FINANCIAL CREDIT SCORE

A MODEL FOR RATING NON-CONVERTIBLE DEBENTURES

Ms. T.Geetha
(Indian Institute of Technology, Bombay)

Name T.Geetha
Designation Research Scholar, Dept. of Humanities and Social Sciences
IIT Bombay, Mumbai- 400 076.
Address A3/32, Maker Kundan Gardens,
UTI Quarters, Opp. Lido Cinema,
Juhu Tara Road,
Santacruz (W), Mumbai - 400 049.
Telephone 660 8004
E-mail geethasaravana@rediffmail.com

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 FINANCIAL CREDIT SCORE
A model to rate Non-Convertible Debentures of Companies

Abstract

Credit Rating is an independent, professional opinion given by a specialised agency,

on the borrower's ability to repay the principal and pay the interest on time as per the
terms of the instrument. In the recent few years, there has been a lot of criticism on the
ratings given by credit rating agencies. Hence, it becomes important to test the reliability
of the credit ratings. This paper examines the ratios that are highly correlated with the
ratings given by CRISIL (Credit Research and Information Services of India Limited).
Then, a score called the Financial Credit Score (FCS) is introduced to rate the companies.
The FCS is calculated for 31 sample companies and the FCS Ratings are compared with
the ratings of CRISIL. It is found that FCS rates companies on par with CRISIL and
sometimes predicts downgrades and upgrades in advance. This might be because of the
wait and watch policy adopted by CRISIL. But, the difference between the previous
rating given by CRISIL and the default is too high. For e.g., Hindustan Motors has been
downgraded from BBB to C within a period of one year, while the FCS predicts a
downgrade one year in advance. The equivalent rating given by FCS is B- when CRISIL
had given a rating of BBB to the company. Similarly, in the case of JK Udaipur Udyog
Ltd., CRISIL has downgraded the company from A to D in a period of one year. The FCS
predicts this default one year in advance. In some cases like Jayant Vitamins, CRISIL has
been able to predict defaults in advance compared to the FCS model. This might be due
to the qualitative variables and other information that the rating experts posses. Thus, it is
suggested that one can use the FCS to rate companies, in case a rating is not available
from any credit rating agency. In exceptional cases like Jayant Vitamins, the company's
financials are strong and still has defaulted. Hence, it becomes necessary to build a model
incorporating the qualitative variables, to rate the companies.

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 FINANCIAL CREDIT SCORE
A Model for Rating Non-Convertible Debentures

1. Introduction
Credit risk is defined as the potential that a borrower or counter-party will
fail to meet its obligations in accordance with agreed terms . Credit risk is gauged
by the quality ratings assigned by the Credit Rating Agencies. Credit risk is an
important dimension of debt market development. In India, the period 1991 to
1995 experienced a general reduction in credit risk. The economy was opened for
foreign investments and the industry was upbeat due to de-licensing. Business was
growing, and credit risk was decreasing due to the infusion of equity funds, from
domestic as well as international sources.

This scenario changed since the middle of financial year 1995 - 96. This
marked the beginning of the increase in credit risk. There are various reasons that
are related to the system and the control of corporate or operating entities, which
have influenced credit risks, and caused uncertainty and unpredictability. The
important reasons are as follows. Firstly, low growth rates that might have been
due to controlled money supply in order to check inflation, has led to high credit
risk. Secondly, Credit risk has been affected by uncertainty in the exchange rates.
Last but not the least, economic growth rate has suffered on account of reduction
in government expenditure. The strategy of controlling deficit, by cutting
development expenditure rather than non-development expenditure and subsidies,
has affected the demand for core industries such as cement, steel, etc. The
infrastructure bottlenecks could affect operations of industry in future while
effecting credit risk due to high infrastructure service costs.

Thus, in an era of increasing credit risk, the role of credit rating agencies,
becomes important. Credit ratings are the principal source of investor information
about the ‘quality’ and ‘marketability’ of various bond issues. The role of credit
rating agencies becomes important in the financial market, because of the growth
in the number of companies raising funds through long term borrowings such as
debentures, fixed deposits etc. and the growth in the volume of shares and
debentures traded in the financial markets. Its role is also important in an
inefficient capital market because, in an efficient capital market all information is
publicly available and hence, it is easy to predict the rating on the basis of the
publicly available information.

In India, agencies are reluctant to invest money in market intelligence and

authorities have failed to protect public interest. In recent years, credit rating

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agencies have been under increasing scrutiny because of their obvious failures to
accurately predict and warn investors of impending firm-related financial
difficulties. Even after the CRB fiasco, the Indian investor depends on the ratings
for taking investment decisions. According to L.C.Gupta (1991), fifty percent of
the Indian investor does not know to interpret and analyse the financial statements
of the companies. This is because all the Indian investors are not educated. The
educated investors do not have the time, money and other information to analyse
the companies before taking investment decisions. Hence, the role of specialised
rating agencies to rate the debt instruments becomes important. With this
background, one is interested to know whether an individual can rate the
companies using the financial statements that are available to the public. If these
ratings are on par with the rating of any Credit Rating Agency or if the model
predicts ratings better than any Credit Rating Agency, then the model can be used
to rate the companies for which credit ratings are not available. The model can
also be used by the lenders for taking decisions on lending.

The main objective of this paper is to build a model to rate companies and
compare it with the ratings of any Credit Rating Agency. In this study, the ratings
of CRISIL are used for comparison. This paper has been organised as follows.
Section 1 gives a brief introduction of Credit rating and the need for Credit rating.
Section 2 examines the financial ratios that are highly correlated with the ratings
of the companies offered by the rating agencies. In Section 3, certain important
ratios that are theoretically emphasised and empirically proven to influence credit
ratings are used to compute a score called the Financial Credit Score (FCS), to rate
companies. Then, a comparison is made between the FCS ratings and the CRISIL
ratings to find whether the FCS can rate companies on par with CRISIL. Then, the
FCS is computed for additional 31 companies for more than a period of one year
to find whether the FCS can predict the ratings in advance. The last section
summarises the findings and conclusions.

2. CORRELATION OF FINANCIAL RATIOS AND CREDIT RATING: AN

EMPIRICAL INVESTIGATION

Financial statements of a company are an important source of information

that is available to the public. If it can be proved that the rating given by the rating
agencies and certain financial ratios are closely associated, then these ratios can be
used to build a model to rate the companies. This section examines the ratios that
are highly correlated with the ratings given by CRISIL.

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2.1 Methodology
The data used to analyse the ratios that are highly correlated with the credit
ratings are drawn from secondary sources. The ratings are taken from CRISIL
Rating Scan, Dec. '97 issue for those companies for which the year-ending is
either Dec.'96, March '97 or June '97. In the case of two companies, VHEL and
Jayant Vitamins the rating on Dec. '96 is chosen, since the financial data for the
year '97 was not available. The studies by Raghunathan and Varma (1993), and
Chaudhury (1999) reveal that CRISIL's ratings are better compared to the ratings
given by ICRA and CARE as per the two criteria of evaluation, namely,
international comparability and internal consistency. Hence, the ratings of
CRISIL have been chosen to undertake the correlation anlaysis and to compare
them with the ratings arrived at in this study, using the Financial Credit Score
(FCS) methodology. We have included at least one company in each rating
category. All the companies rated by CRISIL in the Drugs, Ceramics and Tyre
Sector have been included. These companies have been included because the
Drugs sector has shown above average growth and the other two sectors have
shown average growth in profits. In the case of four companies, namely,
Pharmaceutical Products of India, JK Pharmachemical Ltd., Paras
Pharmaceuticals Ltd. and SPL Ltd., the financial data was not available and
hence they are dropped. Later, since there are not many companies covered in
the speculative grade, judgemental sampling has been used to select companies
in the speculative grade and companies under ratings not covered by the above
three sectors. But, due to the non-availability of financial statements of the
companies that are given ratings in the speculative grade, the sample in the
investment grade is increased. The final list of sample companies, the ratings, the
Sector to which they belong and the balance-sheet date are given in Table 1. The
financial statement figures are collected from HRS Financial Intermediaries Pvt.
Ltd. (A Stock Broking and Research Firm). Since, the ratings are influenced by
the past performance, the ratios of the companies are found by taking the
average of three-year figures.

2.2 EMPIRICAL ANALYSIS AND OBSERVATIONS

This section analyses the ratios that are highly correlated with the ratings
given by CRISIL. Since the credit ratings of the debt instruments are grades and
are not in numerical form, the rank correlation technique is used. The next step is
the selection of the financial ratios that are supposed to determine the credit
ratings of the companies. Altman (1968) and Bathory (1984), in their studies
have found certain ratios to be important in predicting the financial health of the
company.

