wide internal transparency, with each stage of the rating
process for all ratings, including the final rating committee's discussions
- being open to all analytical staff in CRISIL's rating division
∗ Rating methodologies and criteria that are clearly spelt out and
published, and are consistently applied.

After the rating has been assigned, CRISIL continues to monitor the
performance of the issuer, and the economic environment in which the issuer
operates. This surveillance ensures that the analysts are aware of current
developments, so that they can review sensitive areas and learn about
changes in an issuer's plans. All ratings are under continuous surveillance.
Moreover, CRISIL has a policy of conducting detailed management meetings
with each issuer at least once a year. These meetings essentially focus on
developments over the period since the last meeting, and the outlook for the
coming year.

2.6.6 CRISIL Rating Scale

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CRISIL ratings are assigned on a scale that is analogous to CRISIL's rating
scale for long-term and short-term debt ratings. The scale ranges from 'AAA'
to 'D' for a long-term rating (with maturity over 365 days), and from 'P1+' to
'P5' for a short-term rating (maturity of up to 365 days).14

2.6.7 Long Term Rating Scale

2.6.7.1 Investment Grade Ratings

• AAA (Triple A) - Highest Safety: Instruments rated ‘AAA’ are judged to

offer the highest degree of safety with regard to timely payment of
financial obligations.

• AA (Double A) - High Safety: Instruments rated 'AA' are judged to offer

a high degree of safety with regard to timely payment of financial
obligations. They differ only marginally in safety from `AAA' issues.

• A - Adequate Safety: Instruments rated 'A' are judged to offer an

adequate degree of safety with regard to timely payment of financial
obligations.

• BBB (Triple B) - Moderate Safety: Instruments rated 'BBB' are judged

to offer a moderate safety with regard to timely payment of financial
obligations.

2.6.7.2 Speculative Grade Ratings

14
monthly journal on credit quality – Rating Scan
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• BB (Double B) - Inadequate Safety: Instruments rated 'BB' are judged
to carry inadequate safety with regard to timely payment of financial
obligations. They are less likely to default in the immediate future than
other speculative grade instruments.

• B - High Risk: Instruments rated 'B' are judged to have greater likelihood
of default; while currently financial obligations are met, adverse business
or economic conditions would lead to lack of ability or willingness to pay
interest or principal.

• C - Substantial Risk: Instruments rated 'C' are judged to have factors

present that make them vulnerable to default; timely payment of financial
obligations is possible only if favorable circumstances continue.

• D - Default: Instruments rated 'D' are expected to default on scheduled

payment dates. Such instruments are extremely speculative and returns
from these may be realized only on reorganization or liquidation.

CRISIL may apply '+' (plus) or '-' (minus) signs for ratings from 'AA' to 'C' to
reflect comparative standing within the category.

2.6.8. Short Term Rating Scale

∗ P1: This rating indicates that the degree of safety regarding timely
payment on the instrument is very strong.
∗ P2: This rating indicates that the degree of safety regarding timely
payment on the instrument is strong. However, the relative degree of
safety is lower than that for instruments rated 'P-1'.

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 ∗ P3: This rating indicates that the degree of safety regarding timely
payment on the instrument is adequate.

∗ P4: This rating indicates that the degree of safety regarding timely
payment on the instrument is minimal and it is likely to be adversely
affected by short-term adversity or less favourable conditions.

∗ P5: This rating indicates that the instrument is expected to be in default

on maturity or is in default.
CRISIL may apply "+" (plus) sign for ratings from 'P-1' to 'P-3' to reflect a
comparatively higher standing within the category.

