Description
The objective of this presentation about the credit rating definition and concept.
Vikas Thakur Arijit Basu Ankita Vishal
Credit Rating
Credit rating
?Definition and concept
?The credit rating process
?Indian scenario
PB 030502 - 2
CONCEPT & MEANING OF CREDIT RATING
Credit: “trust in the ability and intention to pay”
Rating :
“ estimating worth to assign value with reference to a particular subject matter” Credit rating: “ an act of assigning values to the fund raising instruments by estimating worth , reputation, solvency and honesty of the borrowing entity”
What is credit rating?
•A credit rating is an opinion on the relative degree of risk associated with timely payment of interest and principal on a debt instrument. A simple alphanumeric symbol is normally used to convey a credit rating. •A credit rating is not a recommendation to buy, hold or sell a debt instrument. A rating is one of the inputs that is used by investors to make an investment decision. •A credit rating is not an assurance of repayment of the rated instrument. Rather, it is an opinion on the relative degree of risk associated with such repayment. This opinion represents a probabilistic estimate of the likelihood of default.
The primary focus of the rating exercise is to assess future cash generation capability and their adequacy to meet debt obligations in adverse conditions
PB 030502 - 4
SCOPE OF CREDIT RATING
Mandatorily required for issue of debt instruments like 1. Debentures. 2. Bonds 3. Commercial Paper ( cannot be issued if rating is below A2 {ICRA}) 4. Fixed deposit programmes of NBFCs
PB 030502 - 5
SCOPE OF CREDIT RATING
Commercial paper Debentures. 1.Equity grading/ assessment 2.Line of credit rating 3.Collective Investment schemes 4.Real estate projects
CREDIT RATING
Fixed deposits
Structured obligation
1.Utilities ratings 2.State govt ratings 3.Asset backed securities 4.Mutual fund rating
PB 030502 - 6
What Credit Rating is not?
• •
Rating is specific to the issue or debt instrument that is rated and not that of the issuer. It is not a recommendation to buy, hold or sell. It is a well-informed opinion.
•
•
They are not predictors of default but opinions about the relative probability of default and loss.
Ratings are not guarantees against losses. Under no conditions do they or can they predict losses due to ‘shocks’ or highly unexpected situations.
•
Credit ratings relate only to credit and thus, for example has no relationship to risk preferences of investors or attractiveness of equity.
PB 030502 - 7
Credit rating why?
Independent & unbiased evaluation of credit quality Increased accessibility to funds from the capital markets for infrastructure projects Increased marketability of debt issues Indicative of transparency Benchmarking with other corporate entities Aids investors in investment decision making process Helps the investors in pricing the debt offer
Required by Law
PB 030502 - 8
Rating yield curve
PB 030502 - 9
Credit rating
?Definition and concept
?The rating process
?Indian scenario
PB 030502 - 10
The credit rating process
Comments
1
Rating request
2
Rating team
assignment (confidentiality , the right to the issuer to accept or not to accept the rating) ?composition of the team is based on the expertise and skills required for evaluating the business of the issuer
?mandate spells out the terms of the rating
?list of information requirements and the
3
Information requirements
broad framework for discussions. These requirements are derived from the experience of the issuers business and broadly conforms to all the aspects which have a bearing on the rating
4
Secondary information
?draws on the secondary sources of
information including its own research division. The credit rating agency also has a panel of industry experts who provide guidance on specific issues to the rating team
PB 030502 - 11
The credit rating process (contd)
Comments
?assessment of number of qualitative
5
Management meetings
factors to estimate the future earnings ? relating to plans , future outlook , competitive position and funding policies
6 Preview meeting
?findings are discussed ?opinion on the rating is formed
?final authority for assigning ratings
Rating Committee 7 meeting
?issues identified during discussions in the
internal committee are discussed
?a rating is assigned and all the issues
which influence the rating are clearly spelt out
8
Rating communication
?communicated to the issuer’s top
management (for acceptance)