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 Table 1: Companies included in the sample and their ratings
Co.No. Company Rating Sector Balance-Sheet date
1 Ranbaxy Laboratories Ltd. AAA Drugs March '97
2 Nestle India Ltd. AAA Food Dec. '96
3 Asian Paints (India) Ltd. AAA Paints March '97
4 Nicholas Piramal (India) Ltd. AA+ Drugs March '97
5 Bombay Dyeing & Mfg. Co. Ltd. AA+ Textile March '97
6 Nahar Spinning Mills Ltd. AA+ Textile March '97
7 Kopran Ltd. AA Drugs March '97
8 German Remedies Ltd. AA- Drugs March '97
9 Apollo Tyres Ltd. AA- Tyres March '97
10 BPL Ltd. AA- Consumer Durable March '97
11 Videocon International Ltd. AA- Consumer Durable March '97
12 Merind Ltd. A+ Drugs March '97
13 Ballarpur Industries Ltd. A+ Paper March '97
14 Rajasthan Spg. & Wvg. Mills Ltd. A+ Textiles March '97
15 DCM Shriram Consolidated A+ Diversified March '97
16 Bell Ceramics Ltd. A Ceramics March '97
17 Murudeshwar Ceramics Ltd. A Ceramics March '97
18 Orient Ceramics Ltd. A Ceramics March '97
19 Videocon Appliances Ltd. A Consumer Durable March '97
20 FAL Industries Ltd. A- Consumer Durable March '97
21 Siyaram Silk Mills Ltd. A- Textiles March '97
22 JK Industries Ltd. BBB+ Tyres Dec. '96
23 Shree Rajasthan Syntex Ltd. BBB+ Textiles June '97
24 Bausch and Lomb (India) Ltd. BBB Personal Care March '97
25 Lloyds Steel Industries Ltd. BBB Steel March '97
26 KG Denim Ltd. BBB- Textiles June '97
27 Kolhapur Steels Ltd. BBB- Steels March '97
28 Lupin Laboratories Ltd. BB+ Drugs June '97
29 Rajasthan Petro Synthetics Ltd. BB+ Textiles March '97
30 Lupin Chemicals Ltd. BB+ Drugs March '97
31 Saurashtra Paper & Board Mills Ltd. BB Paper March '97
33 ASIL Industries Ltd. BB Steel March '97
34 VHEL Industries Ltd. B Telecom Equipment March '96
35 Jayant Vitamins Ltd. C Drugs March '96

Edward Altman (1968) worked on a model called the Z score. He used a

technique called the Multiple Discriminant Analysis to arrive at a series of
financial measurements, which are a key to determining the propensity towards
company failure. The ratios are Working Capital to Total Assets (WC/TA),
Retained Earnings to Total Assets (RS/TA), Earnings before interest and tax to

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Total Assets (PBIT/TA), Market Value of Equity to Book Debt value and Sales to
Total Assets (NS/TA). The ratio Market value of equity to book debt value is not
included in this study since the market value of equity fluctuates every day.
Alexander Bathory (1984) studied the important ratios in predicting
corporate collapse. He analysed 25 ratios covering debt-service ability,
profitability, adequacy of reserves and liquidity and finally zeroed in on the five
ratios, which explained the corporate collapse. The ratios are Gross Cash Flow to
Current Debt (CF/CL), Profit before taxation to Capital Employed (ROCE),
Equity to current liabilities (EQ/CL), Tangible Net Worth to Total Liabilities
(NW/TL) and Working Capital to Total Assets (WC/TA).

The ratios used by Standard and Poor (S&P) are, Pre-tax interest coverage
(PBIT/I), Funds from Operations/Long Term Debt (FFO/LTD), Funds From
Operations/Total Debt (FFO/TD), Pre-tax return on Capital Employed (ROCE),
Pretax return on Permanent Capital (RONW), Operating Income/Sales (OP/NS),
Capital to Long term Debt (C/LTD), Capital plus Short term debt/ Total Debt
(C+STD/TD) and Equity/Total Liabilities (E/TL).

The ratios used by Chaudhury (1999) are also included in this study. They
are Cash Flow/Total Assets (CF/TA), Cash Flow/Total Debt (CF/TD),
Debt/Equity (D/E), Interest/ Average Debt (I/Av. Debt), Interest/Profits Before
Depreciation, Interest and Tax (I/PBDIT) and Quick Ratio (QR).

The credit ratings of the companies are ranked by assigning the highest
rank, i.e., rank 1 to the highest rated company, rank 2 to the next in rating and so
on. For example, AAA rated companies are given rank 1, AA+ rated companies
are given rank 2 and so on and the company rated D will get the last rank of 18.
When there are more than two companies falling under the same rating, i.e., when
ratings are tied, average rank is given. The next step is to rank the ratios from the
highest to the lowest. The correlation coefficients between the different ratios and
the rating ranks are given in Table 2.

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 Table 2: Correlation Coefficients between ratings scores and the various ratios
Ratios A-priori Estimated 't' statistic
signs of Correlation
correlation Coefficients
C/LT D + .5061 3.42 **
C+STD/TD + .5090 3.44 **
CF/CL + .0832 0.48
CF/TA + .2000 1.19
D/E - -.5373 -3.72 **
E/CL + -.2932 -1.79
E/TL + -.3052 -1.87
FFO/LTD + .2621 1.58
FFO/TD + .2156 1.28
I/Av.D - -.0429 -0.25
I/PBDIT - -.4865 -3.25 **
NW/TL + .4690 3.09 **
OP/NS + -.1088 -0.63
PBDIT/I + .4865 3.24 **
PBIT/I + .4417 2.87 **
PBIT/TA + .2049 1.22
PBT/TA + .3726 2.34 *
QR + .0791 0.46
ROCE + .0471 0.27
RONW + .1314 0.77
RS/TA + .5317 3.66 **
S/TA + .3052 1.87
TD/TA - -.4733 -3.13 **
WC/TA + .2422 1.45

** Significant at .01 level

* Significant at .05 level

The ‘Z’ value at 5 percent significance level is 1.96 and at 1 percent

significance level is 2.58. Hence, from the Table 2, it is clear that the following
ratios are significant at 1% level. They are C/LTD, C+STD/LTD, D/E, I/PBDIT,
NW/TL, PBIT/I, RS/TA and TD/TA. The significant ratios at 5% level is
PBT/TA. Thus, as expected the capital structure ratio (D/E, TD/TA), interest cover
ratio (PBDIT/I, PBIT/I), the size of the company (NW/TL), the profitability ratio

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(PBT/TA) and adequacy of reserves ratio (RS/TA) are highly correlated with the
ratings of the company.

Hence, it is clear from the Table 2, that ratings do not depend on the ratios,
like ROCE, RONW etc., that the equity investor is interested. The ratings of the
companies depend only on interest cover, the proportion of debt to equity and the
adequacy reserves in which the lender or the creditor is interested. Hence, it can be
concluded, that these ratios can be used to build a model to rate the companies.

3. Financial Credit Score - A Score to rate the creditworthiness of the companies

In this section, a score called the Financial Credit Score (FCS) is
introduced to rate the creditworthiness of the companies. If a model is built, it
should be proved that the performance of the new model is better than the existing
model. An optimal scoring model to rate creditworthiness should include
measurements of debt-service, tangible net worth, adequacy of reserves and
profitability. Hence, the best performing ratios with respect to credit rating is
selected. These ratios are chosen on the basis of performance ability in prediction
as demonstrated in past studies and from current research, and ease of computation
from published accounts. The model is operable both manually and electronically.

This paper compares the results of the ratings of companies with that of the
ratings given by CRISIL. Thus, if it can be proved that the downgrades or default
(D) can be predicted earlier by the FCS model, then it can be concluded that the
model is performing better than the existing model. In this study, the ratios
C/LTD, C+STD/LTD, D/E, I/PBDIT, NW/TL, PBIT/I, RS/TA and TD/TA are
significant at 1% level. The significant ratio at 5% level is PBT/TA. From
Appendix 1, it is clear that C/LTD, C+STD/LTD, RS/TA and NW/TL are highly
correlated with each other. Similarly, PBIT/I, I/PBDIT and PBDIT/I are correlated
with each other. Hence, one of the ratios from among the ratios that are highly
correlated with each other can be used to compute a score for rating the companies
instead of all the ratios. This study has chosen NW/TL, TD/TA and I/PBDIT for
computing the score. PBT/TA is also not taken into account, since NW is inclusive
of Share Capital, Reserves and Surplus and Profits after taxes. That is, NW/TL =
(Share Capital/TL) + RS/TL) + (PAT/TL). Thus, the FCS is calculated using only
the three ratios, namely, NW/TL, TD/TA and I/PBDIT.

It is to be noted that NW/TL and TD/TA are chosen to build the score,
because these two ratios fall within a range as given in Table 5. The interest cover
ratio PBDIT/I is reversed as I/PBDIT, so that this ratio also falls within a range as
shown in Table 5. If I/PBDIT is negative or if it exceeds 1, then it is not advisable
to lend. Still, one can wait and watch for the profits in the coming years. But, if the

9
company incurs loss year after year, this gets reflected in the NW/TL and it is
advisable not to lend. The steps involved in calculating the FCS is as follows.

1) NW/TL always ranges between -1 and 1. If the company has negative profits
(PAT) or reserves (RS), then this ratio can turn to be negative.

2) In the next step, TD/TA is deducted, since higher the debt, the more risky is the
company. TD/TA will always range form 0 to 2. One should note that TD does
not include Current Liabilities. Current Liabilities is deducted from Current
Assets and shown as Net Current Assets or Working Capital in the asset side of
the Balance Sheet. So, (NW/TL) + (TD/TA) =1.

3) Then I/PBDIT is deducted since higher the interest payment higher the risk.
But, in most cases it will not exceed 1. If still the figure is negative, since
I/PBDIT exceeds 1, then the ultimate score will be even more lesser which is
not a good score for the company. The resultant figure is called the Financial
Credit Score (FCS).