2.6.9 Confidentiality of Credit Rating Exercise

CRISIL keeps information obtained for the rating exercise confidential, by

enforcing appropriate process safeguards. For instance, all CRISIL employees
are required to sign a confidentiality agreement. CRISIL does not disclose
confidential information that it has obtained for the purpose of credit rating to
anyone (other than to market regulators or law enforcement authorities). 15

2.6.10 Time Frame for Credit Rating

CRISIL deputes a two-member team to carry out the assignment and the team
after having gone through the information submitted by the company, visits
their office for meetings in connection with the credit assessment. The
meetings take around 1 to 2 days with the involvement of functional,
divisional and business heads. On completion of management meetings, the
team prepares analytical note on the company that is discussed at the Rating

15
http://www.crisil.com/credit-ratings-risk-assessment/rating-process-confidentiality.htm
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Committee Meeting, and the committee assigns the final rating. Starting from
meetings, CRISIL assign a rating in a period of around 2 weeks. 16

2.6.11 Recommendations to the Investors.

By and large, the rating is a very good estimate of the actual creditworthiness
of the company; however, it is not able to predict extreme situations such as
the ones described above, which are unlikely to have been predicted by most
investors in any case. Investors should realize that a credit rating is not
sacrosanct and that one has to do one’s own due diligence and investigation
before investing in any instrument. They should use the rating as a reference
and a base point for their own effort.
One good way of doing this is examining the behavior of
the stock price in case the stock is listed. As a collective, the market is far
smarter at predicting problems than any credit rating agency. Witness the
sharp erosion in stock prices of companies much before their credit ratings
were downgraded. Witness also the fact that foreign currency bonds from
Indian issuer’s trade at yields lower than countries which have been rated
higher by rating agencies.

2.7 Capital Structure and its Sources

Capital structure means the type, composition and proportion of securities to
be issued that make up the total capital of the firm. The two principal sources
of finance for a business firm are equity and debt. For example, a firm that
sells $20 billion in equity and $80 billion in debt is said to be 20% equity
financed and 80% debt financed. Credit ratings are a material consideration
for managers in making capital structure decisions due to discrete costs
(benefits) associated with different ratings levels.

16
sources of the Company, CRISIL
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2.8 Financial Leverage

CRISIL’s framework for assessing credit quality covers various analysis like
business risk analysis, financial risk analysis and project risk analysis.
However, financial risk analysis is considered the most important for credit
rating, as it provides insight into how a risky a company is. It is an assessment
of the company’s past financial performance and its financial flexibility with
particular emphasis on its balance sheet.
The financial risk of a company can be measured by calculating its financial
leverage. A company more heavily financed by debt poses greater risk.
The financial leverage helps in determining the level of fixed financial charge
or in other words the extent of debt financing. As the debt financing is
relatively a cheaper source of finance, the financial leverage may suggest for
more and more use of debt financing, but with every increase in debt
financing, the financial risk, the risk of bankruptcy also increases. More over
the risk perception in the eyes of the equity shareholders also tends to
increase.
Analysis of financial leverage is the most important tool in the hands of a
finance manager who is engaged in framing the capital structure of the firm.
Any firm can easily adopt an all equity capital structure and thus can avoid
the financial risk. With financial leverage, the advantage arises from the
possibility that funds borrowed at a fixed interest rate can be used for
investment opportunities earning a rate of return higher than the interest
paid. The opposite effect will apply if the company fails to earn higher returns.

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 CHAPTER III

3. COLLECTION OF DATA & DATA PRESENTATION

3.1 Primary Data

There is no use primary data’s in the form of interviews, surveys,

questionnaires, etc.

3.2 Secondary Data

The secondary data has been collected majorly through various books on
financial management books and websites. Some of the magazines & journals
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were also brought into use .However there were very few journals & articles
available on the study. Necessary steps were taken to incorporate the right
data in a summarized form.

