Credit Rating

IBFS
Module 7

Meaning
The process of assigning a symbol with specific reference
to the instrument being rated, that acts as an indicator of
the current opinion on relative capability on the issuer to
service its debt obligation in a timely fashion, is known as
credit rating.
Credit Rating is an alphabetical or alphanumerical
representation of the credit worthiness of the individual,
business or instrument of a business.
However Ratings merely express an opinion on the
credibility of the entity and cannot be considered to be a
recommendation.

 The evaluation of the credit worthiness of

the anything is based on several premises,
most important of them being:
Ability to pay
Willingness to pay

Definition
Credit ratings help investors by providing
an easily recognizable simple tool that
couples a possibly unknown issuer with an
informative and meaningful symbol of
credit quality.- Standard & Poor

What is credit rating? (QP)

Assessment of the capacity of an issuer of debt
security : Represents probability of default
Represents credit quality: quickest way of
identifying companys financial conditions
Represents an opinion of rating agency
Done for specific debt security & not for a
company as a whole
It is an ongoing appraisal not one time evaluation

Some of the renowned rating agencies are:

Standard & Poors
Moodys Investor Service
Fitch Rating Agency
In India
CRISIL (Credit Rating and Information Services (India)
Limited) first in India
ICRA Limited (Investment information and Credit Rating
Agency of India Limited)
CARE (Credit Analysis and Research Limited)
Fitch Rating India Pvt Ltd

What can be rated?

1. Bonds/ debentures- [the main product]
2. Commercial paper
3. Structured finance products
4. Bank loans
5. Fixed deposits and bank certificate of
deposits
6. Mutual fund debt schemes
7. Initial Public Offers (IPOs)

How does credit rating help

investors ? (QP)

Advantages of Credit Rating to

Investors
Information service about credit quality
Systematic Risk Evaluation methods followed by credit
rating agency
Establishes a link between risk and return
Easy to understand & Helps in making investment
decision
Helps in Efficient portfolio management for institutional
investors
Encourages corporates to maintain discipline, improve
their financial structure and operating risks to get a better
rating

Benefits of Credit rating to

companies (QP)
Index of faith
Wider Investor base
Benchmark
Credit rating is a way to expect returns

Features of credit Rating

Guidance, not recommendation
Based on assumptions(board parameters)
relativity
Specificity
No guarantor

Credit rating symbols

Moodys Global Rating Scale

Credit rating symbols

Standard & Poor's investment grade ratings in
order from the highest to the lowest are: AAA,
AA+, AA, AA-, A+, A, A-, BBB+, BBB and BBB-.
BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC- CC,
C, D and SD. ( from BB+ to SD consider as noninvestment grade ratings)
The sign of + (plus) or (minus) with rating
symbols indicates their relative position within the
rating categories concerned.

Credit rating symbols

ICRA(Investment Information and Credit
Rating Agency of India Limited)
Long-term Debt- Debenture, Bonds and Pre.Shares
SYMBOLS INDICATOR PROFILE
LAAA
Highest safety risk negligible
LAA
High safety
modest & slight risk
LB
Risk prone
obligation not met
LD Default Extremely default in payment
SEBI rating symbols

Process of credit rating:

1.Credit Rating Agency enters into an agreement with the
client whose securities are to be rated
1.Rights and liabilities of the parties are defined
2.Fees charged is specified
3. Tenure for periodic review of the rating is specified
4. The client shall disclose the credit rating received for its listed
securities and disclosed the same in its offer document whether or not
it is accepted by him.
3.Ensure confidentiality of all the information disseminated by the
client
4.The rating agency shall exercise due diligence to ensure that the
rating assigned is fair and appropriate

2. Rating agencies on the basis of several premises assign

the credit rating and communicate to the client/ issuer.

Process of credit rating:

3.The issuer can make one request for review of the rating
based on fresh facts and clarifications.
4.Then the final rating is assigned and the same is
published along with the definition of the concerned rating
along with the symbol.
5. A copy of the rating is filed with the Board along with any
modifications and additions made thereafter
6. The rating agency will also publish the rationale behind the
rating assigned and the justification to the premises considered,
favorable assessment and factors constituting risk
7. Once accepted, it is disclosed and put in the surveillance
process thereafter

Process of credit rating:

8. Surveillance: Continuous review of the ratings assigned to the
rating agency. Frequency of the reviews may vary from quarterly to
annually as per the agreement
9. Credit Watch: In case of any event taking place, that may result in
major deviations from the expected trends and which are likely to
impact the credibility, rating of the entity, such instruments are put on
credit watch, until the impact of the event is not evident or clear
10. Investments in investment grade: Investors are advised to invest
in securities upto investment grade level, which is BBB (S&P) and Baa
(Moodys). Securities rated below the investment grade are referred to
as speculative grade or junk bonds

Credit Ratings
Methodology

Business
Risk Profile
Analysis

Financial
Risk Profile
Analysis

 Validation of Company
Position
Trends
Quality of Earnings
& Analytical adjustments
Peer Group Comparisons