4) If I/PBDIT is negative, then if this figure is further deducted, then it becomes

positive and gets added to the result. Hence, the FCS increases. So, to avoid
this, in the case of companies having a negative I/PBDIT, twice this ratio is
deducted to arrive at the FCS. This step is better understood by taking the
example of the two companies Merind and Jayant Vitamins from Table 7. In
the case of Jayant Vitamins, the I/PBDIT is -1.1 in the year march 1998 (9803
- 98 indicates the year and 03 indicates the month). If this figure is deducted
while computing the FCS, then the figure is added and the FCS becomes -0.28.
In the case of Merind, which is comparatively very stronger also has the same
FCS. Thus, if I/PBDIT is negative, twice this ratio is deducted for the
computation of FCS. Thus, the score for Jayant Vitamins becomes -3.58.
Note, that the FCS is calculated by deducting TD/TA and I/PBDIT from
NW/TL.
NW TD I
FCS = ------- - ------- - -----------
TL TA PBDIT

In the case of companies where I/PBDIT is negative then, twice the

absolute value of I/PBDIT is deducted. The reason for this can be explained as
follows. For example, if the NW/TL - TD/TA is 0. If I/PBDIT of 1 is deducted,
then the result is -1. If I/PBDIT is -1, then the result is 0 - (-1) = +1. Even, if only
absolute value of I/PBDIT is deducted the score is same (i.e., 0 - 1 = -1). Hence,
there is no difference between a company having an I/PBDIT of 1 and -1. To
reduce the result to -2 (i.e., to shift the value further to the left by an equal

10
distance), twice the absolute value of I/PBDIT is deducted, in the case of
companies having negative I/PBDIT. Thus, the final FCS is lesser for companies
having a negative I/PBDIT.

In the case of companies having negative I/PBDIT,

NW TD I
FCS = ------- - ------- - 2 ABS-----------
TL TA PBDIT

5) The FCS is ranked depending on the range within which the score falls. The
range of FCS and the corresponding FCS Ranks (equivalent to the ratings
given by CRISIL)) is given in Table 3. These ranks are called FCS8 and
CRISIL8, since the companies are classified under eight categories as shown in
Table 3. Later it was thought that the rating scores should be even more
widened so as to cover ratings on positive and negative outlook as well. For
e.g., in Table 3, the classification of range include only ratings like AA, A etc.
It was thought to increase the rating scores by including even AA+ and AA-
etc. Hence, the FCS is then fit into a range of 18 categories as shown in Table
4. The FCS calculated using this 18 range is termed as FCS18 and
corresponding CRISIL rating is termed as CRISIL18. The lowest and the
highest values that these ratios can take are presented in Table 5.

Table 3: Range of FCS8 and The Financial Credit Score

Range of FCS FCS Rank Equivalent CRISIL
Rating
0.26 to 1.00 1 AAA
-0.20 to 0.25 2 AA
-0.50 to -0.21 3 A
-0.80 to -0.51 4 BBB
-1.10 to -0.81 5 BB
-1.40 to -1.11 6 B
-1.50 to -1.41 7 C
Less than -1.50 8 D

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 Table 4: Range of FCS18 and The Financial Credit Score
Range of FCS FCS Rank Equivalent CRISIL
Rating
0.26 to 1.00 1 AAA
0.00 to 0.25 2 AA+
-0.10 to -0.01 3 AA
-0.20 to -0.11 4 AA-
-0.30 to -0.21 5 A+
-0.40 to -0.31 6 A
-0.50 to -0.41 7 A-
-0.60 to -0.51 8 BBB+
-0.70 to -0.61 9 BBB
-0.80 to -0.71 10 BBB-
-0.90 to -0.81 11 BB+
-1.00 to -0.91 12 BB
-1.10 to -1.01 13 BB-
-1.20 to -1.11 14 B+
-1.30 to -1.21 15 B
-1.40 to -1.31 16 B-
-1.50 to -1.41 17 C
Less than -1.50 18 D

Table 5: The lowest, and the highest values that the ratios
used in computing the FCS can take
Ratios used in Lowest values Highest values that
computing FCS that the score can the score can take
take (High risk (Low risk
companies) companies)
NW/TL -1.00 1.00
- TD/TA 2.00 0.00
-3.00 - 1.00
3.00
- I/PBDIT 1.00 -(- 0.00
1.00)
FCS -4.00 (- 1.00
2.00)

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Note: Hence, it is expected that a company that is not credit worthy might show a
FCS of -4.00 while a company which is highly credit worthy might show a FCS of
1.00. It is important to note that I/PBDIT can be negative if PBDIT is negative.
Hence, if we deduct further, the resultant FCS increases and in exceptional cases
exceed even 1.00. In these extreme cases (the extreme cases are shown in brackets
in the second column) the company is not credit worthy. In these cases, twice the
absolute value of I/PBDIT is deducted in calculating the FCS.

3.1 Analysis and Findings

The FCS is calculated for all the 34 companies that are included in the
sample to find the correlation coefficient and then compared with the CRISIL
ratings. CRISIL ratings such as AAA, AA+ etc. are nothing but ranks, in the sense
that AAA rated companies are ranked first, compared to AA+ companies and so
on. Similarly, FCS also indicates ranks, in the sense that an FCS Rank of 1
indicates that it holds the first rank or is rated AAA, an FCS Rank of 2 indicates
that the rating will be AA (with a + or -, indicating a possibility of an upgrade or a
downgrade). The CRISIL Rating (CRISIL8 and CRISIL18) and the FCS Ranks
(FCS8 and FCS18) are given in Table 6.

It is clear from Table 6, that when FCS8 and CRISIL8 ranks are compared,
11 out of 34 companies are rated on par with CRISIL8 ratings. When FCS18 and
CRISIL18 ratings are compared, 2 ratings are on par with CRISIL ratings and 14
are either one notch above or below CRISIL ratings. This is indicated with an '*'
sign in Table 6. There are a total of 34 companies out of which 16 companies are
ranked on par with the ratings of CRISIL. FCS ratings are lesser in the case of 15
companies and higher in the case of 3 companies. These are denoted by the letters
Equal (E), Higher (U) and Lower (D). The score is then compared with the rating
score of CRISIL on Dec. '98 and Dec. '99. In the case of 15 companies where FCS
ranks are lesser, CRISIL has downgraded in the case of 7 companies. In the case
of 2 companies the current rating is not available. In the case of 3 upgrades, one
company (German Remedies) is also upgraded by CRISIL, the second company
(Murudeshwar Ceramics) has been downgraded. German Remedies might have
been upgraded due to the higher cash flows of the Pharmaceutical Companies.
Murudeshwar Ceramics might have been downgraded because the other
companies in the industries were not doing well and the industry factor might have
played an important role. The third company, Jayant Vitamins is an exception,
which shows a better financial score, but has defaulted in payments. Hence, it is
downgraded to C, while it's financial credit score shows a score of 9. Thus, it can
be concluded that, the financial credit score is an approximate score to CRISIL's

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rating, and can be used for rating companies when the ratings of CRISIL or other
agencies are not available. However, as seen in the case of Jayant Vitamins, the
FCS may not be 100% accurate, because it does not take into account the non-
financial variables.

Table 6: Computation of FCS for the companies

Co. nw/tl td/ta I/pbdit nw/tl - (td/ta) FCS8 CRISIL8 FCS18 CRISIL18 Difference Expected Rating on
No. - (I/pbdit) Rating Dec. '98
1 0.69 0.31 0.23 0.14 2 1 2 * 1 * 1 E 1
2 0.45 0.55 0.39 -0.49 3 1 7 1 -6 D 1
3 0.62 0.38 0.18 0.05 2 1 2 * 1 * 1 E 1
4 0.57 0.43 0.44 -0.30 3 2 5 2 3 D 3
5 0.52 0.48 0.56 -0.52 4 2 8 2 6 D 3
6 0.71 0.29 0.12 0.29 1 2 1 * 2 * -1 E 2
7 0.58 0.42 0.32 -0.15 2 ** 2 ** 4 * 3 * 1 E 4 (9)
8 0.77 0.23 0.12 0.42 1 2 1 4 -3 U 4 (3)
9 0.46 0.54 0.54 -0.62 4 2 9 4 5 D 4
10 0.44 0.56 0.32 -0.44 3 2 7 4 3 D 4
11 0.56 0.44 0.35 -0.22 3 2 5 * 4 * 1 E 6
12 0.54 0.46 0.41 -0.33 3 ** 3 ** 6 * 5 * 1 E 5
13 0.42 0.58 0.61 -0.78 4 3 10 5 5 D 5 (9)
14 0.40 0.60 0.51 -0.70 4 3 10 5 5 D 5 (6)
15 0.42 0.58 0.43 -0.60 4 3 9 5 4 D 6 (7)
16 0.40 0.60 0.41 -0.60 4 3 9 6 3 D 12 (18)
17 0.72 0.28 0.37 0.06 2 3 2 6 -4 U 8
18 0.34 0.66 0.14 -0.46 3 ** 3 ** 7 * 6 * 1 E 9 (15)
19 0.34 0.66 0.58 -0.90 5 3 12 6 6 D 6
20 0.53 0.47 0.42 -0.35 3 ** 3 ** 6 * 7 * -1 E -
21 0.28 0.72 0.46 -0.90 5 3 12 7 -5 D 7
22 0.44 0.56 0.56 -0.69 4 ** 4 ** 9 * 8 * -1 E 8
23 0.44 0.56 0.53 -0.65 4 ** 4 ** 9 * 8 * -1 E 8 (11)
24 0.34 0.66 0.59 -0.92 5 4 12 9 3 D 6
25 0.47 0.53 0.69 -0.76 4 ** 4 ** 10 * 9 * 1 E 18
26 0.35 0.65 0.59 -0.89 5 4 11 * 10 * -1 E 10 (18)
27 0.48 0.52 0.56 -0.60 4 ** 4 ** 9 * 10 * -1 E 17
28 0.34 0.66 0.54 -0.85 5 ** 5 ** 11 ** 11 ** 0 E 11 (18)
29 0.36 0.64 0.66 -0.94 5 ** 5 ** 12 * 11 * 1 E 18
30 0.45 0.55 0.51 -0.61 4 5 9 11 -2 D 11 (18)
31 0.43 0.57 0.53 -0.67 4 5 9 12 -3 D 12

