CRISILs Bank Loan Ratings process, scale and default recognition

Executive Summary A CRISIL bank loan rating (BLR) reflects CRISILs opinion on the likelihood of the financial obligations (arising out of a rated facility) being serviced on time and in full, as specified in the terms of the facility. CRISILs process for assigning ratings to bank loans is similar to the process followed for ratings bonds and debentures. The ratings assigned by CRISIL to the bank facilities are disseminated through a variety of channels, including publications and the CRISIL website. CRISIL assigns ratings on the long- and short-term scales, depending on the original maturity of the facility. CRISIL recognises default on term loans on the first instance of a missed payment, while in the case of working capital and non fund-based facilities, default is recognised if the facility remains overdrawn for more than 30 days in a row. CRISIL has been assigning bank loan ratings (BLRs) since June 2007, following Reserve Bank of India (RBI)s announcement of the prudential guidelines for implementation of the new capital adequacy framework for banks, in April 2007. These guidelines require banks to link the capital they maintain on credit exposures to the external credit ratings on these exposures. RBI has recognised CRISIL as an eligible external credit assessment institution. Banks can, therefore, use CRISILs ratings to compute the capital levels they need to maintain on rated credit exposures. Scope and methodology CRISIL rates fund- and non-fund-based facilities extended by banks. This article describes CRISILs approach to rating bank loansthe process followed, the rating scale used for, and the recognition of default on, each type of bank loan facility, and the policy for withdrawal of ratings. This article provides an overview of the criteria and processes used for assigning CRISIL ratings. For detailed criteria and industry-specific parameters used in the assessment of credit risk, refer to the section, Criteria and Methodology, on the CRISIL website. Significance of rating bank loans The Reserve Bank of India (RBI), in its Guidelines for Implementation of the New Capital Adequacy Framework issued in April 2007, had asked foreign banks, and Indian banks with operations outside India, to adopt the standardised approach for credit risk, and the basic indicator approach for operations risk by March 31, 2008. All other scheduled commercial banks in India were required to do the same by March 31, 2009. In the Basel-II approach, which is an improvement over the Basel-I approach, the credit risk of an exposure is governed by four parameters: the probability of default (PD), the loss-given default (LGD), the exposure at default (EAD), and maturity. Of the four components of credit risk, CRISIL BLRs address the firstthe PD component. A CRISIL BLR reflects CRISILs opinion on the likelihood of the financial obligations (arising out of a rated facility) being serviced on time and in full, as specified in the terms of the facility.

CRISIL Bank loan ratings process, scale and default definition

CRISILs process for BLRs The process that CRISIL follows (refer to Chart 1) in rating bank loans is similar to the process it follows in rating capital market debt instruments such as bonds, debentures and commercial paper. Chart 1 illustrates CRISILs rating process for BLRs.

Chart 1: Process flow for a rating assignment

Dissemination of CRISIL ratings Ratings assigned by CRISIL and accepted by the issuers are disseminated through CRISIL publications and various other media. RBIs guidelines require ratings on bank loan facilities to be available in the public domain, to be eligible for risk-weighting purposes. Additionally, SEBI guidelines require rating agencies to adhere to the International Organisation for Securities Commissions (IOSCO) Code of Conduct, which stipulates that rating agencies publish the ratings along with a report which explains the rationale for the rating opinion. CRISIL disseminates the rating on the bank facilities through its website and updates the rating lists on CRISILs websites on a real time basis, in addition to publishing the detailed rating report on its website. The impact of security on CRISIL BLRs CRISILs ratings address Probability of Default, one of the four components of credit risk, as identified under the Basel-II approach. Since lenders usually enforce their security interests only after default has occurred, realisations from assets do not influence the probability of default. For instance, for availing of a letter of credit (LC) facility, companies may offer 10 to 20 per cent of the facility limit as cash margins to the bank. However, the cash margin does not help the bank pre-empt a default by the company. CRISIL, therefore, does not provide any uplift to the facility rating on account of these cash margins. Nevertheless, asset security does have a significant impact on the LGD component of credit risk under the Basel-II approach. The presence of liquid assets on a companys balance sheet does, however, add to its financial flexibility. CRISIL factors this additional financial flexibility into all its BLRs. CRISILs rating scales for BLRs CRISIL assigns BLRs on the same scales as those it uses in assigning ratings to capital market debt instruments, including bonds, debentures, and commercial paper (refer to Annexure 1). Long- vs short-term rating scale The scale used in assigning a rating to a term loan depends on the loans original maturity as specified in the terms of the facility. This is in line with CRISILs approach for assigning ratings to debentures. Also, RBI guidelines specify that a bank facilitys maturity is the original contracted maturity, and not residual maturity. Therefore, a term loan with an original contracted maturity of 7 years, for instance, will be rated on the long-term scale, even if the residual maturity is only 8 months. Some fund-based facilities such as cash credit and working capital demand loans (WCDLs) are sanctioned for a period of one year; however, these facilities are often rolled over, and are, thus, akin to long-term exposures from the banks perspective. CRISIL, therefore, usually assigns ratings to these facilities on the long-term scale. In fact, RBIs guidelines specify that banks use the long-term ratings to compute capital requirement on such exposures. Other fund-based facilities such as packing credit, post-shipment credit, and bill discounting have maturity of less than a year, and are, therefore, rated on the short-term scale. CRISIL assigns ratings to non-fund based facilities such as LC or bank guarantees usually on the short-term scale. When a bank guarantee is invoked, or an LC devolves on the borrower, the bank makes a payment to the third party on behalf of the borrower. The borrower is required to make good this payment to the bank as per the terms of the bank guarantee facility within a short timeframe. Since the period available for the borrower for repayment is short, these facilities are rated on a short-term scale.