3.3 Data Presentation: Tabulation

ANNEXURE 1
Figure 1
CITY BEAUTIFUL TRAVELS
Estimate of Revenues, Costs and PBIT

(Rupees in crores)
Financial Revenue Variable Fixed Cost Total Cost PBIT
Year (1) Costs (3) (4)=(2)+(3 (5)=(1)-(4)
(2) )
1 220.5 74.0 154.0 228.0 (7.5)
2 252.0 98.3 129.0 227.3 24.7
3 283.5 120.6 112.1 232.7 50.8
4 283.5 135.5 100.9 236.4 47.1
5 283.5 151.4 93.6 245.0 38.5
Figures in bracket shows negative balance
17

17
Source: Pandey, I. M., Bhat, Ramesh, “Cases in Financial Management”, Tata McGraw-Hill Publishing
Company Ltd., 2003, Third Edition Reprint, pg-253

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Figure 2

CITY BEAUTIFUL TRAVELS

Estimate of Interest tax and PAT

(Rupees in crores)
Financial PBIT Interest PBT Tax PAT
Year (2) (3) (4)=(2)–(3) (5) (6)=(4)-(5)
(1)
1 (7.5) 25.8 (33.3) - (33.3)
2 24.7 19.2 5.5 - 5.5
3 50.8 12.0 38.8 2.6 36.2
4 47.1 4.8 42.3 10.6 31.7
5 38.5 0.2 38.3 9.6 28.7
Figures in bracket shows negative balance
18

Annexure1 (contd)
Figure 3

CITY BEAUTIFUL TRAVELS

COMPUTATION OF FINANCIAL LEVERAGE(FL)
Financial PBIT PBT FL ESTIMATED CRISIL
year Ratings SCALE
1 -7.5 -33.3 -
2 24.7 5.5 4.49090909 B
1
3 50.8 38.8 1.30927835 BBB
1
4 47.1 42.3 1.11347517 AA
7
5 38.5 38.3 1.00522193 AAA
2
Figures in bracket shows negative balance
Note:
Financial leverage = profit before interest & taxation/profit before taxation.

18
Source: Pandey, I. M., Bhat, Ramesh, “Cases in Financial Management”, Tata McGraw-Hill Publishing
Company Ltd., 2003, Third Edition Reprint, pg-254

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CHART 1

CITY BEAUTIFUL TARVELS

YEARS

FL – FINANCIAL LEVERAGE

3.4 Data Analysis & Interpretation

3.4.1 Effect of Financial Leverage on Credit Rating

Interpretation & Analysis of the Annexure 1

The effect of financial leverage on credit rating has been discussed by interpreting Figure 1,
2, and 3 in Annexure 1.

In the financial year 1, the financial leverage of the company cannot be

determined. In that case, the financial stability of the company cannot be
judged. Thereby the rating of the company is difficult to estimate.

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However in the year 2, the company has managed to derive revenues out of
operational sales. The financial leverage of the company is 4.5
(approximated) which is very high compared to other years. Thus the
company is not expecting a high rating in the year 2 because the financial risk
is high.
However, the financial leverage is expected to decrease to 1.31(app) in the
financial year 3, because, the company has projected that their net revenue
from the sales would rise from 252.0 crores to 283.5 crores in the financial
year 4. This will lead to an increase of Rs 26.2 crores in EBIT. Apart from this,
the interest payable is also expected to fall from 19.2 crores to 12 crores.
Thus the risk of the defaults will decrease and hence the company has
projected that their ratings would be upgraded in the F.Y 3.
The company’s financial leverage is projected to decrease to 1.11 in the F.Y 4.
The EBIT in the same year is expected to decrease from 50.8 crores to 47.1
crores but along with it the fixed charge i.e., the interest burden has slipped
from 12.0 crores to 4.8 crores registering decrease in the fixed charges to the
extent of 60 percent. On the other hand due to this effect the PBT has risen to
the extent of 42.3 percent. The combined effect has lowered down the
financial leverage of the 1.3 to 1.1. This is why; it has been projected by the
company that they will be able to obtain a higher rating in F.Y 4 in comparison
to F.Y 3.
Furthermore, in the F.Y 5, the company is expecting that their financial
leverage will fall from 1.1 in F.Y 4 to 1.00 (app) F.Y 5. This is because the EBIT
& PBT has both declined to the extent of 18.1 percent (app) & 9.5 percent
(app) respectively. The company still manages to meet the current year’s
financial charge of 0.2 crores. It also indicates that the company is currently
having no or very minimal capital from debt financing. This will help the
company to further upgrade their ratings in F.Y 5.
Therefore, it is evident from table 1 that the company has tried to minimize
the capital raised from debt – financing to increase the creditability in the