14
32 0.33 0.67 0.62 -0.95 5 ** 5 ** 12 ** 12 ** 0 E 15
33 0.33 0.67 0.53 -0.86 5 6 11 15 -4 D -
34 0.55 0.45 -0.37 0.47 4 7 9 17 -8 U 18
Note: '** 'denotes that the ratings given by FCS and CRISIL are the same. '* 'denotes that
the ratings given by FCS are either one notch above or below the ratings given by
CRISIL. The numbers given in brackets in the last column are the ratings given by
CRISIL on Dec. '99.

The FCS shown in Table 6, is calculated for the same companies that are
used to find the correlation coefficients and only for a period of one year. It was
then realised that the FCS should be calculated for different sets of companies and
also for a period more than a year to make better comparison with the CRISIL
rating scores and to arrive at a better conclusion. Hence, the FCS is calculated for
a different set of sample companies which included all the companies rated by
CRISIL in Cement, Automobiles and Pharmaceutical Sectors and four companies
from Automobile Ancillaries Sector. The period of study for all the companies
varied depending on the availability of financial data and the ratings of CRISIL.
The FCS for the sample companies is calculated to find whether the model is able
to predict the ratings of the companies in advance. The sample companies, their
ratings by CRISIL for different years and the FCS under both the categories (i.e., 8
categories and 18 categories) are given in Table 7.

A further analysis of the trend in FCS18 calculated for the different

companies is made and compared with the ratings of CRISIL18 and the results are
given in Table 8 and Table 9. To know the companies rated under each
classification in Table 8 and Table 9, a reference to Table 7 should be made. In
Table 7, the category under which a company is classified is given in the last four
columns of the Table. E stands for Expected movement in the rating given by
CRISIL by analysing the FCS movement. O stands for the Observed movement of
the ratings given by CRISIL. For example, in the case of Automobile Axles of
India Ltd., the trend of the FCS ranks in Table 7 indicates that the company is
expected to upgrade but CRISIL has downgraded (Expected = U and Observed =
D) which is used in Table 8. Here, U refers to Upgrade, S refers to Same and D
refers to Downgrade. The rating A- given in the second last column is the rating
given by CRISIL on July 2000. The last column specifies the number or the
category to which the company belongs in Table 9. For e.g., Automobile Axles
belongs to the seventh category indicating that the company is expected to be
upgraded but CRISIL has downgraded by one notch in !999.

15
 Table 7: FCS18,FCS8, CRISIL18 and CRISIL8 Ratings
for the sample companies

NW/TL TD/TA I/PBDIT NW/TL - (TD/TA) FCS18 Rating CRISIL18 FCS8 CRISIL8 E O Rating on Cl. for

- (I/PBDIT) CRISIL July '00 Table 9

Automotive Axle
9909 0.62 0.38 0.13 0.12 2 A- 7 2 3 U D A- 7
9809 0.60 0.40 0.23 -0.03 3 A 6 2 3
9709 0.52 0.48 0.19 -0.15 4 A+ 5 2 3
9609 0.52 0.48 0.21 -0.17 4 2
9509 0.52 0.48 0.32 -0.29 5 3
Bharat Gears
9903 0.51 0.49 0.37 -0.34 6 A 6 3 3 S S BBB+ 1
9803 0.50 0.50 0.31 -0.31 6 A 6 3 3
9703 0.59 0.41 0.25 -0.08 3 A 6 2 3
9603 0.53 0.47 0.29 -0.24 5 A 6 3 3
9503 0.49 0.51 0.39 -0.42 7 A 6 3 3
9403 0.46 0.54 0.54 -0.62 9 A 6 4 3
9303 0.45 0.55 0.43 -0.52 8 4
9203 0.48 0.52 0.39 -0.43 7 3
9103 0.40 0.60 0.47 -0.67 9 4
Gabriel India
9903 0.36 0.64 0.74 -1.03 13 A 6 5 3 D D BBB+ 2
9803 0.36 0.64 0.59 -0.86 11 AA- 4 5 2
9703 0.39 0.61 0.49 -0.71 10 AA- 4 4 2
9603 0.29 0.71 0.31 -0.73 10 AA- 4 4 2
9503 0.46 0.54 0.27 -0.36 6 3
9403 0.43 0.57 0.34 -0.47 7 3
9303 0.43 0.57 0.43 -0.57 8 4
9203 0.40 0.60 0.41 -0.60 9 4
9103 0.33 0.67 0.46 -0.81 11 5
Rico Auto

16
 9903 0.36 0.64 0.41 -0.69 9 BBB 9 4 4 D D BBB 2
9803 0.50 0.50 0.39 -0.39 6 A- 7 3 3
9703 0.44 0.56 0.45 -0.57 8 A- 7 4 3
9603 0.40 0.60 0.48 -0.68 9 A 6 4 3
9503 0.31 0.69 0.41 -0.79 10 A 6 4 3
9403 0.41 0.59 0.35 -0.52 8 A 6 4 3
9303 0.36 0.64 0.38 -0.67 9 4
9203 0.42 0.58 0.32 -0.48 7 3
9103 0.45 0.55 0.24 -0.34 6 3

Table 7: FCS18,FCS8, CRISIL18 and CRISIL8 Ratings

for the sample companies
(contd.)
NW/TL TD/TA I/PBDIT NW/TL - (TD/TA) FCS18 Rating CRISIL18 FCS8 CRISIL8 E O Rating on Cl. for

- (I/PBDIT) CRISIL July '00 Table 9

Sona
9903 0.52 0.48 0.36 -0.31 6 A 6 3 3 D D A 2
9803 0.58 0.42 0.35 -0.19 4 A+ 5 2 3
9703 0.50 0.50 0.37 -0.37 6 A+ 5 3 3
9603 0.48 0.52 0.33 -0.37 6 A+ 5 3 3
9503 0.49 0.51 0.34 -0.35 6 A+ 5 3 3
9403 0.45 0.55 0.34 -0.43 7 3
9303 0.48 0.52 0.33 -0.36 6 3
9203 0.40 0.60 0.31 -0.51 8 4
9103 0.38 0.62 0.22 -0.45 7 3
Sund_Fast
9903 0.58 0.42 0.26 -0.11 4 A- 7 2 3 U D A- 7
9803 0.52 0.48 0.33 -0.28 5 A+ 5 3 3
9703 0.45 0.55 0.33 -0.44 7 A 6 3 3
9603 0.42 0.58 0.25 -0.42 7 A 6 3 3
9503 0.41 0.59 0.22 -0.41 7 A 6 3 3
9403 0.35 0.65 0.39 -0.69 9 4
9303 0.31 0.69 0.47 -0.85 11 5
9203 0.33 0.67 0.42 -0.76 10 4
9103 0.30 0.70 0.49 -0.88 11 5
Bajaj Auto
9903 0.89 0.11 0.01 0.77 1 AAA 1 1 1 S S AAA 1
9803 0.89 0.11 0.01 0.77 1 AAA 1 1 1
9703 0.89 0.11 0.01 0.77 1 AAA 1 1 1
9603 0.87 0.13 0.01 0.73 1 AAA 1 1 1
9503 0.84 0.16 0.02 0.66 1 AAA 1 1 1
9403 0.71 0.29 0.04 0.37 1 AAA 1 1 1
9303 0.69 0.31 0.13 0.26 1 AAA 1 1 1
9203 0.62 0.38 0.17 0.07 2 AAA 1 2 1
9103 0.59 0.41 0.13 0.05 2 AAA 1 2 1

17
Hero Honda
9903 0.77 0.23 0.04 0.51 1 1 U U AAA 3
9803 0.70 0.30 0.06 0.35 1 1
9703 0.57 0.43 0.10 0.04 2 2
9603 0.64 0.36 0.10 0.18 2 2
9503 0.63 0.37 0.15 0.12 2 AA 3 2 2
9403 0.54 0.46 0.24 -0.17 4 AA 3 2 2
9303 0.45 0.55 0.25 -0.36 6 AA 3 3 2
9203 0.44 0.56 0.23 -0.35 6 3
9103 0.36 0.64 0.19 -0.47 7 3

