CHAPTER 5

TYPES OF RATINGS

Following are the different kinds of rating:

(1) Bond/debenture rating

Rating the short term and medium term debentures/bonds issued by corporate,
government etc. is called debenture or bond rating.

(2) Equity rating

Rating of equity shares issued by a company is called equity rating. An evaluation
of

a stock's expected performance and/or

its risk level as

judged

by a

rating agency such as Standard and Poor's. A stock rating will usually help the
investor to find out fair value for the stock, based on an objective evaluation of
the company. The greater the amount by which the fair value exceeds the market

value, the more highly recommended a buy the stock is. Conversely, if the market
value of the stock exceeds the fair value of the stock, then analysts recommend
that the stock be sold. Most stock rating systems give stocks 1 to 5 stars, with 5
being

the

best.

(3) Preference share rating

Rating of preference share issued by a company is called preference share rating.

(4) Commercial paper rating

Commercial papers are instruments used for short-term borrowing. Commercial
papers are issued by manufacturing companies, finance companies, banks and
financial institutions and rating of these instruments is called commercial paper
rating.

(5) Fixed deposits rating

Fixed deposits programmers are medium term unsecured borrowings. Rating of

such programmes is called as fixed deposits rating.

(6) Borrowers rating

Rating of borrowers is referred as borrower rating.

(7) Individuals rating

Rating of individuals is called as individual's credit rating.

(8) Structured obligation

Structured obligations are also debt obligations and are different from debenture
or bond or fixed deposit programmes and commercial papers. Structured
obligation is generally asset-backed security. Credit rating agencies assessed the
risk associated with the transaction with the main trust on cash flows emerging
from the asset would be sufficient to meet committed payments, to the investors in
worst case scenario.

(9) Sovereign rating

Is a rating of a country, which is being considered whenever a loan is to be
extended, or some major investment is envisaged in a country. It is a grading of
a country's ability to

meet

its financial

agencies provide these ratings and investors use

of risk related

with investing in

country.

obligations.Credit
this
The

to
rating

assess
may

rating
the

also

level
include

an evaluation of a country's political risk. For example, India has been given BBB
negative rating by Standard and poors as on April 2012.
Because it is the doorway into a country's investment atmosphere, the sovereign
rating is the first thing most institutional investors will look at when making a decision
to invest money abroad. This rating gives the investor an immediate understanding
of the level of risk associated with investing in the country. A country with a sovereign
rating will therefore get more attention than one without. So to attract foreign money,
most countries will strive to obtain a sovereign rating and they will strive even more

so to reach investment grade. In most circumstances, a country's sovereign credit

rating of AAA indicates lowest risk.

(10) Rating of real estate

CRISIL has started assigning rating to the builders and developers with the objective
of helping and guiding prospective real estate buyers. CRISIL thoroughly scrutinizes
the sale deed papers, sanctioned plan; lawyers report government clearance
certificates before assigning rating to the builder or developer. Past experience of the
builder, number of properties built by the builder, financial strength, and time taken
for completion are some of the factors taken into consideration by the CRISIL before
giving a final rating to the real estate builder developer.

(11) Bank ratings

CRISIL and ICRA both are engaged in rating of banks based on the following six
parameters also called CAMELS.

C - C stands for capital adequacy of banks. A bank needs to maintain at least 10 %

capital against risky assets of the bank.
A - A stands for asset quality. The loan is examined to determine non-performing
assets. An asset/loan is considered non-performing asset where either interest or
principal is unpaid for two quarters or more. Ratios like NPA to Net Advances,
Adequacy of Provision & Debt Service Coverage Ratio are also calculated to
know exact picture of quality of asset of a bank.
M - M stands for management evaluation. Here, the efficiency and effectiveness of
management in framing plans and policies is examined. Ratios like ROI, Return
on Capital Employed (ROCE), and Return on Assets (ROA) are calculated to
comment upon banks efficiency to utilize the assets.
L - L indicates liquidity position. Liquid and current ratios are determined to find out
banks ability to meet its short-term claims.
S - S stands for Systems and Control studied to determine their adequacy and
efficiency.

CHAPTER 6
ROLES AND OPRATIONS OF CREDIT RATING
AGENCIES: CRISIL, ICRA and CARE
CRISIL (Credit Rating
Information Services of
India Limited)

ICRA (Investment
Information and Credit
Rating Agency of India
Ltd.)

CARE (Credit Analysis

and Research Ltd.)