CRISIL Bank loan ratings process, scale and default definition

Table 1 lists the rating scales that CRISIL follows in rating bank loan facilities.

* Based on tenure of loan Banks often sanction credit limits to borrowers, and allow them the flexibility to draw down the limits as one of several pre-determined facilities. In other words, these facilities are fungible between those usually rated on the long-term scale (referred to as a long-term facility) and those rated on the short-term scale (referred to as a short-term facility). In such instances, the portion of the facility that can be drawn down as a long-term facility is assigned a rating on the long-term scale, while the remaining portion is assigned a rating on the short-term scale. CRISILs approach is in line with RBIs clarification on this issue. Recognition of default on bank loan facilities CRISIL assigns ratings to bank loans as per the terms of the facility, with respect to both repayment amount and repayment date. Consequently, any failure to honour debt obligations as per the terms of the facility is construed as default on the rated facility; this is distinct from the banking norms, where an account is recognised as a non-performing asset (NPA) only when it remains unpaid for more than 90 days after the due date. All facilities in default will carry a rating of CRISIL D on the long-term scale, or the short-term scale. The rating will remain in default category until the arrears are cleared, and a track record of timely repayment is established, subsequently. For term loans, failure to repay the amounts in full on due date is construed as default on the rated facility. Some bank facilities such as cash credit, which do not have specific due dates for repayment, allow borrowers to overdraw on the facility for a specified period with permission from the bank. Though such overdrawing may not necessarily indicate weakening in the borrowers credit quality, banks believe that facilities overdrawn for more than 30 days indicate deteriorating credit quality, and may classify such exposures as potential NPAs. As a result, CRISIL deems cash credit facilities to be in default if they remain overdrawn for more than 30 consecutive days. Similar terms apply for some non-fund based

Table 1: Types of Credit Facilities and Rating Scale Applicable Fund-based facilities Rating scale

Packing credit Shortterm Cash credit Longterm

Working capital demand loan (WCDL) Longterm Purchase bill discounting Shortterm Bill purchase/discounting Shortterm

Factoring/Forfeiting Shortterm Post-shipment credit Shortterm

Short-term loan Shortterm Foreign-currency non-resident loan Longterm /Shortterm *

Term loans Longterm External commercial borrowings (ECBs) Long-term

Mortgage loan facility Long-term Vendor financing Short-term

Non-fund-based facilities Rating scale Bank guarantee Shortterm Letter of credit Shortterm

facilities such as bank guarantees. Typically, banks classify non-fund based facilities which remain overdue beyond 30 days as potential NPAs. CRISIL deems these facilities to be in default if the devolved amount remains unpaid for more than 30 days. CRISIL also follows a similar approach to recognition of default for other working capital facilities like packing credit and bill discounting. This is in line with the RBIs guidance to the rating agencies on approach to recognising default on bank loan facilities.

Treatment of restructuring and rescheduling CRISIL expects entities that have requested restructuring or rescheduling of their debt obligations to continue to meet interest payment and principal repayment obligations on time and in full, until the lenders formally approve such requests. If borrowers fail to meet debt service obligations on time and in full pending approval of the request, CRISIL will treat such failure as default on the rated facilities. Upon receiving formal lender consent to the restructured terms, CRISIL will use the revised repayment schedule in its future analysis and recognition of default. Withdrawal of ratings A BLR assigned by CRISIL is not a one-time exercise. CRISIL keeps all outstanding ratings, including BLRs under continuous surveillance over the life of the rated facility. CRISILs policy for withdrawal of ratings stipulates that ratings on facilities (such as term loans), which have scheduled repayment dates, may be withdrawn only on redemption/maturity of the rated facilities. The ratings may also be withdrawn if the rated facilities are pre-paid by the borrower, with the lenders consent, before maturity. For facilities such as cash credit, which do not have a scheduled repayment date, the rating is placed on notice of withdrawal for one year, and subsequently withdrawn. CRISIL does not withdraw ratings immediately on request by borrowers; this is because end users of ratings (banks) may face sudden changes in prudential capital requirements, when rated facilities suddenly go to an unrated state.

