CREDIT RATING

Definition of Credit Rating

 CRISIL, the first rating agency in India defines

credit rating as “unbiased and independent
opinion as to issuer’s capacity to meet its
financial obligation. It does not constitute a
recommendation to buy or hold a particular
security.”
Objectives of Credit Rating

 To rate the debt instruments in order to build the confidence of

investors.
 To promote the growth of the primary market as well as the
capital market.
 To ensure optimum allocation of capital
 To minimize the cost of floatation because highly rated securities
advertise on their own.
 To protect the interest of investors by giving adequate clues
regarding the safety and profitability of investment.
Features of Credit rating

 1.Guide to ordinary investors- aiming lay investors

 2.Specific rating : exclusively for the purpose of grading
debentures, bonds, public deposits, commercial papers, etc.
 3.Current assessment: assessment of the creditworthiness of the
issuer of securities.
 4.Simple: provide with simple system of gradation
 5.Opinion about safety: credit rating is an opinion of credit
rating agencies indicating safety of timely payment of interest
and principal on securities.
 6.Symbolic presentation: credit rating exhibited either in
alphabetical manner or alphanumerical way for quick
understanding.
Features of Credit rating

 7.Opinion about repayment: it is specific disclosure reflecting

the opinion on repayment capacity of issuer body.
 8.Independent assessment : rating is not based on audit.
 9.Flexible : rating can be revised either upward or downward by
assessing various conditions and factors.
 10.Helps decision making: rating helps decision by the
investors.
 11.Latest information : rating based on current information
about issuer and securities.
Types of Credit rating

 1. Equity rating : The equity shares and preference shares of

companies are rated as to its worth.
 2. Bond Rating: this is the primary and major business of credit
rating agencies. Bonds and debentures issued by companies, govt,
quasi- govt etc.
 3. Commercial papers: commercial papers are issued by
companies to raise short term funds. Regulatory agencies insist
companies should get credit rating for issue of commercial
papers
 4. Individual rating : borrowers and customers are rated to asses
their paying capacity.
 5. Asset backed securities rating : These are the undertaken to
assess the risk associated with debt securitisation.
Types of Credit rating

 6.Country rating : This is also known as sovereign rating. Assess

the Creditworthiness of a country and its debt paying capacity
before making any investment in that country.
 7.Rating of states : just like country, the states would also like to
get rated to attract investors. CRISIL has already rated several
states like Maharashtra, Tamilnadu, Kerala. etc
 8.Other ratings: Banks , real estates agencies, health care
institutions, IPOs, etc also rated now a days.
 Benefits of Credit Rating
A. Benefits to investors
 1.Safeguards against bankruptcy: it gives an idea about the
degree of financial strength of the issuer company.
 2. Easy understanding of risk: the rating symbols used by rating
agencies is easily recognisable.
 3.Credibility of issuer: The rating agency is quite independent of
the issuer company and has no business connection with it. Rating
symbol assigned to a credit instrument gives a clue to the
credibility of the issuer company.
 4.Expert knowledge: Since the rating is done by professionals the
investor can rely on it.
 Benefits of Credit Rating
A. Benefits to investors

 5. Direct invest decision: the rating symbol assigned to a particular

instrument as the credit worthiness of the instrument. Thu, investors can
make direct invest decision.
 6.Choice of investment: the investors can make choice depending upon
their risk profile and diversification.
 7. Rating surveillance: continues monitoring of the rated instruments of
different companies is another benefit.
 Benefits of Credit Rating
B. Benefits of rating to the issuing company
 1.Lower cost of borrowing: investors are usually prefer to invest
in safe securities through rate of return is low.
 2.Extensive borrowing : the investors is certain about timely
payment of interest and principal on a debt instrument with better
rating.
 3. Marketing tool: Companies with rated instruments improve
their own image. They can use the image as a marketing tool in
dealing with its customers, lenders and creditors.
 4.Self discipline by companies: Rating encourages the
companies to improve their accounting system, financial
reporting, management pattern etc.
 Benefits of Credit Rating
B. Benefits of rating to the issuing company
 5.Reduction of cost in public issues: A companies with higher
rated instrument is able to attract large investors.
 6.Motivation for growth: promotors of high rated companies
feel confident in their own effort and are encouraged to expand
their operations.
 Limitations of credit rating

 1.Biased rating and misrepresentations : if the quality of rating

is poor, credit rating will be a curse for the capital market.
 2.Static study: rating is done on the present and past historical
data of the company and this is only a static study.
 3.Concealment of material information: a company might
conceal material information from the investigating team.
 4.No guarantee for soundness of the company: independent
views should be formed by the user of the rating symbols
 5.Down grading: this will damage the image of the company.
Process/ Procedure of Credit
Rating
 1.Request for Rating: The entire process of rating starts with a
request letter for rating.
 2.Rating agreement : on receipt of the request, the rating agency
makes out a detailed agreement with terms and conditions of such
assignment.
 3.Assignment of rating Team: the credit rating agency appoints
an analytical team of two expert members for evaluating the
business of the issuer.
 4.Data collection: the analytical team obtains information from
the issuer (primary) and from rating agency’s research division
(secondary). Financial statement, cash flow projections, annual
reports etc .
Process/ Procedure of Credit
Rating
 4.Management Meeting & Plant Visits: To estimate future earnings of
the issuer the team visits the plant for a qualitative assessment.
 5.Preview Meeting : in this stage all issues relating to the rating are
discussed and opinions are formed.
 6.Rating committee meeting : the internal and external rating
committee together is the final authority for assigning ratings. Based on
the discussions, views of internal committee, report of rating team and
other key factors, the committee assign the rating.
 7.Rating communication: the rating assigned is communicated to the
issuer in writing with rationales of rating.
 8.Rating surveillance : surveillance is the monitoring of credit rating
agency over the period of the rated instrument. Ratings are reviewed
from time to time.
Rating methodology