Session 4 – Credit Rating- Internal & External (Part-1)

www.equalifi.org
Credit Rating…
A Credit Rating is an opinion on the creditworthiness or the relative degree of risk
of timely payment of interest and principal on a debt instrument. A credit rating is
a quantified assessment of the creditworthiness of a borrower in general terms or
with respect to a particular debt or financial obligation. A credit rating can be
assigned to any entity that seeks to borrow money—an individual, corporation,
state or provincial authority, or sovereign government

www.equalifi.org
How Credit Rating works?
A loan is a debt—essentially a promise, often contractual, and a credit rating
determines the likelihood that the borrower will be able and willing to pay back a
loan within the confines of the loan agreement, without defaulting.
• A high credit rating indicates a high possibility of paying back the loan in its entirety
without any issues
• A poor credit rating suggests that the borrower has had trouble
paying back loans in the past and might follow the same pattern in the future.

The credit rating affects the entity's chances of being approved for a given loan
or receiving favorable terms for said loan

www.equalifi.org
History of Credit Rating…
Moody's issued publicly available credit ratings for bonds, in 1909, and other
agencies followed suit in the decades after. These ratings didn't have a profound
effect on the market until 1936 when a new rule was passed that prohibited
banks from investing in speculative bonds, or bonds with low credit ratings, to
avoid the risk of default which could lead to financial losses. This practice was
quickly adopted by other companies and financial institutions and, soon enough,
relying on credit ratings became the norm The global credit rating industry is
highly concentrated, with three agencies— Moody's, Standard & Poor's and
Fitch—controlling nearly the entire market

www.equalifi.org
Fitch, history….
John Knowles Fitch founded the Fitch Publishing Company in 1913, providing
financial statistics for use in the investment industry via "The Fitch Stock and Bond
Manual" and "The Fitch Bond Book." In 1924, Fitch introduced the AAA through a D
rating system that has become the basis for ratings throughout the industry. With
plans to become a full-service global rating agency, in the late 1990s, Fitch merged
with IBCA of London, subsidiary of Fimalac, S.A., a French holding company. Fitch
also acquired market competitors Thomson BankWatch and Duff & Phelps Credit
Ratings Co. Beginning in 2004, Fitch began to develop operating subsidiaries
specializing in enterprise risk management, data services, and finance-industry
training with the acquisition of a Canadian company, Algorithmics, and the creation of
Fitch Solutions and Fitch Training.

www.equalifi.org
Moody’s Investor Services, history

John Moody and Company first published "Moody's Manual" in 1900. The
manual published basic statistics and general information about stocks and
bonds of various industries. From 1903 until the stock market crash of 1907,
"Moody's Manual" was a national publication. In 1909 Moody began publishing
"Moody's Analyses of Railroad Investments," which added analytical information
about the value of securities. Expanding this idea led to the 1914 creation of
Moody’s Investors Service, which in the following 10 years, would provide ratings
for nearly all of the government bond markets at the time. By the 1970s Moody's
began rating commercial paper and bank deposits, becoming the full-scale rating
agency that it is today.

www.equalifi.org
Standard & Poor, history
Henry Varnum Poor first published the "History of Railroads and Canals in the
United States" in 1860, the forerunner of securities analysis and reporting to be
developed over the next century. Standard Statistics formed in 1906, which
published corporate bond, sovereign debt, and municipal bond ratings. Standard
Statistics merged with Poor's Publishing in 1941 to form Standard and Poor's
Corporation, which was acquired by The McGraw-Hill Companies, Inc. in 1966.
Standard and Poor's has become best known by indexes such as the S&P 500, a
stock market index that is both a tool for investor analysis and decision-making
and a U.S. economic indicator

www.equalifi.org
Rating Scales…

www.equalifi.org
Factors affecting Credit Rating of a Company…

• Financial History
• Current Assets
• Liabilities
• Auditor’s Information
• Payment History
• Age of Company
• Size of Company
• Punctuality of filing accounts
• Director’s History

www.equalifi.org
Financial History
Company’s last two/three years turnover, profitability is important criteria for
rating. A profit making company can expect good rating compared to a loss
making company. Also during rating the rating agencies see the growth and rate
of growth of revenue and profitability. Apart from these two, other important ratios
(D/E, Current Ratio, DSCR etc) are also evaluated by rating agencies.