PB 030502 - 12
The credit rating process
Comments
?rating is not acceptable to the issuer , he
9
Rating Reviews
has a right to appeal ?reviews are usually taken up only if the issuer provides fresh inputs on the issues that were considered for assigning the rating
10 Surveillance
?obligatory on the part of the credit rating
agency to monitor the accepted ratings over the tenure of the rated instrument ?the issuer is bound by the mandate letter to provide information to the credit rating agency ?ratings are generally reviewed every year ?initial rating could be retained or revised (upgrade or downgrade )
PB 030502 - 13
Rating framework
Risk drivers
Financial risk
Funding policy Financial flexibility
Business risk Industry characteristics Market position Operational efficiency New projects Management quality
All the factors which have a bearing on future cash generation and claims that require servicing are considered to assign ratings
PB 030502 - 14
INDICATIVE FACTORS CONSIDERED FOR RATINGS
competition Demand and supply Regulations and legislation
Industry risk
Cash flow adequacy
Operating efficiency
Management evaluation
Financial flexibility
Capital adequacy
…
PB 030502 - 15
Industry characteristics (Rating framework)
Drivers & potential Availability of raw material Dependenc e on a particular supplier Switching costs Threat of forward integration Role of the industry in the economy Product develope ments Nature of demand seasonal , cyclical Bargaining position of customers
Demand factors
Existing & expected capacities
supplier
Industry characteristics
Environmental factors Government policies -current and. future direction
State of competition
Intensity of competition Entry /exit barriers Threat of substitutes
Extent of government regulation
PB 030502 - 16
Financial aspects (Rating framework)
Constituent
Challenges Future funding requirements Level of leveraging Target returns for shareholders Views on retaining shareholding control Asset-liability tenure matching.
? availability of liquid investments and unutilized lines of credit ? financial strength of group companies
Funding policies
Financial flexibility
? market reputation , relationship with financial institutions and banks
? experience of tapping funds from different sources.
Past financial performance
?Profitability ?Gearing or level of leveraging and Coverage ratios ?Liquidity position and Cash flow analysis ?Future cash flow adequacy
PB 030502 - 17
Market position (Rating framework)
All the factors influencing the relative competitive position of the issuer are examined in detail.
positioning of the products perceived quality of products or brand equity
proximity to the markets
distribution network and relationship with the customers In markets where competitiveness is largely determined by costs, the market position is determined by the unit’s operational efficiency The result of these factors is reflected in the ability of the issuer to maintain /improve its market share and command differential in pricing. It may be mentioned that the issuers, whose market share is declining, generally do not get favorable long-term ratings.
PB 030502 - 18
Management quality (Rating framework)
When the business conditions are adverse, it is the strength of management that provides resilience. A detailed discussion is held with the management to understand its •objectives, • plans & strategies , • competitive position • views about the last performance and future outlook of the business. Other important factors are: labour relations , track record of meeting promises specifically relating to returns and project implementation , performance of "group" companies , transactions with the "group" companies etc. Issues like dependence on a particular individual and succession planning are also addressed.
PB 030502 - 19
New project risks (Rating framework)
All the factors influencing the relative competitive position of the issuer are The scale and nature of new projects can significantly influence the risk profile of any issuer. Unrelated diversification’s into new products are invariably assessed in greater detail. Time and cost overruns even non-completion in an extreme case during construction phase financing tie-up operational risks market risk track record of the management in project implementation, experience and quality of the project implementation team, implementation schedule, status of the project,
composition of operations team and market outlook and plans.