1987

1991

1993

Industrial Credit and

Investment Corporation of
India Ltd. (ICICI) and Unit

Industrial Finance
Corporation of Ind

IDBI Jointly with

investment institutions,
banks and finance

Particular
Incorporated in
Promoted By

Registered
Office

Trust of India

ia(26%), and UTI, LIC,

GIC, PNB, Central Bank
of India, Bank of Baroda,
Uco Bank etc. (74%)

companies

Mumbai

New Delhi

Mumbai

Rating Process

1. Request of the
company
2. Assignment to
Analytical team
3. Obtaining and
processing of data
4. Finding
presentation
5. Communication of
decision
6. Monitoring of
change of rating

1. Rating request
2. Rating team
3. Information
requirement
4. Secondary
information
5. Management
meeting and
plant visits
6. Preview Meeting
7. Rating
Committee
meeting
8. Rating
communication
9. Rating reviews
10. Surveillance

1. Client request
and submission
of information
2. Analyze
information
3. Team
undertakes site
4. Form Internal
Committee for
preview
analyses
5. Assign Rating
6. Review of rating
assign

Rating Symbols

1. AAA Highest
Safety
2. AA High Safety

1. LAAA : Highest
Safety
2. LAA+, LAA, LAA-

1. CARE AAA :
Highest Safety
2. CARE AA : High

Long Term
(Rating
Symbols for
Debentures)

3. A Adequate
Safety
4. BBB Moderate
Safety
5. BB Inadequate
Safety
6. B High Risk
7. C Substantial
Risk
8. D Default

3.
4.
5.
6.
7.

: High Safety
LA+, LA, LA- :
Adequate Safety
LBBB+, LBBB,
LBBB- :
Moderate Safety
LBB+, LB, LB- :
Risk Prone
LC+, LC, LC- :
Substantially
Risk
LD : Extremely
speculative

3.
4.
5.
6.
7.
8.

Medium Term
(Fixed Deposit)

1. FAAA : Highest
Safety
2. FAA : Adequate
Safety
3. FA : Safety
4. FB : Inadequate
Safety
5. FC : High Risk
6. FD : Default

1. MAAA : Highest
Safety
2. MAA+, MAA,
MAA- : High
Safety
3. MA+, MA, MA- :
Adequate Safety
4. MB+, MB, MB- :
Inadequate
Safety
5. MC+, MC, MC- :
Risk Prone

Safety
CARE A :
Adequate Safety
CARE BBB :
Moderate Safety
CARE BB : High
Risk
CARE B :
Substantially
Risk
CARE C :
Extremely High
Risk
CARE D : Likely
to be default
soon

1. CARE 1 :
Excellent Safe
2. CARE 2 : Very
Well Safe
3. CARE 3 :
Adequate Safety
4. CARE 4 :
Favorable Safe
5. CARE 5 :
Default

Short Term
(Commercial
Paper)

6. MD : Default
1. A1+, A1 : Highest
Safety
2. A2+, A2 : High
Safety
3. A3+, A3 :
Adequate Safety
4. A4+, A4 : Risk
Prone
5. A5 : Default

1. P1 : Very Strong
Safety
2. P2 : Strong Safety
3. P3 : Adequate
Safety
4. P4 : Favorable
5. P5 : Default

1. PR1 : High Rate

of Return
2. PR2 : Strong
Capacity for
repayment
3. PR3 : Adequate
capacity for Re
4. PR4 : Minimal
Degree of
Safety
5. PR5 : Likely to
be default

QUESTONRIES
1. Is your company regulated for providing credit ratings on a professional basis?
Yes

No

2.

If you answer yes to Qu1, in which country is your company regulated?

3. Can your company rate a bond or any other debt or financial obligation issued in a
country in which you are not regulated?
4. Yes
No
5. . If a bond issuer seeks credit ratings from your company for a bond issued in
Mauritius, will your company consider rating the bond issue?

10

6.

YES
NO
6. If you answer no to Qu4, please state the reason.

....

....
7. Will your company consider taking a licence from the Financial Services
Commission in Mauritius to issue credit ratings for bonds issued in Mauritius?
Yes
No
8. If you answer no to Qu6, please state the reason.
......
....

8. Does your company adopt a Code of Conduct, as set out in the principles of the
International Organization of Securities Commission?
Yes
No

TYPES OF RATING

Following are the different kinds of rating:

(1) Bond/Debenture Rating

11

Rating the debentures/ bonds issued by corporates, government etc. is

called debenture or bond rating.

(2) Equity Rating

Rating of equity shares issued by a company is called equity rating.

(3) Preference Share Rating

Rating of preference share issued by a company is called preference

share rating.

(4) Commercial Paper Rating

12

Commercial papers are instruments used for short-term borrowing.

Commercial papers are issued by manufacturing companies, finance
companies, banks and financial institutions and rating of these
instruments is called commercial paper rating.

(5) Fixed Deposits Rating

Fixed deposits programmes are medium term unsecured borrowings.

Rating of such programmes is called as fixed deposits rating.

(6) Borrowers Rating

Rating of borrowers is referred as borrower rating.

13

(7) Individuals Rating

Rating of individuals is called as individual's credit rating.

(8) Structured Obligation Rating

Structured obligations are also debt obligations and are different from
debenture or bond or fixed deposit programmes and commercial
papers. Structured obligation is generally asset-backed security. Credit
rating agencies assessed the risk associated with the transaction with
the main trust on cash flows emerging from the asset would be
sufficient to meet committed payments, to the investors in worst case
scenario.