www.equalifi.org
Current Assets…
Current Assets are extremely important as they keep the business running.
Cash, inventory, short term investment, everything are carefully evaluated by the
rating agencies. If current assets are less than current liabilities, that means the
company can not repay the current liabilities with the current assets. Also if the
current assets are too high (in cash form or inventory form) that also means the
business is not using the current assets properly

www.equalifi.org
Liabilities…
The amount of liability (mainly external liability) the company is having is also a
determinant of rating. More the liability, lesser is the chance of good rating

www.equalifi.org
Auditor’s Information…
In case the auditor has made some adverse comment about the bookkeeping
and financial of the company, it affects the rating

www.equalifi.org
Payment History…
The payment history of the company to its financiers, creditors is one important
determinant factor of the intention of the company and it also is a determinant of
rating. If the company makes prompt payment, it gets a good rating. If the
payment of the company is poor, it will get adverse rating

www.equalifi.org
Age of the company…
An older company can assist the rating agency with some more information than
the newly formed company. Also the seasoning in the business is a positive
factor for rating.

www.equalifi.org
Size of the Company…
A large sized company has many factors of rating than a small sized
company…so for a large sized company even if one factor is not good, make
over can be given with some other factor, but the same is not possible for small
company as the factors are limited.

www.equalifi.org
Punctuality of filing accounts…

It has been observed that the good rated companies files accounts & returns in
time. They never delay. This is an important parameter to get well rated

www.equalifi.org
Director’s history…
Background of the Directors is extremely important in rating. Directors involved in
some scam or some illegal activities or defaulters in the loans taken in their
personal name, are all the factors that affect rating…Also the change in Director
also affects the company. An influential person joining the company as a Director
will always have a positive affect on rating

www.equalifi.org
Importance of Credit Rating…

• Lowering Cost of Borrowing

• Wider Audience for Borrowing
• Rating as a marketing tool
• Reduction in cost in public issues
• Motivation for growth
• Unknown issuer
• Benefits to Brokers & Financial Intermediarie

www.equalifi.org
Risks associated with Credit Rating…

• Biasness
• Quality of rating
• Confusion between rating of an instrument and rating of the company
• Industry/Sector specific affect on rating
• Qualitative aspects differs with different rating agency
• Rating agency can not quickly foresee worsening credit condition
• Rating Agency can not predict future ris

www.equalifi.org
Types of Credit Rating

• Bond/Debenture Rating
• Equity Rating
• Preference Share Rating
• Commercial Paper Rating
• Fixed Deposits Rating
• Borrower’s Rating
• Individual’s Rating
• Structured Obligation
• Sovereign Ratin

www.equalifi.org
Internal Credit Rating…
Internal Credit Risk Rating System refers to the system to analyze a borrower's
repayment ability based on information about a customer's financial condition
including its liquidity, cash flow, profitability, debt profile, market indicators,
industry and operational background, management capabilities, and other Under
the Basel II guidelines, banks are allowed to use their own estimated risk
parameters for the purpose of calculating regulatory capital. This is known as the
internal ratings-based approach to capital requirements for credit risk

www.equalifi.org
External Credit Rating…

In the case of external credit ratings, agencies are hired by the respective issuer
to evaluate the creditworthiness by analyzing the qualitative and quantitative
information of the issuer. ... Both credit ratings mirror the likelihood of a full
payment of an issuer in a certain time frame

www.equalifi.org
Process of Credit Rating….

www.equalifi.org
Credit Rating Agency Vs. Credit Information Company

www.equalifi.org
Thank You