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market. The significant fall in the financial leverage would enhance the
creditworthiness of the company. This will help them to take more loans from
the bank at a cheaper rate of interest and the goodwill of the company will
also improve. As the F.Y has progressed Chart 1 has recorded a significant
downfall in the financial leverage of the company. This has helped the
company to enhance its ratings in the market.
Again it should be noted that the ratings proposed above to the City Beautiful
Travels in all the financial years is based on the assumption that no other
factors are present.
But in reality CRISIL considers many factors while calculating the ratings to a
particular concern.
The calculations for financial leverage have been done in fig 3 in Annexure 1.

CHAPTER VI

4. DATA ANALYSIS

4.1 By Using Statistical Tools

There were no uses of any statistical tool analysis.

4.2 By using computer assistance

The computation of the financial leverage of the company on the basis of

different data available has been done through Microsoft Excel. No other
computer assistance is used to determine and analyze the values.

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 CHAPTER V

5. Summary

5.1 Findings

Capital structure decisions are affected by the potential for both an upgrade
as well as a downgrade in credit ratings. The rating of a company is inversely
related to its financial leverage. The firms, if their ratings are expected to
upgrade, can increase its debt capital by extending loans from banks and
other financial institutions. However, if the ratings are expected to
downgrade, then the debt capital of the firm will be reduced. Therefore it can
be said that credit ratings directly affect the equity and debt financing
decisions of a firm. Hence, credit ratings are a material consideration for
managers in making capital structure decisions.

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5.2 Final Conclusion

Ratings are opinions on credit worthiness based on objective and subjective

analysis. Rating agencies play an important role in the world markets; they
can best serve markets when they operate independently, adopt and enforce
internal guidelines to avoid conflicts of interest and protect confidential
information received from issuers. Credit rating agencies cannot afford to
commit too many mistakes as it the investors who pays the price for their
mistakes. Credit rating agencies should be made accountable for any faulty
rating by panelizing them or even de-recognizing them, if needed. Since
lending money has become more global and diverse, it is difficult for the
lenders to determine which companies have a minimum risk of default and
assure themselves of the continuous soundness of borrowers after a loan has
been extended. The financial intermediaries such as banks turn to credit
rating agencies to provide necessary information on borrower’s
creditworthiness. Credit rating appraises the default risk which is a
combination of business risk and financial risk.
These agencies help lenders decide how risky it is to lend money to a certain
company. In sum, credit ratings can help lenders pierce the fog of asymmetric
information that surrounds lending relationships. Equivalently, credit ratings
can help borrowers emerge from that same fog.

5.3 Areas of Further Research

A CR agency takes into account various factors while grading a particular

company. The major ones are cash flow adequacy, operating efficiency,
accounting quality, long term earning powers, management evaluation,
industry interface and risk and of course financial leverage. However in the
paper, the research is carried only on the financial leverage factor. So there is
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a scope of further research on the other factors affecting the creditworthiness
of the company.

REFERENCE & BIBLIOGRAPHY

careratings.com

www.crisil.com

sebi.gov.in

WWW.Defaultrisk.com

www.Moneycontro.com

www.Dailytimes.com

Hindustantimes.com- corporate news

press trust of india articles

India credit rating is raised by S&P,By Justin Huggler

The State of Credit Rating in Indi, Ragunathan V Varma Jayant R

S&P downgrades Tata Motors’ credit rating By Joe Leahy in Mumbai

Published: March 25 2009

I.M. PANDEY 9TH EDITION.

Pandey, I. M., Bhat, Ramesh, “Cases in Financial Management”, Tata

McGraw-Hill Publishing Company Ltd., 2003, Third Edition Reprint, pg-254

., Bhat, Ramesh, “Cases in Financial Management”, Tata McGraw-Hill

Publishing Company Ltd., 2003, Third Edition Reprint, pg-254
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