(9) Sovereign Rating

14

Is a rating of a country, which is being considered whenever a loan is to

be extended, or some major investment is envisaged in a country.

15

BENEFITS OF CREDIT RATING`

For different classes of persons different benefits accrue from the use of rated
instruments. The benefits directly accruing to investors through rated
instruments are:

(A) BENEFITS TO INVESTORS

Investors are benefited in many ways if the corporate security in which they
intend to invest their saving has been rated. Some of the benefits are:

(1)Safeguards Against Bankruptcy

Credit rating of an instrument done by a credit rating agency gives an idea to

the investors about the degree of financial strength of the issuing company,
which enables him to decide about the investment. A highly rated instrument

16

of a company gives an assurance to the investors of the safety of that

instrument and a minimum risk of bankruptcy.

(2)Recognition Of Risk

Credit rating provides investors with rating symbols that carry information in
easily recognizable manner for the benefit of investors to perceive the risk
involved in the investment. It becomes easier for the investors by looking at
the symbol to understand the worth of the issuing company. The rating symbol
gives them the idea about the risk involved or the expected advantages from
the investment.

(3)Credibility Of Issuer

Rating gives a clue about the credibility of the issuing company. The rating
agency is quite independent of the issuer company and has no business
connections or any relationship with it or its Board of Directors, etc. Absence

17

of business links between the rater and the rated firm establishes ground for
credibility and attract investors.

(4)Easy Understandability Of Investment Proposal

An investor needs no analytical knowledge on his part and can understand the
rating symbol. The investor can take quick decisions about the investment to
be made in any particular rated security of a company.

(5)Saving Of Resources

Investors rely upon credit rating. This relieves investors from the hassle of
acquiring knowledge about the fundamentals of a company, its actual
strength, financial standing, management details, etc. The quality of credit
rating done by professional experts of the credit rating agency repose
confidence in him to rely upon the rating for taking investment decisions.

18

(6)Independence Of Investment Decisions

For making investment decisions, investors have to seek advice of financial

intermediaries, the stockbrokers, merchant bankers, the portfolio managers
etc. about the good investment proposal. For rated instruments, investors
need not depend upon the advice of these financial intermediaries as the
rating symbol assigned to a particular instrument suggests the credit
worthiness of the instrument and indicates the degree of risk involved in it.

(7)Choice Of Investments

Several alternative credit rating instruments are available at a particular point

of time for investing in the capital market and the investors can make choice
depending upon their own risk profile and diversification plan.
(B) BENEFITS OF RATING TO THE COMPANY

Company which had its credit instrument or security rated by a credit rating
agency is benefited in many ways as summarized below:

19

(1) Lower Cost Of Borrowing

A company with highly rated instrument has the opportunity to reduce the
cost of borrowing from the public by quoting lesser interest on fixed deposits
or debentures or bonds as the investors with low risk preference would come
forward to invest in safe securities though yielding marginally lower rate of
return.

(2) Wider Audience For Borrowing

A company with a highly rated instrument can approach the investors

extensively for the resource mobilization using the press media. Investors in
different strata of the society could be attracted by higher rated instrument,
as the investors understand the degree of certainty about timely payment of
interest and principal on a debt instrument with better rating.

20

(3) Rating As Marketing Tool

Companies with rated instruments improve their own image and avail of the
rating as a marketing tool to create better image in dealing with its customers
feel confident in the utility products manufactured by the companies carrying
higher rating for their credit instruments.

(4) Reduction Of Cost In Public Issues

A company with higher rated instrument is able to attract the investors and
with least efforts can raise funds. Thus, the rated company can economize and
minimize cost of public issues by controlling expenses on media coverage,
conferences and other publicity stunts and gimmicks. Rating facilitates best
pricing and timing of issues.

(5) Motivation For Growth

21

Rating provides motivation to the company for growth as the promoters feel
confident in their own efforts and are encouraged to undertake expansion of
their operations or new projects. With better image created though higher
credit rating the company can mobilize funds from public and instructions or
banks from self-assessment of its own status, which is subject to self-discipline
and self-improvement, it can perceive and avoid sickness.

(6) Unknown Issuer

Credit rating provides recognition to a relatively unknown issuer while entering

into the market through wider investor base who rely on rating grade rather
than on 'name recognition'.

(C) BENEFITS TO BROKERS AND FINANCIAL INTERMEDIARIES

22

Rating is a useful tool for merchant bankers and other capital market
intermediaries in the process of planning, pricing, underwriting and placement
of issues. The intermediaries, like brokers and dealers in securities, could use
rating as an input for their monitoring of risk exposures. The merchant
bankers are also using credit ratings for pre-packing of issues by way of
securitisation/ structured obligations. Highly rated instruments put the brokers
at an advantage to make less efforts in studying the company's credit position
to convince their clients to select an investment proposal. This enables
brokers and other financial intermediaries to save time, energy, costs and
manpower in convincing their clients about investment in any particular
instrument.

23