The Rating

Agencies
CORPORATE CREDIT AND FINANCIAL ANALYSIS
UDAY SARAF

Road Map

Introduction to Rating Agencies

Major Players Across the world

The Rating Process

Back testing the Ratings

Influence of Rating Agencies

Rating Agencies

Ratings What does these tell you?

Specialized agencies across the globe assign

these ratings

Independent and objective opinion on

creditworthiness

Major Players Globally

Moodys

Standard and Poors

Fitch

Major Players in India

CRISIL (Subsidiary of S&P)

ICRA (Moodys is the major shareholder)

CARE (Majorly owned by Banks and FIs)

How does it work?

The Regulations globally warrant issuers to get a credit

rating before floating any new paper

The issuers pay a ratings fee to these agencies and

allows them for due diligence

The issuer have a right to agree to the ratings assigned

by the agencies

For borrowers credit ratings are critical as they affect

their access to markets and cost of borrowings

The focus is on bondholders, other creditors and

counterparties interests

The time horizon looked into for ratings is multidimensional

The rating agencies broadly follow very similar

approaches to each other for assigning a rating

Ratings Criteria

The criteria differs from type of issuer

For a corporate bond the following are of

interest

Business Risk

Industry characteristics

Competitive positioning

Financial Risk, characteristics and policies

Capitalization

Cash flow Protection

Source of information

Publically available financial statements, industry

reports and economic parameters

Management specific information obtained through

meeting with borrower

Highly experienced, senior analysts in own

organization

The Rating Process

The process gets a kick off when a borrower gets

requests for a rating

Gather all relevant public information

Prepare a preliminary report with key points affecting

the creditworthiness

Conduct management meetings with borrower to

gather information on policies and future trajectory

Quantitative comparison of borrowers with other

borrowers with a rating

Preparing a rationale behind the suggested rating

Committee Presentation of the quantitative and

qualitative analysis and rating assignment

Once the committee members agree with the analysts

judgement the rating is finalised

The rationale is then released for public with the rating

information

The process is similar for periodic reviews as well which

are generally not kicked off by the borrower

Regulations across the globe warrant that the rating

agencies must regularly keep reviewing the ratings
previously assigned

Ratings are expected to change in review meetings but

are very less volatile owning to their long-term horizon

The Back-test of ratings

Ratings have generally performed very well across

the globe

Historically the default for the highest rated

papers have been very minimal and the it
increases as credit quality decreases

Moreover it has been found that the ratings

changes and gradual

The gradual movement of ratings gives another

important tool The Transition Matrix

The matrix is used for ex-ante credit risk models

Influence of Rating
Agencies

The increasing emphasis by regulators have created a

huge acceptance for rating agencies

Based on credit ratings there had a been a huge surge

in CDO market

The rating agencies have been under a scanner after

the credit crunch of 2007-08

Obliviously rating agencies have received their share of

blame across academic literature

Even with a history of blemish the role of rating

agencies is ever growing