Profitability
/ Peer Group
Comparisons

Competitive Factors
Market position
Keys to Success
Size
Diversification
Management

Country
Risk

Industry
Factors

Business
Risk

Company
Position

Political
Economic
Industry Specific factors
Foreign exchange

Industry Trends
Industry Structure
Market Size
Growth Potential
Cyclicality
Bases of Competition
Changing Technology
Operating Risk
Regulatory Environment

 Operating sources & uses

Of liquidity
Other potential calls on
Liquidity
Debt Characteristics
Bank credit facilities

Liquidity /
Short-term
Factors

Focus on debt
service capability
Analytical distinctions with
profitability
Cash flow measures /
ratios

Accounting

Accounting Regime
Reporting & Disclosure
Analytical adjustments

Governance
Risk

Financial
Risk

Cash Flow
Adequacy

Ownership
Board of directors
Management practices
Financial Strategy
Risk Tolerance
Accounting Practices
Internal controls

Major Credit Rating Agencies(CRA)

CRISIL (Credit Rating Information services of India LTD)
ICRA (Investment Credit Rating Agency of India Ltd)
CARE (Credit Analysis & Research Ltd)
FITCH Ratings India Pvt Ltd
SMERA (SME rating agency of India)

CRISIL Ltd
First credit rating agency in India
Promoted in 1987 jointly by ICICI Ltd & UTI. Other share
holders include ADB,LIC, HDFC Ltd, GIC & several
foreign & Indian bank
It pioneered the concept of rating services & innovated
new concepts in rating services
It provides a broad range of services
Credit ratings
Advisory services in the area of energy, transport, urban
infrastructure, capital markets, banking & finance
Global data services: provide high quality, reliable & timely
financial analysis of around 1500 Indian corporate.
Credibility first: rating & evaluation services across the cross
section of companies in small sized sector.
Training services
CRIS: CRISIL RESEARCH & INFORMATION SERVICES

CRISIL Ltd
It has a strategic alliance with the US based
rating agency, the Standard & poors rating
services
Relationship further strengthened with S&Ps
acquiring 9.6% CRISIL stake

ICRA
ICRA Limited (formerly Investment Information and Credit
Rating Agency of India Limited)
Promoted by IFCI Ltd, UTI,LIC,GIC, ILFS Ltd , EXIM
Bank & other
Entered into a MOU with Moodys Investors Service
ICRA is a Public Limited Company, with its shares listed
on the Bombay Stock Exchange and the National Stock
Exchange.
Services
Rating services
Credit assessment & advisory services
Grading services
Information Services

SME rating agency of India

(SMERA)
is a joint initiative by SIDBI, Dun & Bradstreet Information
Services India Private Limited (D&B), and several leading
banks in the country.
SMERA commenced its operations in 2005 as an
exclusive credit rating agency for Micro, Small and
Medium Enterprises (MSME) sector in the country.
SMERA has assigned ratings to over 35678 MSMEs pan
India so for.
Objective is to enhance credit flow to credit-constrained
SME sector. It was first of its kind in the world.
The agency would rate any individual or company
engaged in any field like manufacturing, trading, business
and commerce but not the non banking finance
corporations (NBFCs), chit funds and nidhis.

Credit Analysis and Research

(CARE) Ltd
A full service rating company that offers a wide range of rating and
grading services across sectors.
Incorporated in 1993 by consortium of Banks/financial institutions in
India. The three largest shareholders of CARE are IDBI Bank,
Canara Bank and State Bank of India.
Registered with SEBI under the Securities & Exchange Board of
India(Credit Rating Agencies) Regulations, 1999.
CAREs Ratings are recognized by Govt. of India and all
regulatory authorities like RBI and SEBI.
CARE is a founder member of Association of Credit Rating Agencies
in Asia (ACRAA).

SECURITISATION

Introduction
Securitization is simple terms means the
conversion of existing or future cash in-flows
of any person into tradable security, which
then may be sold in the market.
The cash inflow from financial assets such as
mortgage loans, automobile loans, trade
receivables, credit card receivables, fare
collections become the security, against
which, borrowings are made.

What is Securitization?
Securitization is the packaging of a pool of financial
assets into marketable securities.
Typically relatively illiquid assets are converted into
securities.
The aim behind a securitization structure is to
serve the risk of originator insolvency from the risk
of the asset/ receivable performance, allowing the
investor to rely on the asset risk rather the general
corporate credit risk of an originator.

The Why of Securitisation

1.Companies with low credit rating can issue asset
backed securities at lower interest cost due to
higher credit rating on such security.
2.Relatively illiquid assets are converted into
marketable securities providing liquidity and
alternative funding sources.
3.Removal of assets from the balance sheet under
a true sale can improve capital adequacy.
4.The operations in a particular business
area/portfolio of assets can be increased while
not increasing the total exposure to that area or
assets.
5.In case the originator also acts as the servicer
/receiving and paying agent (RPA), it also gets
the servicing fee.

