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Dr.N.Moogana Goud, Professor RITM, Bangalore

CREDIT RATINGCREDIT RATING

An over view of Credit ratingBy

Dr.N.Moogana Goud

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Dr.N.Moogana Goud, Professor RITM, Bangalore

IntroductionIntroduction

In a market, financial markets play the role of efficientintermediary. They act as alink between savers andinvestors, mobilizing capitalon one hand, and efficientlyallocating them betweencompeting users to the other hand.In addition to this aninvestor can also base the

investment decision on thegrading offered by creditrating agencies.

Definition

Origin

Features

The credit ratingsystem.

Major issues.

RegulatoryFramework.

Credit rating

symbols.

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Dr.N.Moogana Goud, Professor RITM, Bangalore

IMPETUSIMPETUS

The credit rating system originated in the USA inThe credit rating system originated in the USA inseventies.seventies.

The high levels of default, which occurred after The high levels of default, which occurred after Great Depression, in the US capital markets, gaveGreat Depression, in the US capital markets, gavethe impetus for the growth of credit rating.the impetus for the growth of credit rating.

The default of $82 million of commercialThe default of $82 million of commercialpaper by Penn Central in he year 1970. and thepaper by Penn Central in he year 1970. and the

consequent panic of investor in commercialconsequent panic of investor in commercialpapers, resulted in massive defaults and liquiditypapers, resulted in massive defaults and liquiditycrisis.crisis.

US made rating Mandatory for institutionsUS made rating Mandatory for institutionssuch as Govt Pension funds, and Insurancesuch as Govt Pension funds, and Insurancecompaniescompanies

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Dr.N.Moogana Goud, Professor RITM, Bangalore

IMPETUSIMPETUS

Reasons for the origin of credit ratingReasons for the origin of credit ratingagenciesagencies the increasing role of capital and money marketsthe increasing role of capital and money markets

consequent to disintermediation.consequent to disintermediation. Increased securitizaton of borrowing and lendingIncreased securitizaton of borrowing and lending

consequent to disinitermediation.consequent to disinitermediation. Globalization of the credit market.Globalization of the credit market. The continuing growth of information technology.The continuing growth of information technology. The growth of confidence in the efficiency of theThe growth of confidence in the efficiency of the

market mechanism.market mechanism. the withdrawal of Govt safety nets and the trendthe withdrawal of Govt safety nets and the trend

towards privatizationtowards privatization

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Growth of Credit Rating AgenciesGrowth of Credit Rating Agencies

1841- Merchantile Credit Agency (USA)1900- Moodys Investors Services(USA)1916- Poor Publishing Company(USA)

1922- Standard Statistics Company(USA)1924- Pitch Publishing Company(USA)1941- Standard and Poor(USA)1074- Thomson Bank Watch(USA)

1975- Japanese Bond Rating Institution (JAPAN)1987- CRISIL by ICICI (INDIA)1991- ICRA by IFCI (INDIA)1994- CARE by IDBI (INDIA)

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Features of CreditFeatures of Creditratings.ratings.

Specificity. Relativity. Guidance. Not a Recommendation. Broad Parameters.

No Guarantee. Quantitative and Qualitative.

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The credit ratingThe credit ratingsystem.system.

Credit rating has facilitated authorities aroundthe world to issue mandatory ratingrequirements. For instance, specific rulesrestrict the of new issues that are rated below a

particular grade.

Growth Factors : Credibility and Independence.

Capital Market Mechanism. Disclosure requirements. Credit Education. Creation of Debt Market.

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Major issuesMajor issues

Investment Vs speculative Grades. Continuous Monitoring. Grade Surveillance. Rating Ceiling. Evaluation of Line.

Ownership Consideration.

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Investment Grade RatingsInvestment Grade RatingsS&P and OthersS&P and Others

RatingAAAAA+AAAA-A+A-

BBB+BBBBBB-

InterpretationHighest QualityHigh QualityHigh Quality

High QualityStrong Payment CapacityStrong Payment CapacityAdequate Payment Capacity

Adequate Payment CapacityAdequate Payment Capacity

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Speculative Grade RatingsSpeculative Grade RatingsS&P and Others Moody's Interpretation

BB+ Ba1 Ongoing uncertainty

BB Ba2 Ongoing uncertaintyBB- Ba3 Ongoing uncertainty

B+ B1 High Risk Obligations

B B2 High Risk Obligations

B- B3 High Risk Obligations

CCC+ Vulnerability to defaultCCC Caa Vulnerability to default

CCC- Vulnerability to default

C Ca In Bankruptcy

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Regulatory FrameworkRegulatory Framework

credit rating has been made mandatory inIndia for issuance of instruments. Following aresome of the important regulatory agenciesconnected with credit rating.

SEBI : As per the regulations of SEBI, a public issue of debentures and bonds convertible/redeemable beyond aperiod of 18 months, needs credit rating.

RBI : According to the guidelines of RBI, one of the

conditions for issuance of commercial paper inIndia is that the issue must have a rating notbelow the P2 grade from CRISIL/A2 grade fromICRA/PR2 from CARE.

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Rating FrameworkRating Framework

Credit rating at providing an opinion on the relativecredit risk associated with an instrument.while assigning ratings, all the factors that have a

bearing on future cash generation, and claims thatrequire servicing, are considered. The major factorsthat determine the rating profile of a security issueare discussed below :

Business Factors1. Nature of industry2. Market position3. Efficiency of operation.4. Project risk5. Protective factors6. Quality of management.

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Financial Factors :Financial Factors :

1.Financing Policies.1.Financing Policies.2.Flexibility of financial structure.2.Flexibility of financial structure.

3.Past track record.3.Past track record.4. Quality of accounting policy.4. Quality of accounting policy.5.Financial performance indicators.5.Financial performance indicators.

Profitability.Profitability.

Gearing.Gearing.

Coverage ratios.Coverage ratios. Liquidity.Liquidity. Cash flow.Cash flow.

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AdvantagesAdvantages

1. To investors. Information service.. Systematic risk evaluation.

. Professional competency.

. Easy to understand.

. Low cost.

. Efficient portfolio management.

.Other benefits.

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DrawbacksDrawbacks

Guidance, not recommendation. Based on assumptions.

Competitive ratings .

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