PB 030502 - 20
Operational efficiency (rating framework)
All the factors influencing the relative competitive position of the issuer are examined in detail. Location of the production unit(s) Access to raw materials Scale of operations Quality of technology
Level of integration
Experience ability of the unit to efficiently use its resources
PB 030502 - 21
Credit rating process (CRISIL)
PB 030502 - 22
Sample Requisitions for information
Bank Financial institution Manufacturing firm
PB 030502 - 23
Rating Scale
Rating Symbol
AAA AA A BBB BB B C D
Definition
Investment Grades
Highest Safety High Safety Adequate Safety Moderate Safety Inadequate Safety High Risk Substantial Risk Default
PB 030502 - 24
Speculative Grades
Credit rating
?Definition and concept
?The rating process
?Indian scenario
PB 030502 - 25
Credit rating agency Regulations
?Company registered under the companies act
( private or public) ?Promoters should be: –A public financial inst –A SCB or foreign bank (RBI approval) –Foreign CRA ( at least 5 yrs exp) –Body corporate having Net worth of 100crores for previous 5 years
Regulator SEBI
PB 030502 - 26
Credit rating agency Regulations
?Eligibility criterion
–Min net worth : Rs 5 crores –Body corporate and promoters should have professional competence , financial soundness and reputation for fairness and integrity
?Certificate of registration granted by SEBI
Regulator SEBI Credit rating agencies regulations(1999)
PB 030502 - 27
MONITORING OF RATING
•Compulsory continuous monitoring of the rating assigned to the securities during the life time of such securities. •To disseminate information regarding newly assigned rating and changes in earlier ratings •In case of listed securities CRA shall provide information regarding change in the rating to the concerned stock exchanges where the security is listed
PB 030502 - 28
Corporate Governance and Value Creation Ratings (CGVR)
Opinion on the relative level to which the rated company accepts and follows the codes and guidelines of corporate governance practices both in letter and spirit.
evaluates entity's performance and future expectation on 'balanced value creation through sound corporate governance practices'. The key variables analysed are: Shareholding Structure Governance Structure and Management Processes Board Structure and Processes
Stakeholder Relationship
Transparency and Disclosures Financial Discipline
PB 030502 - 29
Credit rating in INDIA
year •1987
•1991 •1993 •1994
agency CRISIL
ICRA CARE Fitch
foreign associate promoted by (S&P) ICICI
(Moody’s) IFCI
Market share
IDBI
others
ICRA
CRISIL
PB 030502 - 30
The Road Ahead… Concerns Regarding Credit Rating Agencies
Issuer Influence – A likely outcome of Issuer- fee model . ? How to hold CRAs accountable for the ratings given by them. (Argued that reputation of CRA is on the line). ? Advisory Services - concerns expressed wrt. potential conflicts of interest that may arise when a rating agency offers consulting or other advisory services to issuers it rates . ? Lead to herding behaviour thereby increasing the volatility of capital flows
PB 030502 - 31
The road ahead
India has three established rating agencies in which leading international credit rating agencies are stakeholders and also extend technical support. However, the level of rating penetration is not very significant as, so far, ratings are restricted to issues and not issuers. While Basel II gives some scope to extend the rating of issues to issuers, this would only be an approximation and it would be necessary for the system to move to ratings of issuers. Encouraging ratings of issuers would be a challenge. Who pays for a credit rating? Most credit rating agencies across the world use a revenue model where the issuer pays for the credit rating. Alternative revenue models (like the one based on investor fees) pose numerous challenges in terms of ease and practicality of implementation that have not yet been overcome.
PB 030502 - 32
Possible Risks of over-reliance on Ratings
? Lack of supervision and loopholes in regulatory framework may lead to laxity.
Tends to create demand for easy and accommodating raters. In other words, it stimulates `rating shopping’. ? Could induce ritualism and even enhance risk. Thus, issuers will get rated because they are required to do so and investors will tend to use it as a proxy for internal analysis . ? Assumption of uniform/standard ratings and rating criteria by different rating agencies, is not necessarily valid at all times. ? Mandatory ratings on domestic debt instruments etc. are no substitutes to a strong regulatory framework, transparency, accounting and disclosure standards.
PB 030502 - 33
Certain moot points for the future of CRA’s
Should competition be encouraged by liberalizing rules of entry… ? Who would venture into credit rating given the substantial investment and track record necessary to achieve marketplace acceptance of ratings …. ? Should the scope of ratings be expanded to issuer rating …..? Should equity issues be also brought under the ambit of rating……?
PB 030502 - 34
Impediments to the Accurate Appraisal of Issuers by CRA’s
Inability of rating agencies to access a continuous flow of accurate and reliable information from issuers Level and quality of Disclosure by Issuers given the consequences of a downgrade Regulations for disclosure by issuers need to be framed
Do the CRA’s exercise due diligence……?
PB 030502 - 35
Stability of ratings (for ICRA)
PB 030502 - 36
Thank you
PB 030502 - 37
doc_660089137.pptx
The objective of this presentation about the credit rating definition and concept.