Uniform default definition for bank loan facilities prescribed by RBI To ensure that all credit rating agencies follow a common approach for recognising defaults on bank loan facilities rated by them, RBI has prescribed a uniform default definition for bank loan facilities

i. For the facilities having a pre-defined repayment date / due date, the definition of one day one rupee may be adhered to

ii. For revolving facilities like cash credit, CRAs may allow, as of now, grace period upto a maximum of 30 days from the date of overdrawal, beyond which an entity would be considered to be in default.

iii. After the default is cured and the loan facility is regularized, the CRAs should upgrade the rating only if the rated entity shows satisfactory track record for at least 90 days / 3 months from the date of default. Generally in such cases, the rating would move to non-investment grade after curing.

CRISIL Bank loan ratings process, scale and default definition

Annexure 1: CRISIL rating scales

Long-Term Rating scale

Short-Term Rating scale Structured Finance Rating scale

Symbol (Rating category)

Symbol (Rating category)

Long-Term Structured Finance Instruments

(Rating category)

Short-Term Structured Finance Instruments

(Rating category) CRISIL AAA CRISIL A1 CRISIL AAA (SO) CRISIL A1 (SO)

CRISIL AA CRISIL A2 CRISIL AA (SO) CRISIL A2 (SO)

CRISIL A CRISIL A3 CRISIL A (SO) CRISIL A3 (SO)

CRISIL BBB CRISIL A4 CRISIL BBB (SO) CRISIL A4 (SO)

CRISIL BB CRISIL D CRISIL BB (SO) CRISIL D (SO)

CRISIL B CRISIL B (SO)

CRISIL C CRISIL C (SO)

CRISIL D CRISIL D (SO)

CRISIL may apply '+' (plus) or '-' (minus) signs to ratings from ' CRISIL AA' to ' CRISIL C' to reflect

comparative standing within the category; CRISIL may apply + (plus) sign to ratings from 'A1' to 'A4' to reflect a comparatively higher standing within the category.

CRISIL may assign rating outlooks to ratings from ' CRISIL AAA' to ' CRISIL B'. Ratings on Rating Watch will not carry outlooks. A rating outlook indicates the direction in which a rating may move over a medium-term horizon of six months to two years. A rating outlook may be 'Positive', 'Stable', or 'Negative'. A 'Positive' or 'Negative' rating outlook is not necessarily a precursor of a rating change.

The suffix 'r' indicates investments carrying non-credit risk. The 'r' suffix indicates that payments on the rated instrument have significant risks other than credit risk. The terms of the instrument specify that payments to investors will not be fixed, and may be linked to one or more external variables such as commodity prices, equity indices, or foreign exchange rates. This may result in variability in paymentsincluding possible material loss of principalbecause of adverse movement in the values of external variables. The risk of such adverse movement in price/value is not addressed by the rating.

About CRISIL Limited CRISIL is a global analytical company providing ratings, research, and risk and policy advisory services. We are India's leading ratings agency. We are also the foremost provider of high-end research to the world's largest banks and leading corporations. About CRISIL Ratings CRISIL Ratings is India's leading rating agency. We pioneered the concept of credit rating in India in 1987. With a tradition of independence, analytical rigour and innovation, we have a leadership position. We have rated over 60,000 entities, by far the largest number in India. We are a full-service rating agency. We rate the entire range of debt instruments: bank loans, certificates of deposit, commercial paper, non-convertible debentures, bank hybrid capital instruments, asset-backed securities, mortgage-backed securities, perpetual bonds, and partial guarantees. CRISIL sets the standards in every aspect of the credit rating business. We have instituted several innovations in India including rating municipal bonds, partially guaranteed instruments and microfinance institutions. We pioneered a globally unique and affordable rating service for Small and Medium Enterprises (SMEs).This has significantly expanded the market for ratings and is improving SMEs' access to affordable finance. We have an active outreach programme with issuers, investors and regulators to maintain a high level of transparency regarding our rating criteria and to disseminate our analytical insights and knowledge CRISIL Privacy Notice CRISIL respects your privacy. We use your contact information, such as your name, address, and email id, to fulfil your request and service your account and to provide you with additional information from CRISIL and other parts of McGraw Hill Financial you may find of interest. For further information, or to let us know your preferences with respect to receiving marketing materials, please visit www.crisil.com/privacy. You can view McGraw Hill Financials Customer Privacy Policy at http://www.mhfi.com/privacy. Last updated: May, 2013

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