Table 7: FCS18,FCS8, CRISIL18 and CRISIL8 Ratings

for the sample companies
(contd.)
NW/TL TD/TA I/PBDIT NW/TL - (TD/TA) FCS18 Rating CRISIL18 FCS8 CRISIL8 E O Rating on Cl. for

-(I/PBDIT) CRISIL July '00 Table 9

Kinetic Engg.
9903 0.48 0.52 0.25 -0.28 5 AA 3 3 2 D S AA 6
9803 0.57 0.43 0.16 -0.03 3 AA 3 2 2
9703 0.66 0.34 0.18 0.14 2 AA 3 2 2
9603 0.67 0.33 0.10 0.24 2 2
9503 0.69 0.31 0.15 0.23 2 2
9403 0.56 0.44 0.18 -0.07 3 2
9303 0.53 0.47 0.22 -0.16 4 2
9203 0.52 0.48 0.22 -0.18 4 2
9103 0.60 0.40 0.19 0.01 2 2
Ashok Leyland
9903 0.54 0.46 0.61 -0.54 8 AA- 4 4 2 D D AA- 2
9803 0.47 0.53 0.65 -0.72 10 AA 3 4 2
9703 0.48 0.52 0.38 -0.42 7 AA+ 2 3 2
9603 0.54 0.46 0.34 -0.27 5 AA+ 2 3 2
9503 0.62 0.38 0.41 -0.16 4 AA+ 2 2 2
9403 0.47 0.53 0.50 -0.56 8 AA+ 2 4 2
9303 0.44 0.56 0.70 -0.81 11 AA+ 2 5 2
9203 0.29 0.71 0.49 -0.91 12 AAA 1 5 1
9103 0.47 0.53 0.32 -0.39 6 AAA 1 3 1
Eicher
9903 0.53 0.47 0.25 -0.19 4 AA- 4 2 2 S S AA- 1
9803 0.63 0.37 0.27 -0.01 3 AA- 4 2 2
9703 0.66 0.34 0.26 0.05 2 AA- 4 2 2
9603 0.61 0.39 0.29 -0.07 3 AA- 4 2 2
9503 0.59 0.41 0.06 0.12 2 AA- 4 2 2
9403 0.54 0.46 0.10 -0.03 3 AA- 4 2 2
Escorts
9903 0.59 0.41 0.39 -0.22 5 A+ 5 3 3 S S A+ 1
9803 0.60 0.40 0.27 -0.07 3 A+ 5 2 3

18
 9703 0.62 0.38 0.29 -0.05 3 A 6 2 3
9603 0.61 0.39 0.28 -0.05 3 A- 7 2 3
9503 0.40 0.60 0.38 -0.58 8 A- 7 4 3
9403 0.42 0.58 0.65 -0.82 11 A- 7 5 3
9303 0.39 0.61 0.70 -0.92 12 A+ 5 5 3
9203 0.47 0.53 0.58 -0.65 9 4
9103 0.50 0.50 0.34 -0.34 6 3
Pal -Peugoat
9506 0.39 0.61 0.10 -0.31 6 A 6 3 3 S S D 1

Table 7: FCS18,FCS8, CRISIL18 and CRISIL8 Ratings

for the sample companies
(contd.)
NW/TL TD/TA I/PBDIT NW/TL - (TD/TA) FCS18 Rating CRISIL18 FCS8 CRISIL8 E O Rating on Cl. for

-(I/PBDIT) CRISIL July '00 Table 9

TELCO
9903 0.52 0.48 0.52 -0.48 7 AA+ 2 3 2 D D AA+ 2
9803 0.53 0.47 0.41 -0.35 6 AAA 1 3 1
9703 0.59 0.41 0.18 0.00 3 AA+ 2 2 2
9603 0.65 0.35 0.16 0.14 2 AA+ 2 2 2
9503 0.55 0.45 0.24 -0.14 4 AA+ 2 2 2
9403 0.37 0.63 0.52 -0.78 10 AA+ 2 4 2
9303 0.35 0.65 0.67 -0.98 12 5
9203 0.41 0.59 0.34 -0.51 8 4
9103 0.55 0.45 0.22 -0.13 4 2
Tractor&Far
9703 0.80 0.20 0.08 0.51 1 FAAA 1 1 1 S S FAAA 1
9603 0.85 0.15 0.09 0.60 1 1
9503 0.80 0.20 0.12 0.49 1 1
9403 0.77 0.23 0.12 0.42 1 1
Deccan Cement
9903 0.75 0.25 0.25 0.25 2 A- 7 2 3 U S A- 3
9803 0.72 0.28 0.23 0.20 2 A 6 2 3
9703 0.65 0.35 0.25 0.05 2 A 6 2 3
9603 0.62 0.38 0.23 0.01 2 A 6 2 3
9503 0.66 0.34 0.26 0.06 2 A 6 2 3
9403 0.45 0.55 0.43 -0.54 8 BBB+ 8 4 4
9303 0.31 0.69 0.41 -0.79 10 BBB+ 8 4 4
9203 0.40 0.60 0.41 -0.62 9 BBB+ 8 4 4
GACL
9906 0.59 0.41 0.32 -0.14 4 AA+ 2 2 2 D D AA+ 2
9806 0.50 0.50 0.34 -0.34 6 AAA 1 3 1
9706 0.51 0.49 0.28 -0.26 5 AAA 1 2 1
9606 0.57 0.43 0.24 -0.10 4 AAA 1 2 1
9506 0.39 0.61 0.21 -0.42 7 AAA 1 3 1

19
 9406 0.37 0.63 0.31 -0.58 8 AA+ 2 4 2
9306 0.46 0.54 0.21 -0.29 5 AA+ 2 3 2
9206 0.47 0.53 0.17 -0.23 5 AA+ 2 3 2
9106 0.44 0.56 0.19 -0.31 6 3

Table 7: FCS18,FCS8, CRISIL18 and CRISIL8 Ratings

for the sample companies
(contd.)

NW/TL TD/TA I/PBDIT NW/TL - (TD/TA) FCS18 Rating CRISIL18 FCS8 CRISIL8 E O Rating on Cl. for

-(I/PBDIT) CRISIL July '00 Table 9

JK Udaipur
9806 0.00 D 18 8 D D D 9
9806 0.00 D 18 8
9703 0.40 0.60 4.93 -5.14 18 A 6 8 3
9603 0.47 0.53 0.59 -0.64 9 A 6 4 3
9503 0.38 0.62 0.77 -1.01 13 A 6 5 3
Madras Cement
9903 0.44 0.56 0.45 -0.58 8 AA 3 4 2 D D AA 2
9803 0.39 0.61 0.50 -0.72 10 AA+ 2 4 2
9703 0.41 0.59 0.23 -0.41 7 AA+ 2 3 2
9603 0.53 0.47 0.15 -0.08 3 AA+ 2 2 2
9503 0.52 0.48 0.18 -0.14 4 2
9403 0.52 0.48 0.32 -0.28 5 3
9303 0.44 0.56 0.33 -0.46 7 3
9203 0.44 0.56 0.28 -0.41 7 3
9103 0.29 0.71 0.32 -0.74 10 4
Prism Cem
3 0.28 0.72 1.00 -1.45 17 7 D D B 2
9903 0.32 0.68 1.09 -1.45 17 BBB- 10 7 4
9803 0.36 0.64 -4.86 -10.00 18 BBB 9 8 4
Saurashtra Cem
9906 0.44 0.56 0.94 -1.05 13 C 17 5 7 D D C 2
9806 0.44 0.56 0.64 -0.76 10 BB 13 4 5
9706 0.44 0.56 0.94 -1.05 13 BBB 9 5 4
9606 0.51 0.49 0.41 -0.39 6 A- 7 3 3
9506 0.51 0.49 0.36 -0.35 6 A- 7 3 3
9406 0.51 0.49 0.39 -0.37 6 A- 7 3 3
Emerck
9912 0.90 0.10 0.08 0.71 1 AA 3 1 2 U S Redeem 8

20
9812 0.83 0.17 0.10 0.57 1 AA 3 1 2
9712 0.68 0.32 0.13 0.23 2 2
9612 0.66 0.34 0.18 0.14 2 2
9512 0.56 0.44 0.23 -0.11 4 2
9412 0.52 0.48 0.25 -0.21 5 3
9312 0.52 0.48 0.54 -0.49 7 3
9212 0.18 0.82 0.74 -1.38 16 6
9112 0.18 0.82 0.94 -1.58 18 8

Table 7: FCS18,FCS8, CRISIL18 and CRISIL8 Ratings

for the sample companies
(contd.)
NW/TL TD/TA I/PBDIT NW/TL - (TD/TA) FCS18 Rating CRISIL18 FCS8 CRISIL8 E O Rating on Cl. for

