credit rating by financial firms.

1. Credit rating
Functions, origins, benefits,
methodology and regulations

2. Concept
 It is essentially a symbolic indicator of the
current opinion of the rating agency
regarding the relative ability and
willingness of the issuer of a financial
instrument (debt) to meet the service
obligations as and when they arise.
 It reduces the informational asymmetry
between the investor and the issuing
company.

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 It is only an opinion expressed by an
independent professional organization, on
the basis of a detailed study of all relevant
factors, the rating does not amount to any
recommendation to buy, hold, or sell an
instruments as it does not take into
consideration factors such as market
prices and personal risk preference of the
investor

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 It is done for specific debt security and not
for a company as a whole
 A debt rating is not an one time evaluation
of the credit risk, which can be regarded
as valid for the entire life of the security.

5. Functions
 Superior information
 Low cost information
 Quick investment decision
 Independent investment decision
 Investor protection

6. Benefits to rated companies
 Sources of additional certification
 Increase the investor population
 Forewarns risks
 Encourages financial discipline
 Merchant bankers job made easy
 Foreign collaboration made easy
 Benefits the industry as a whole
 Low cost of borrowing
 Rating as a marketing tool

7. Methodology
Any debt obligation and the issuer is
evaluated on the basis of :
1. Business risk analysis
 Industry risk
 Market position of the company
 Operating efficiency of the company
 Management evaluation

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1. Financial risk analysis
 Earnings protection
 Leverage and asset protection
 Cash flow adequacy
 Financial flexibility
 Accounting quality
 Indenture

9. A .Business risk analysis
 Industry risk
1. Is the industry in a growth, stable or declining phase?
2. Is the business cycle independent of economy or it
moves with economy in general
3. What is the nature of the competition? Is it regional,
national, or international?
4. What is the nature of govt regulation and policies?
5. What is the labour situation? Is it unionised
6. Does the industry have good control of key raw
material
7. To what extent the industry is fixed capital or working
capital intensive?
8. Ease of entry or exit

10. Market position of the company
The rating company would evaluate a
company’s sales position in terms of:
Market share
Marketing
Distribution
Strengths and weaknesses
Diversity of products and customer base

11. Operating efficiency
This is assessed from the operating
margins of the company and its ability to
maintain or improve them based upon
pricing or cost advantages.

12. Management evaluation
Management is assessed for its role in
determining operational success and also for its
risk tolerance.
A company’s earning performance, financial
structure and business mix are all a function of
management.
Evaluation of management emphasises past
performance, fulfillment of earlier plans and debt
usage policies. It has also concern with the
philosophy, experience, maturity, capability and
depth of management

13. B. Financial risk analysis
Earning protection can be viewed from
1. Profit potential angle
2. Break even analysis
the most significant measures of profitability are
1. Return on capital (pre-tax)
2. Profit margin
Finally the aim is to find out the source of future
earning growth.

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Leverage and asset protection
1. Long term debt/total capitalisation
2. Total debt/total capitalisation
The concept of asset protection refers to
measurement of the relative amount of
equity supporting the asset base

15. Cash flow adequacy:
 Earnings may be the best long-term determinant
of creditworthiness.
 The principal ratio computed is the debt service
coverage ratio.
Financial flexibility
It is an evaluation of a company’s financing needs,
plans and alternatives and its flexibility to
accomplish its financing program under adverse
condition without damaging creditworthiness

16. Accounting quality
 The various aspects reviewed in this category
would include:
1. Auditor’s qualification
2. Method of income recognition
3. Inventory valuation policies
4. Depreciation policies
5. Interconnection with subsidiaries
6. Undervaluation/overvaluation of assets
7. Off-balance sheet liabilities

17. Indenture
 Whether the provision of indenture deviate the
standard practice?
 Whether the indenture allow the company to
issue other bonds with equal or greater claim on
the assets of the company?
 Whether creation of sinking fund for redemption
of principal is stipulated?
 Are bonds senior or subordinated to other
bonds.
 Is the indenture too restrictive in terms of
payments of dividends, further borrowings, etc.

18. Credit rating for advance accounts with fund based
working capital limits of Rs. 1 cr and above from the
banking system
PARAMETERS
1. financial standing (actual)
Current ratio
score
1.33 and above 10
1.25 to 1.32 08
1.34 to 1.24 05
1.00 to 1.10 03
below 1.00 00

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D/E ratio
3.0 and below 10
above 3.00 and upto 4.00 08
Above 4.00 and upto 5.00 05
Above 5.00 00

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 Sales
increasing trend
Achievement more than 90% 05
Achievement between 75% and 90% 03
Achievement less than 75% 02
 Tangible net worth
increasing trend for last 3 yrs 03
stangant 01
decreasing 00

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PARAMETERS SCORE
II Information system
a. various statements
Timely submission 03
delayed upto 30 days 01
non submission 00
b.Renewal data
timely submission 06
delayed 03
Non submission 00

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III financial discipline
prompt compliance 06
Delayed 03
Non 00

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Credit rating aggregate score
AAA 50 and above
AA 40 to 49
A 30 to 39
B Below 30

24. CRISIL RATING SYMBOLS
High investment grade
 AAA-Highest security
 AA-High safety
Investment grade
 A- Adequate safety
 BBB-Moderate safety

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Speculative grade
 BB-Inadequate safety
 B-High risk
 C-Substantial risk
 D -Default

26. THANK YOU …..