Vikas Thakur Arijit Basu Ankita Vishal
Credit Rating
Credit rating
?Definition and concept
?The credit rating process
?Indian scenario
PB 030502 - 2
CONCEPT & MEANING OF CREDIT RATING
Credit: “trust in the ability and intention to pay”
Rating :
“ estimating worth to assign value with reference to a particular subject matter” Credit rating: “ an act of assigning values to the fund raising instruments by estimating worth , reputation, solvency and honesty of the borrowing entity”
What is credit rating?
•A credit rating is an opinion on the relative degree of risk associated with timely payment of interest and principal on a debt instrument. A simple alphanumeric symbol is normally used to convey a credit rating. •A credit rating is not a recommendation to buy, hold or sell a debt instrument. A rating is one of the inputs that is used by investors to make an investment decision. •A credit rating is not an assurance of repayment of the rated instrument. Rather, it is an opinion on the relative degree of risk associated with such repayment. This opinion represents a probabilistic estimate of the likelihood of default.
The primary focus of the rating exercise is to assess future cash generation capability and their adequacy to meet debt obligations in adverse conditions
PB 030502 - 4
SCOPE OF CREDIT RATING
Mandatorily required for issue of debt instruments like 1. Debentures. 2. Bonds 3. Commercial Paper ( cannot be issued if rating is below A2 {ICRA}) 4. Fixed deposit programmes of NBFCs
PB 030502 - 5
SCOPE OF CREDIT RATING
Commercial paper Debentures. 1.Equity grading/ assessment 2.Line of credit rating 3.Collective Investment schemes 4.Real estate projects
CREDIT RATING
Fixed deposits
Structured obligation
1.Utilities ratings 2.State govt ratings 3.Asset backed securities 4.Mutual fund rating
PB 030502 - 6
What Credit Rating is not?
• •
Rating is specific to the issue or debt instrument that is rated and not that of the issuer. It is not a recommendation to buy, hold or sell. It is a well-informed opinion.
•
•
They are not predictors of default but opinions about the relative probability of default and loss.
Ratings are not guarantees against losses. Under no conditions do they or can they predict losses due to ‘shocks’ or highly unexpected situations.
•
Credit ratings relate only to credit and thus, for example has no relationship to risk preferences of investors or attractiveness of equity.
PB 030502 - 7
Credit rating why?
Independent & unbiased evaluation of credit quality Increased accessibility to funds from the capital markets for infrastructure projects Increased marketability of debt issues Indicative of transparency Benchmarking with other corporate entities Aids investors in investment decision making process Helps the investors in pricing the debt offer
Required by Law
PB 030502 - 8
Rating yield curve
PB 030502 - 9
Credit rating
?Definition and concept
?The rating process
?Indian scenario
PB 030502 - 10
The credit rating process
Comments
1
Rating request
2
Rating team
assignment (confidentiality , the right to the issuer to accept or not to accept the rating) ?composition of the team is based on the expertise and skills required for evaluating the business of the issuer
?mandate spells out the terms of the rating
?list of information requirements and the
3
Information requirements
broad framework for discussions. These requirements are derived from the experience of the issuers business and broadly conforms to all the aspects which have a bearing on the rating
4
Secondary information
?draws on the secondary sources of
information including its own research division. The credit rating agency also has a panel of industry experts who provide guidance on specific issues to the rating team
PB 030502 - 11
The credit rating process (contd)
Comments
?assessment of number of qualitative
5
Management meetings
factors to estimate the future earnings ? relating to plans , future outlook , competitive position and funding policies
6 Preview meeting
?findings are discussed ?opinion on the rating is formed
?final authority for assigning ratings
Rating Committee 7 meeting
?issues identified during discussions in the
internal committee are discussed
?a rating is assigned and all the issues
which influence the rating are clearly spelt out
8
Rating communication
?communicated to the issuer’s top
management (for acceptance)
PB 030502 - 12
The credit rating process
Comments