(I/PBDIT) CRISIL July '00 Table 9

German Rem
9903 0.87 0.13 0.04 0.70 1 AA 3 1 2 U U AA+ 3
9803 0.86 0.14 0.08 0.63 1 AA- 4 1 2
9703 0.77 0.23 0.12 0.42 1 AA- 4 1 2
9603 0.68 0.32 0.15 0.21 2 A 6 2 3
9503 0.67 0.33 0.14 0.19 2 A- 7 2 3
9403 0.55 0.45 0.28 -0.17 4 A 6 2 3
9303 0.30 0.70 0.71 -1.10 14 BBB+ 8 6 4
9203 0.31 0.69 0.62 -1.00 16 5
9103 0.37 0.63 0.41 -0.68 9 4
Pharma Products
9812 -0.34 1.34 -0.30 -1.39 18 D 18 8 18 D D D 2
9503 0.48 0.52 0.29 -0.34 6 3
9403 0.38 0.62 0.44 -0.67 9 4
9303 0.32 0.68 0.39 -0.75 10 4
9203 0.42 0.58 0.30 -0.47 7 3
9103 0.73 0.27 0.46 -0.01 3 2
Wockhardt
9806 0.71 0.29 0.00 0.43 1 AA 3 1 2 U D AA 8
9706 0.86 0.14 0.00 0.72 1 AA+ 2 1 2
9606 0.95 0.05 0.00 0.90 1 1
9506 0.95 0.05 0.01 0.89 1 1
9406 0.98 0.02 0.02 0.95 1 1
9306 0.87 0.13 0.21 0.53 1 1
9206 0.58 0.42 0.30 -0.13 4 2
9106 0.43 0.57 0.29 -0.42 7 3
Ranbaxy
9803 0.72 0.28 0.26 0.18 2 AAA 1 2 1 S U Redeem 1
9703 0.69 0.31 0.23 0.14 2 AA+ 2 2 2
9603 0.63 0.37 0.20 0.05 2 AA+ 2 2 2

21
 9503 0.60 0.40 0.24 -0.05 3 AA+ 2 2 2
9403 0.43 0.57 0.29 -0.42 7 AA+ 2 3 2
9303 0.41 0.59 0.37 -0.56 8 AA+ 2 4 2
9203 0.28 0.72 0.46 -0.89 11 AA 3 5 2
9103 0.33 0.67 0.41 -0.75 10 4
Merind
9703 0.54 0.46 0.40 -0.32 6 A+ 5 3 3 D S A+ 1
9603 0.65 0.35 0.19 0.12 2 2
9503 0.79 0.21 0.13 0.45 1 1
9403 0.85 0.15 0.19 0.51 1 1
9303 0.32 0.68 0.48 -0.84 11 5
9203 0.33 0.67 0.41 -0.75 10 4

Table 7: FCS18,FCS8, CRISIL18 and CRISIL8 Ratings

for the sample companies
(contd.)

NW/TL TD/TA I/PBDIT NW/TL - (TD/TA) FCS18 Rating CRISIL18 FCS8 CRISIL8 E O Rating on Cl. for

-(I/PBDIT) CRISIL July '00 Table 9

Lupin Chem.
9907 0.42 0.58 0.46 -0.63 9 D 18 4 8 S D D 4
9807 0.42 0.58 0.48 -0.64 9 BB+ 11 4 5
9707 0.46 0.54 0.51 -0.60 9 BBB 9 4 4
9607 0.41 0.59 0.51 -0.68 9 BBB 9 4 4
9507 0.41 0.59 0.51 -0.69 9 BBB 9 4 4
9407 0.41 0.59 0.43 -0.61 9 BBB 9 4 4
9307 0.32 0.68 0.30 -0.66 9 BBB 9 4 4
Jayant Vitamins
9803 -0.19 1.19 -1.10 -3.58 18 D 18 8 8 D D D 4
9703 0.55 0.45 -0.37 -0.64 9 C 17 4 7
9603 0.62 0.38 0.23 0.01 2 C 17 2 7
9503 0.34 0.66 0.62 -0.95 12 C 17 5 7
HMR
9903 0.61 0.39 0.27 -0.05 3 AA+ 2 2 2 D D AA 2
9803 0.57 0.43 0.18 -0.04 3 2
9703 0.62 0.38 0.19 0.05 2 2
9603 0.61 0.39 0.22 -0.01 3 2
9503 0.62 0.38 0.15 0.10 2 2
9403 0.63 0.37 0.33 -0.07 3 2
9303 0.57 0.43 0.55 -0.41 7 2
9203 0.61 0.39 0.54 -0.33 6 2
9103 0.56 0.44 0.54 -0.42 7 2
HM
9903 0.31 0.69 0.96 -1.33 16 BBB 9 6 4 D D C 9
9803 0.40 0.60 0.44 -0.65 9 4
9703 0.45 0.55 0.45 -0.55 8 4
9603 0.46 0.54 0.40 -0.49 7 3
9503 0.41 0.59 0.49 -0.67 9 4

22
9403 0.34 0.66 0.59 -0.92 12 5
9303 0.23 0.77 1.39 -1.93 18 8
9203 0.23 0.77 1.04 -1.58 18 8
9103 0.32 0.68 0.76 -1.12 14 6

Table 8: The Expected Rating Scores and

CRISIL's (Observed) Rating Scores

Expected Observed Total

Same Up Down
Same 6 1 1 8
Up 2 2 3 7
Down 2 - 14 16
Total 10 3 18 31

Table 9: Comparison of CRISIL ratings with the

ratings given by FCS

1 Almost equal 7

2 Predicted downgrade well in advance 11

And CRISIL downgrades

3 Predicted Upgrade well in advance 4

And CRISIL upgrades

4 Did not predict downgrade/default 2

5 Did not predict upgrade

6 Predicting downgrade 1

7 Predicting upgrade & CRISIL downgrades 2

8 Predicting Upgrade 2

9 Predicted default in advance 2

Total 31

23
 From Table 8, it is clear that the total number of companies are 31, out of
which 16 companies are expected to be downgraded and CRISIL has downgraded
14 and the ratings remain the same in the case of 2. Out of the 8 companies
expected to remain the same, 6 companies remained same, one went up and
another went down. Out of the 7 companies expected to go up, 2 remained same, 2
went up and 3 went down.

The diagonal in Table 7 indicates the number of expectations matching

with the ratings given by CRISIL. It indicates that out of 31 companies, 22
companies are moving in the same direction as CRISIL (i.e.) 6 companies are
expected to be same, 2 companies are expected to go up and 14 companies are
expected to go down and CRISIL's ratings are also the same.

The next step is to find the current rating of the companies by CRISIL and
compare with the ratings given by the FCS. The ratings of CRISIL as on July 2000
as given in CRISIL Rating Scan are taken as the current rating. The comparison is
summarised in Table 9. Table 9 indicates that out of 31 cases, FCS18 predicts 7
companies to remain the same, 11 cases to be downgraded and 4 cases to be
upgraded and CRISIL's current ratings has also moved in the same direction. Thus,
the ratings of 20 companies out of 31 companies behaved as predicted. Two
companies, namely JK Udaipur Udyog and Hindustan Motors are expected to
default well in advance, while CRISIL has downgraded them too late. Thus, the
model has worked out well in the case of 22 out of 31 companies. Defaults in the
case of Pal-Peugeot and Lupin Chemicals are not predicted by both CRISIL and
FCS18. In the case of Ranbaxy, the rating is expected to remain at AA+, while
CRISIL has upgraded it to AAA. This rating is only one notch higher and not
much of a difference. This might also be due to the higher cash flows of the
Pharmaceutical companies. The only exception is Jayant Vitamins, in which case
the company is fundamentally strong, but still it has defaulted. Hence, it can be
concluded that FCS18 is able to predict ratings on par with CRISIL18 and in most
cases it predicts downgrades and defaults well in advance compared to CRISIL.
Thus, FCS can be used to rate companies in case if a rating is not available from
any of the rating agency. However, there is a difference of a notch or two between
the FCS rating and CRISIL rating, which might be attributed to the qualitative
variables not included in the study or the other information that is available to the
rating agencies which the public do not possess. Hence, the role of rating agencies
becomes necessary. But, one can still conclude that the rating agencies depend
mostly on the financial ratios to provide ratings.

4. Summary and Conclusions

Credit rating is the opinion about the quality of the issuer of securities with
reference to a particular debt instrument as to whether he will make timely
payments of the interest and the principal amount. In a financially liberalised

24
economy, there are numerous innovative financial instruments that are floated by
the companies and the small investor is not able to judge the quality of the
instruments. His ability to decide on the quality of the instrument further decreases
when the capital market proves to be inefficient. That is, in an inefficient capital
market, all information regarding the company or industry is not publicly available
and hence, the investor has to depend on the rating agencies for taking investment
decisions based on their credit ratings. Thus, even after the CRB fiasco, investors
depend on credit rating agencies since all the information regarding a company is
not publicly available. Even if the information is available, an investor does not
get the time, money and resources to analyse the information.
The role of the credit rating agencies becomes very important. But, to what
extent the credit ratings are reliable should be analysed. In the recent few years,
there has been a lot of criticism on the ratings by credit rating agencies. The rating
agencies are reluctant to invest money in research and they have failed to protect
the public interest. Hence, it becomes important to test the reliability of the credit
ratings.

The second section of this paper examines the extent of association of the
ratings given by rating agencies and the ratios of the different companies. If
certain ratios are closely correlated with the ratings, then it becomes easier to rate
companies using these ratios. It has been found that certain ratios like the capital
structure ratios, adequacy of reserves ratio and the interest cover ratio are
correlated to a larger extent with the ratings of the companies. The ratios in which
the equity investor is interested, like the ROCE, RONW, etc., are not highly
correlated with the credit ratings.