Features of Securitization (QP)

Marketability
Credit Ratings
Wide distribution
Homogeneity Similar loans are bunched
together
Integration and Differenciation

Securitisation How?
Homogeneous Loans (assets) are pooled together by Co. A
The Pool is sold to SPV (Special Purpose Vehicle)
SPV makes payment to Co. A at a Discount
SPV issues the pool certificate to Co. B collecting the sale
proceeds and promising to pay Co. B installment and the
interest regularly for a given period of time
SPV collects the payment from borrowers passes on the
proceeds to Co. B after deducting its service charges

Parties to securitisation transaction

Originator
Obligors
Special purpose vehicle: single/ multiple
Trustees
Investors
Merchant banker/ underwriter
Credit rating agency
Servicing agent / receiving & paying agent(RPA)

Basic process of securitisation

1. Cash flow before
securitisation

Originator
2.Assigns
Cash flow

Security
trustee

4. Proceeds
of sale of
receivables

SPV
special
purpose
entity

3. Issues
securities/ notes

Obligors
6.Passes over to SPV,
less fees

8. Reinvestment
proceeds/liquidity
facility

4. Proceeds of
issue of securities

Investors

5.Collection and servicing

7. Reinvestment/liquidity
buffer

Reinvestment
contract
9. Payments to
investors

Stages involved in
Securitisation
Identification stage
Transfer stage
Issue stage
Redemption stage
Credit rating stage

Stages involved in
Securitisation
Identification stage
the bank or any other institution decide to
go for Securitisation called originator. He
pick up the pool of assets of homogenous
nature, considering the maturities, interest
rated involved and frequency of repayment
and marketability.

Stages involved in
Securitisation
Identification stage
Transfer stage
selected pool of asset is passed through the
other institution which is ready to help the
originator to convert those pools asset into
securities. This institution called SPV.

Stages involved in
Securitisation
Identification stage
Transfer stage
Issue process
SPV split the packaged into individual
securities of smaller values and they are
sold to the investing public. The securities
issued by SPV is called different names like
pay through certificate, pass through
certificate, interest only certificate,
principal only certificate.

Stages involved in
Securitisation
Identification stage
Transfer stage
Issue stage
Redemption process
the redemption and payments of interest
on these securities are facilitated by the
collections received by the SPV from
securitized asset.

Stages involved in
Securitisation
Identification stage
Transfer stage
Issue stage
Redemption stage
Credit rating process
since pass through certificate issued publically,
required credit rating agency to rate so that it
become more attractive.

The Types of Securities Structure

1.Pass Through Certificates:
Sale of asset to SPV
Investors purchase interest in the assets of SPV
Cash flow (interest and principal) passed through as
and when occurred without any reconfiguration
Payments made are most often on monthly basis
Reinvestment risk carried by investor

The Types of Securities Structure

1.Pay Through Certificates:

Sale of assets to SPV

SPV issues a debt security collateralized by asset cash
flows
Cash flows (interest and principal) reconfigured to suit
the requirements of the investors i.e. based on the
maturity period of the security
Reinvestment risk carried by SPV
Each trench is redeemed one at a time
Payments would be at different time intervals than the
flows from the underlying assets

Senior Notes, Junior Notes etc

SPV can issue these notes in addition to Pass through
Certificates and Pay through Certificates
Senior notes are paid interest and principal repayments
first

 Stripped Securities:
Under this, the securities are classified as interest only
(IO) securities or Principal Only securities;
IO holders are paid back out of interest only and PO security
holders are paid out of principal repayments only.
These securities are highly volatile in nature and are least
preferred by the investors.
PO securities increase in value when interest rates go down
because it becomes lucrative to prepay existing mortgages
and undertake fresh loans at lower interest rates.

Benefits to Companies
Increased Liquidity: illiquid assets are converted into
tradable securities.
Higher Credit Quality: The structure of the instrument can
be tailored in such a manner that a desired credit rating,
which is higher that the rating of company holding the
assets, is achieved.
Risk Diversification: securities allows the issuer its credit
exposure to a particular borrow/ sectors and thus helps in
risk diversification of asset portfolio.

 Asset Liability Management: Securitisation offers

an efficient way of matching of assets,
Funding Sources: Securitisation allows the issuer
to find alternate sources of funding and also raise
funds at low costs with improved credit rating.
In short, it is a total risk management on the
balance sheet itself.

To Investor
Liquidity: instruments are freely tradable in the
market.
Safety: instruments are rated and backed by
assets and collaterals. Bankruptcy of seller will
not have any impact since SPV is in charge of
assets and it will protect the interest of investors.
Cash flows: flexible range of maturities to suit
different cash flow requirements.
Diversification: different types of instruments in
different portfolios for risk mitigation.

To Market
It creates more depth in the market by adding
more diversified instruments with different
maturities.
More fee based income for financial institutions,
since they may act as administrators.

Issues in securitization
involves the Transfer of beneficial, and not the legal
title.
Cumbersome transfer process
no secondary market for securitised debt.
The market is unregulated and lacks transparency
in terms of volume, price, parties to the transaction,
etc.
The settlement procedures are not clear.
There are no standard accounting and valuation
norms.
Inadequate credit rating facility