?rating is not acceptable to the issuer , he
9
Rating Reviews
has a right to appeal ?reviews are usually taken up only if the issuer provides fresh inputs on the issues that were considered for assigning the rating
10 Surveillance
?obligatory on the part of the credit rating
agency to monitor the accepted ratings over the tenure of the rated instrument ?the issuer is bound by the mandate letter to provide information to the credit rating agency ?ratings are generally reviewed every year ?initial rating could be retained or revised (upgrade or downgrade )
PB 030502 - 13
Rating framework
Risk drivers
Financial risk
Funding policy Financial flexibility
Business risk Industry characteristics Market position Operational efficiency New projects Management quality
All the factors which have a bearing on future cash generation and claims that require servicing are considered to assign ratings
PB 030502 - 14
INDICATIVE FACTORS CONSIDERED FOR RATINGS
competition Demand and supply Regulations and legislation
Industry risk
Cash flow adequacy
Operating efficiency
Management evaluation
Financial flexibility
Capital adequacy
…
PB 030502 - 15
Industry characteristics (Rating framework)
Drivers & potential Availability of raw material Dependenc e on a particular supplier Switching costs Threat of forward integration Role of the industry in the economy Product develope ments Nature of demand seasonal , cyclical Bargaining position of customers
Demand factors
Existing & expected capacities
supplier
Industry characteristics
Environmental factors Government policies -current and. future direction
State of competition
Intensity of competition Entry /exit barriers Threat of substitutes
Extent of government regulation
PB 030502 - 16
Financial aspects (Rating framework)
Constituent
Challenges Future funding requirements Level of leveraging Target returns for shareholders Views on retaining shareholding control Asset-liability tenure matching.
? availability of liquid investments and unutilized lines of credit ? financial strength of group companies
Funding policies
Financial flexibility
? market reputation , relationship with financial institutions and banks
? experience of tapping funds from different sources.
Past financial performance
?Profitability ?Gearing or level of leveraging and Coverage ratios ?Liquidity position and Cash flow analysis ?Future cash flow adequacy
PB 030502 - 17
Market position (Rating framework)
All the factors influencing the relative competitive position of the issuer are examined in detail.
positioning of the products perceived quality of products or brand equity
proximity to the markets
distribution network and relationship with the customers In markets where competitiveness is largely determined by costs, the market position is determined by the unit’s operational efficiency The result of these factors is reflected in the ability of the issuer to maintain /improve its market share and command differential in pricing. It may be mentioned that the issuers, whose market share is declining, generally do not get favorable long-term ratings.
PB 030502 - 18
Management quality (Rating framework)
When the business conditions are adverse, it is the strength of management that provides resilience. A detailed discussion is held with the management to understand its •objectives, • plans & strategies , • competitive position • views about the last performance and future outlook of the business. Other important factors are: labour relations , track record of meeting promises specifically relating to returns and project implementation , performance of "group" companies , transactions with the "group" companies etc. Issues like dependence on a particular individual and succession planning are also addressed.
PB 030502 - 19
New project risks (Rating framework)
All the factors influencing the relative competitive position of the issuer are The scale and nature of new projects can significantly influence the risk profile of any issuer. Unrelated diversification’s into new products are invariably assessed in greater detail. Time and cost overruns even non-completion in an extreme case during construction phase financing tie-up operational risks market risk track record of the management in project implementation, experience and quality of the project implementation team, implementation schedule, status of the project,
composition of operations team and market outlook and plans.