In the third section, a score called the Financial Credit Score (FCS) is
introduced. This score is used to rate the companies. It is found that FCS rates
companies on par with CRISIL and in many cases predicts downgrades and
defaults in advance. This indicates that the rating agencies depend more on the
financial ratios. The FCS can be used to rate companies when a rating from any
Credit Rating Agency is not available. In certain exceptional cases, like Jayant
Vitamins, the company is financially strong, but still has defaulted. In such cases,
experience and knowledge of the company (qualitative factors) becomes essential,
which only the specialised agencies possess. Hence, it can be concluded that the
role of rating agencies is very important.

The following conclusions can be drawn from this study. Firstly, since in
most of the cases, the FCS can rate the companies on par with CRISIL, it can be
concluded that CRISIL gives more weight to the financial statement figures while
rating a company. Secondly, it is evident from the cases of JK Udaipur Udyog Ltd.
and Hindustan Motors, that CRISIL adopts the wait and watch policy, because of
which FCS is able to predict downgrades and defaults in advance. Thirdly, the

25
difference of few notches in certain companies like Prism Cements and Jayant
Vitamins, indicate that there are qualitative variables or other information that
only the rating agencies possess. Thus, the role of specialised rating agencies are
required in the expanding and sophisticated financial markets.

It is suggested to use the FCS, if a rating is not available from any credit
rating agency. Still, it would be better to supplement the FCS with an analysis of
the qualitative variables like the industrial scenario, the economic and political
factors, the quality of the management, the union-management relationship, etc.
Hence, it becomes necessary to build a model to rate the companies using both the
quantitative and qualitative variables affecting the company.

Appendix 1
Correlation Matrix of the various ratios used in the study
C/LTD C+STD/TD CF/CL CF/TA D/E E/CL E/TL FFO/LTD FFO/TD
C/LTD 1.00 0.91 ** 0.25 0.49 * -0.85 ** -0.07 -0.13 0.75 ** 0.64 **
(0.00) (8.38) (0.99) (2.12) (-6.24) (-0.26) (-0.51) (4.31) (3.18)
C+STD/TD 0.91 ** 1.00 0.34 0.34 -0.86 ** -0.01 -0.13 0.52 * 0.57 **
(8.38) (0.00) (1.35) (1.38) (-6.53) (-0.04) (-0.50) (2.27) (2.63)
CF/CL 0.25 0.34 1.00 0.56 * -0.18 0.25 -0.12 0.20 0.57 **
(0.99) (1.35) (0.00) (2.57) (-0.71) (0.99) (-0.47) (0.79) (2.60)
CF/TA 0.49 * 0.34 0.56 * 1.00 -0.39 -0.06 -0.04 0.81 ** 0.88 **
(2.12) (1.38) (2.57) (0.00) (-1.61) (-0.23) (-0.16) (5.26) (7.13)
D/E -0.85 ** -0.86 ** -0.18 -0.39 1.00 0.02 0.11 -0.57 ** -0.55 *
(-6.24) (-6.53) (-0.71) (-1.61) (0.00) (0.09) (0.43) (-2.61) (-2.52)
E/CL -0.07 -0.01 0.25 -0.06 0.02 1.00 0.72 ** -0.15 -0.06
(-0.26) (-0.04) (0.99) (-0.23) (0.09) (0.00) (3.89) (-0.60) (-0.25)
E/TL -0.13 -0.13 -0.12 -0.04 0.11 0.72 ** 1.00 -0.05 -0.13
(-0.51) (-0.50) (-0.47) (-0.16) (0.43) (3.89) (0.00) (-0.19) (-0.52)
FFO/LTD 0.75 ** 0.52 * 0.20 0.81 ** -0.57 ** -0.15 -0.05 1 0.85 **
(4.31) (2.27) (0.79) (5.26) (-2.61) (-0.60) (-0.19) (0.00) (6.06)
FFO/TD 0.64 ** 0.57 ** 0.57 ** 0.88 ** -0.55 * -0.06 -0.13 0.85 ** 1
(3.18) (2.60) (2.63) (7.13) (-2.52) (-0.25) (-0.52) (6.06) (0.00)
I/Av.D 0.23 0.18 -0.19 0.36 -0.34 -0.06 0.19 0.42 0.34
(0.88) (0.68) (-0.74) (1.45) (-1.38) (-0.23) (0.75) (1.78) (1.36)
I/PBDIT -0.69 ** -0.62 ** -0.50 * -0.64 ** 0.59 ** 0.17 0.25 -0.58 ** -0.60 **
(-3.60) (-2.95) (-2.18) (-3.15) (2.75) (0.65) (0.97) (-2.77) (-2.84)
NW/TL 0.81 ** 0.92 ** 0.51 * 0.32 -0.84 ** 0.10 -0.24 0.40 0.57 **
(5.17) (8.80) (2.24) (1.29) (-5.78) (0.38) (-0.93) (1.64) (2.59)
OP/NS -0.06 0.02 0.39 -0.13 0.06 0.55 0.19 -0.30 -0.10
(-0.25) (0.07) (1.58) (-0.52) (0.24) (2.48) (0.75) (-1.19) (-0.39)
PBDIT/I 0.67 ** 0.54 * 0.47 * 0.55 * -0.47 * -0.20 -0.22 0.56 * 0.52 *
(3.39) (2.44) (2.03) (2.48) (-2.01) (-0.77) (-0.85) (2.57) (2.28)
PBIT/I 0.68 ** 0.54 * 0.41 0.58 ** -0.48 * -0.25 -0.23 0.60 ** 0.53 *
(3.52) (2.40) (1.72) (2.68) (-2.10) (-0.96) (-0.91) (2.87) (2.38)
PBIT/TA 0.38 0.24 0.21 0.79 ** -0.39 -0.22 -0.06 0.63 ** 0.61 **
(1.54) (0.93) (0.83) (4.82) (-1.58) (-0.84) (-0.25) (3.08) (2.94)
PBT/TA 0.61 ** 0.45 0.28 0.77 ** -0.52 * -0.26 -0.18 0.71 ** 0.65 **
(2.89) (1.90) (1.11) (4.55) (-2.29) (-1.03) (-0.69) (3.87) (3.24)
QR 0.09 0.21 0.58 ** -0.02 0.02 0.12 -0.25 -0.17 0.10
(0.33) (0.81) (2.67) (-0.07) (0.10) (0.48) (-0.96) (-0.64) (0.37)
ROCE 0.39 0.17 -0.08 0.64 ** -0.34 -0.26 0.06 0.68 ** 0.48 *

26
 (1.58) (0.65) (-0.30) (3.14) (-1.35) (-1.04) (0.24) (3.52) (2.07)
RONW 0.28 0.12 0.23 0.78 ** -0.17 -0.29 -0.14 0.59 ** 0.55 *
(1.13) (0.47) (0.90) (4.79) (-0.64) (-1.14) (-0.56) (2.80) (2.49)
RS/TA 0.70 ** 0.79 ** 0.46 0.28 -0.72 ** -0.23 -0.63 ** 0.34 0.51 *
(3.73) (4.87) (1.97) (1.09) (-3.89) (-0.90) (-3.05) (1.37) (2.25)
S/TA -0.09 -0.13 -0.27 -0.02 0.01 -0.37 -0.08 -0.07 -0.21
(-0.35) (-0.50) (-1.08) (-0.08) (0.05) (-1.49) (-0.30) (-0.29) (-0.81)
TD/TA -0.81 ** -0.91 ** -0.51 * -0.32 0.83 ** -0.10 0.24 -0.40 -0.57 **
(-5.16) (-8.72) (-2.22) (-1.29) (5.75) (-0.37) (0.94) (-1.65) (-2.60)
WC/TA 0.00 0.09 0.15 -0.24 0.02 -0.15 -0.37 -0.32 -0.19
(0.00) (0.35) (0.58) (-0.95) (0.08) (-0.56) (-1.49) (-1.27) (-0.74)

Correlation Matrix of the various ratios used in the study

(contd.)
I/Av.D I/PBDIT NW/TL OP/NS PBDIT/I PBIT/I PBIT/TA PBT/TA
C/LTD 0.23 -0.69 ** 0.81 ** -0.06 0.67 ** 0.68 ** 0.38 0.61 **
(0.88) (-3.60) (5.17) (-0.25) (3.39) (3.52) (1.54) (2.89)
C+STD/TD 0.18 -0.62 ** 0.92 ** 0.02 0.54 * 0.54 * 0.24 0.45
(0.68) (-2.95) (8.80) (0.07) (2.44) (2.40) (0.93) (1.90)
CF/CL -0.19 -0.50 * 0.51 * 0.39 0.47 * 0.41 0.21 0.28
(-0.74) (-2.18) (2.24) (1.58) (2.03) (1.72) (0.83) (1.11)
CF/TA 0.36 -0.64 ** 0.32 -0.13 0.55 * 0.58 ** 0.79 ** 0.77 **
(1.45) (-3.15) (1.29) (-0.52) (2.48) (2.68) (4.82) (4.55)
D/E -0.34 0.593 ** -0.84 ** 0.06 -0.47 * -0.49 * -0.39 -0.52 *
(-1.38) (2.75) (-5.78) (0.24) (-2.01) (-2.10) (-1.58) (-2.29)
E/CL -0.06 0.17 0.10 0.55 * -0.20 -0.25 -0.22 -0.26
(-0.23) (0.65) (0.38) (2.48) (-0.77) (-0.96) (-0.84) (-1.03)
E/TL 0.19 0.253 -0.24 0.19 -0.22 -0.23 -0.06 -0.18
(0.75) (0.97) (-0.93) (0.75) (-0.85) (-0.91) (-0.25) (-0.6)
FFO/LTD 0.43 -0.58 ** 0.40 -0.30 0.56 * 0.61 ** 0.63 ** 0.71 **
(1.78) (-2.70) (1.64) (-1.19) (2.57) (2.87) (3.08) (3.87)
FFO/TD 0.34 -0.60 ** 0.57 ** -0.10 0.52 * 0.53 * 0.61 ** 0.65 **
(1.36) (-2.84) (2.59) (-0.39) (2.28) (2.38) (2.94) (3.24)
I/Av.D 1.00 0.150 0.03 -0.28 -0.23 -0.18 0.56 * 0.18
(0.00) (0.56) (0.14) (-1.12) (-0.91) (-0.71) (2.56) (0.70)
I/PBDIT 0.15 1.000 -0.58 ** 0.00 -0.89 ** -0.91 ** -0.53 * -0.8 **
(0.56) (0.00) (-2.66) (-0.00) (-7.63) (-8.29) (-2.39) (-6.1)
NW/TL 0.03 -0.58 ** 1.00 0.15 0.48 * 0.46 0.16 0.36
(0.14) (-2.66) (0.00) (0.57) (2.05) (1.94) (0.62) (1.48)
OP/NS -0.28 0.000 0.15 1.00 0.04 -0.01 -0.19 -0.1
(-1.12) (-0.00) (0.57) (0.00) (0.16) (-0.05) (-0.75) (-0.6)
PBDIT/I -0.23 -0.89 ** 0.48 * 0.04 1.00 0.99 ** 0.40 0.74 **
(-0.91) (-7.63) (2.05) (0.16) (0.00) (28.68) (1.67) (4.16)
PBIT/I -0.18 -0.91 ** 0.46 -0.01 0.99 ** 1.00 0.48 * 0.80 **
(-0.71) (-8.29) (1.94) (-0.05) (28.65) (0.00) (2.05) (5.09)
PBIT/TA 0.56 * -0.53 * 0.16 -0.19 0.40 0.48 * 1.00 0.85 **
(2.56) (-2.39) (0.62) (-0.75) (1.67) (2.05) (0.00) (6.05)
PBT/TA 0.18 -0.85 ** 0.36 -0.17 0.74 ** 0.80 ** 0.85 ** 1
(0.70) (-6.17) (1.48) (-0.66) (4.16) (5.09) (6.05) (0.00)
QR -0.45 -0.21 0.38 0.21 0.20 0.17 -0.14 -0.03
(-1.89) (-0.80) (1.54) (0.82) (0.77) (0.65) (-0.56) (-0.16)
ROCE 0.65 ** -0.37 -0.01 -0.30 0.35 0.42 0.88 ** 0.73 **

27
 (3.20) (-1.53) (-0.04) (-1.17) (1.41) (1.75) (6.98) (4.06)
RONW 0.22 -0.65 ** 0.03 -0.23 0.53 * 0.60 * 0.84 ** 0.87 **
(0.86) (-3.23) (0.11) (-0.90) (2.37) (2.84) (5.96) (6.86)
RS/TA -0.05 -0.57 ** 0.90 ** 0.03 0.48 * 0.47 * 0.16 0.37
(-0.20) (-2.62) (7.94) (0.12) (2.06) (2.00) (0.61) (1.50)
S/TA 0.28 -0.14 -0.28 -0.29 0.04 0.10 0.45 0.30
(1.10) (-0.55) (-1.10) (-1.16) (0.18) (0.38) (1.91) (1.20)
TD/TA -0.04 0.57 ** -1.00 ** -0.14 -0.47 * -0.45 -0.16 -0.36
(-0.15) (2.63) (-187.0) (-0.55) (-2.04) (-1.93) (-0.62) (-1.47)
WC/TA -0.33 -0.13 0.18 0.13 0.06 0.08 -0.06 -0.00
(-1.33) (-0.49) (0.71) (0.52) (0.25) (0.30) (-0.23) (-0.02)

Correlation Matrix of the various ratios used in the study

(contd.)
QR ROCE RONW RS/TA S/TA TD/TA WC/TA
C/LTD 0.09 0.39 0.28 0.70 ** -0.09 -0.81 ** 0.00
(0.33) (1.58) (1.13) (3.73) (-0.35) (-5.16) (0.00)
C+STD/TD 0.21 0.17 0.12 0.79 ** -0.13 -0.91 ** 0.09
(0.81) (0.65) (0.47) (4.87) (-0.50) (-8.72) (0.35)
CF/CL 0.58 ** -0.08 .2350 0.46 * -0.27 -0.51 * 0.15
(2.67) (-0.30) 0.905 (1.97) (-1.08) (-2.22) (0.58)
CF/TA -0.02 0.64 ** 0.78 ** 0.28 -0.02 -0.32 -0.24
(-0.07) (3.14) (4.79) (1.09) (-0.08) (-1.29) (-0.95)
D/E 0.02 -0.34 -0.17 -0.72 ** 0.01 0.83 ** 0.02
(0.10) (-1.35) (-0.64) (-3.89) (0.05) (5.75) (0.08)
E/CL 0.12 -0.26 -0.29 -0.23 -0.37 -0.10 -0.15
(0.48) (-1.04) (-1.14) (-0.90) (-1.49) (-0.37) (-0.56)
E/TL -0.25 0.06 -0.14 -0.63 ** -0.08 0.24 -0.37
(-0.96) (0.24) (-0.56) (-3.05) (-0.30) (0.94) (-1.49)
FFO/LTD -0.17 0.68 * 0.60 * 0.34 -0.07 -0.40 -0.32
(-0.64) (3.52) (2.80) (1.37) (-0.29) (-1.65) (-1.27)
FFO/TD 0.10 0.48 * 0.55 * 0.51 * -0.21 -0.57 * -0.19
(0.37) (2.07) (2.49) (2.25) (-0.81) (-2.60) (-0.74)
I/Av.D -0.45 0.65 ** 0.22 -0.05 0.28 -0.04 -0.33
(-1.89) (3.20) (0.86) (-0.20) (1.10) (-0.15) (-1.33)
I/PBDIT -0.21 -0.37 -0.65 ** -0.57 ** -0.14 0.57 ** -0.13
(-0.80) (-1.53) (-3.23) (-2.62) (-0.55) (2.63) (-0.47)
NW/TL 0.38 -0.01 0.03 0.90 ** -0.28 -1.00 ** 0.18
(1.54) (-0.04) (0.11) (7.94) (-1.10) (-187.0) (0.71)
OP/NS 0.21 -0.30 -0.23 0.03 -0.29 -0.14 0.13
(0.82) (-1.17) (-0.90) (0.12) (-1.16) (-0.55) (0.52)
PBDIT/I 0.20 0.35 0.53 ** 0.48 * 0.04 -0.47 * 0.06
(0.77) (1.41) (2.37) (2.06) (0.18) (-2.04) (0.25)
PBIT/I 0.17 0.42 0.60 ** 0.47 * 0.10 -0.45 0.08
(0.65) (1.75) (2.84) (2.00) (0.38) (-1.93) (0.30)
PBIT/TA -0.14 0.88 ** 0.84 ** 0.16 0.45 -0.16 -0.06
(-0.56) (6.98) (5.96) (0.61) (1.91) (-0.62) (-0.23)
PBT/TA -0.03 0.73 ** 0.87 ** 0.37 0.30 -0.36 -0.00
(-0.14) (4.06) (6.86) (1.50) (1.20) (-1.47) (-0.02)
QR 1.00 -0.44 -0.15 0.41 -0.10 -0.38 0.75 **
(0.00) (-1.86) (-0.56) (1.70) (-0.39) (-1.53) (4.36)
ROCE -0.44 1.00 0.70 ** -0.03 0.46 0.01 -0.28
(-1.86) (0.00) (3.75) (-0.13) (1.96) (0.04) (-1.13)
RONW -0.15 0.70 ** 1.00 0.09 0.33 -0.03 -0.12

28
 (-0.56) (3.75) (0.00) (0.33) (1.31) (-0.11) (-0.46)
RS/TA 0.41 -0.03 0.09 1.00 -0.19 -0.90 ** 0.31
(1.70) (-0.13) (0.33) (0.00) (-0.72) (-7.98) (1.22)
S/TA -0.10 0.46 0.33 -0.19 1.00 0.28 0.31
(-0.39) (1.96) (1.31) (-0.72) (0.00) (1.12) (1.23)
TD/TA -0.38 0.02 -0.03 -0.90 ** 0.28 1.00 -0.18
(-1.53) (0.04) (-0.11) (-7.98) (1.12) (0.00) (-0.69)
WC/TA 0.75 ** -0.28 -0.12 0.31 0.31 -0.18 1.00
(4.36) (-1.13) (-0.46) (1.22) (1.23) (-0.69) (0.00)

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