PB 030502 - 20
Operational efficiency (rating framework)
All the factors influencing the relative competitive position of the issuer are examined in detail. Location of the production unit(s) Access to raw materials Scale of operations Quality of technology
Level of integration
Experience ability of the unit to efficiently use its resources
PB 030502 - 21
Credit rating process (CRISIL)
PB 030502 - 22
Sample Requisitions for information
Bank Financial institution Manufacturing firm
PB 030502 - 23
Rating Scale
Rating Symbol
AAA AA A BBB BB B C D
Definition
Investment Grades
Highest Safety High Safety Adequate Safety Moderate Safety Inadequate Safety High Risk Substantial Risk Default
PB 030502 - 24
Speculative Grades
Credit rating
?Definition and concept
?The rating process
?Indian scenario
PB 030502 - 25
Credit rating agency Regulations
?Company registered under the companies act
( private or public) ?Promoters should be: –A public financial inst –A SCB or foreign bank (RBI approval) –Foreign CRA ( at least 5 yrs exp) –Body corporate having Net worth of 100crores for previous 5 years
Regulator SEBI
PB 030502 - 26
Credit rating agency Regulations
?Eligibility criterion
–Min net worth : Rs 5 crores –Body corporate and promoters should have professional competence , financial soundness and reputation for fairness and integrity
?Certificate of registration granted by SEBI
Regulator SEBI Credit rating agencies regulations(1999)
PB 030502 - 27
MONITORING OF RATING
•Compulsory continuous monitoring of the rating assigned to the securities during the life time of such securities. •To disseminate information regarding newly assigned rating and changes in earlier ratings •In case of listed securities CRA shall provide information regarding change in the rating to the concerned stock exchanges where the security is listed
PB 030502 - 28
Corporate Governance and Value Creation Ratings (CGVR)
Opinion on the relative level to which the rated company accepts and follows the codes and guidelines of corporate governance practices both in letter and spirit.
evaluates entity's performance and future expectation on 'balanced value creation through sound corporate governance practices'. The key variables analysed are: Shareholding Structure Governance Structure and Management Processes Board Structure and Processes
Stakeholder Relationship
Transparency and Disclosures Financial Discipline
PB 030502 - 29
Credit rating in INDIA
year •1987
•1991 •1993 •1994
agency CRISIL
ICRA CARE Fitch
foreign associate promoted by (S&P) ICICI
(Moody’s) IFCI
Market share
IDBI
others
ICRA
CRISIL
PB 030502 - 30
The Road Ahead… Concerns Regarding Credit Rating Agencies
Issuer Influence – A likely outcome of Issuer- fee model . ? How to hold CRAs accountable for the ratings given by them. (Argued that reputation of CRA is on the line). ? Advisory Services - concerns expressed wrt. potential conflicts of interest that may arise when a rating agency offers consulting or other advisory services to issuers it rates . ? Lead to herding behaviour thereby increasing the volatility of capital flows
PB 030502 - 31
The road ahead
India has three established rating agencies in which leading international credit rating agencies are stakeholders and also extend technical support. However, the level of rating penetration is not very significant as, so far, ratings are restricted to issues and not issuers. While Basel II gives some scope to extend the rating of issues to issuers, this would only be an approximation and it would be necessary for the system to move to ratings of issuers. Encouraging ratings of issuers would be a challenge. Who pays for a credit rating? Most credit rating agencies across the world use a revenue model where the issuer pays for the credit rating. Alternative revenue models (like the one based on investor fees) pose numerous challenges in terms of ease and practicality of implementation that have not yet been overcome.
PB 030502 - 32
Possible Risks of over-reliance on Ratings
? Lack of supervision and loopholes in regulatory framework may lead to laxity.
Tends to create demand for easy and accommodating raters. In other words, it stimulates `rating shopping’. ? Could induce ritualism and even enhance risk. Thus, issuers will get rated because they are required to do so and investors will tend to use it as a proxy for internal analysis . ? Assumption of uniform/standard ratings and rating criteria by different rating agencies, is not necessarily valid at all times. ? Mandatory ratings on domestic debt instruments etc. are no substitutes to a strong regulatory framework, transparency, accounting and disclosure standards.
PB 030502 - 33
Certain moot points for the future of CRA’s
Should competition be encouraged by liberalizing rules of entry… ? Who would venture into credit rating given the substantial investment and track record necessary to achieve marketplace acceptance of ratings …. ? Should the scope of ratings be expanded to issuer rating …..? Should equity issues be also brought under the ambit of rating……?
PB 030502 - 34
Impediments to the Accurate Appraisal of Issuers by CRA’s
Inability of rating agencies to access a continuous flow of accurate and reliable information from issuers Level and quality of Disclosure by Issuers given the consequences of a downgrade Regulations for disclosure by issuers need to be framed
Do the CRA’s exercise due diligence……?
PB 030502 - 35
Stability of ratings (for ICRA)
PB 030502 - 36
Thank you
PB 030502 - 37
doc_660089137.pptx