IPO Grading

A PROJECT REPORT ON

IPO GRADING
SUBMITTED BY

ANKITA NARESH TRIVEDI

T.Y.B.M.S. [SEMESTER V]
DIV.: B
ROLL NO.: 6323
ACADEMIC YEAR

2013 2014
UNDER THE GUIDANCE OF

DATE OF SUBMISSION

THAKUR COLLEGE OF SCIENCE AND COMMERCE

KANDIVALI (E), MUMBAI - 400 101
SUBMITTED TO
UNIVERSITY OF MUMBAI

-1-

IPO Grading

DECLARATION

I, ANKITA NARESH TRIVEDI, of THAKUR COLLEGE OF SCIENCE

AND COMMERCE of TYBMS [Semester V] hereby declare that I have
completed my project, titled IPO GRADING the Academic Year 2013
2014. The information submitted herein is true and original to the best of my
knowledge.

_______________
_________
ANKITA
NARESH TRIVEDI

-2-

IPO Grading

CERTIFICATE
I, Miss

, hereby certify that ANKITA NARESH TRIVEDI of Thakur

College Of Science And Commerce of TYBMS [Semester V] has completed

the project on IPO GRADING in the academic year 2013 2014 under my
guidance. The information submitted herein is true and original to the best of
my knowledge.

_________________________
_________________________
Miss.

Dr. Chakrobarty
Project Guide

Principal

_______________________________
EXAMINER

-3-

IPO Grading

ACKNOWLEDGEMENT

It has always been my sincere desire as a management student to get an

opportunity to express my views, skills, attitude and talent in which I am
proficient. A project is one such avenue through which a student who aspires
to be a future manager does something creative. This project has given me the
chance to get in touch with the practical aspects of management.
I am extremely grateful to the University of Mumbai for having prescribed this
project work to me as a part of the academic requirement in the Bachelor of
Management (BMS) course.
I wish to appreciate the Thakur College Of Science And Commerce for
providing all the required facilities. I would like to thank the Principal, Shri
______ for his dynamic leadership. I would also like to thank the BMS
Coordinator, Mrs.Richa Jain for all her support and help.
I also wish to thank my Project Guide, Miss. ______, for guiding me
throughout the project and without whose support; the project may not have
taken shape.
I also appreciate all the support provided by the library staff and the teaching
and supporting staff of Thakur College for providing all the necessary
academic content and the entire state of the art infrastructure and resources to
enable the completion of my project.
I take this opportunity to express my profound gratitude to all the people
associated with the project for providing all the necessary information and
valuable inputs in my survey.
Finally, I thank all my friends and family members who have directly or
indirectly helped me towards the execution of this project.
-4-

IPO Grading

-5-

IPO Grading

PREFACE
Change is a natural phenomenon. Time cycle necessitates a
change in perception because almost all of us dont venture to go against the
wind. It is said that the equity market is more risky than any other investment
alternative, but also high return. So the phrase HIGHER THE RISK, HIGHER
THE RETURN is suitable for equity market.
Yesterday, the scenario of the market was different compare to
today, where investors blindly invest in IPO. Today investors are more
conscious about their investment plans in IPO. Also SEBI plays very
important role in money market. As per the rules and regulation of SEBI ACT
1992, there are many steps which a company has to follow in order issue IPO
to the investors. One of them is IPO GRADING which is very important. After
introducing IPO grading the risk of bogus IPO is minimized. This has the
whole concept of IPO.
Sky is the limit. Whatever the perception we perceive today
regarding even tomorrow. The increasing safety measurement taken by an
investor and SEBI has been found playing a big role in shaping the IPO. We
dont find a boundary for perfection. I have made best of my efforts to make
this project, to view on newly concept IPO Grading. We find sky the only limit
for quality; whatever the lapses and short coming identified would be
welcome.

-6-

IPO Grading

EXECUTIVE SUMMARY

When a business entity needs money the general course of action that it
follows is that it goes to the bank. However banks may not be ready to
provide huge finance for a long time especially if the returns are not fixed.
The best way to raise money is through offer of shares. The securities
which the companies issue for the first time to the public and other
financial institutions either after incorporation or on conversion from
private to public company is called INITIAL PUBLIC OFFERING or
IPO. Raising equity gives boost to economical development of the
country.
Raising money through IPO is a very complex process. It requires
analysis and implementation of various commercial laws applicable to
IPO-Prospectus. These laws are Companies Act, Income Tax Act, FEMA,
Securities Contract Act and SEBI Guidelines on Disclosure and Investor
Protection. It is also necessary to implement circulars from time to time
by SEBI. The introduction of SEBI attracted Foreign Institutional
Investors to invest money in stock market in India. It has also helped
Indian Companies to offer securities in most scientific method to Indian
and Foreign investors. One of the rules and regulations of the SEBI ACT ,
1992 is IPO GRADING which is very important for the new investors,
as it helps them for investing purposes. Investors can have a secured
feeling by investing in a high graded company. Thus, let us understand
the process and methodology of IPO GRADING , its advantages and
disadvantages and whether it is help or hindrance for the investors.

-7-

IPO Grading

INDEX
SR.
NO..

TITLE

PAGE NO.

EXECUTIVE SUMMARY

OBJECTIVE OF THE STUDY

RESEARCH METHODOLOGY

LITERATURE REVIEW

10

FINANCIAL MARKETS IN IPO

11

PRIMARY MARKET

13

IPO - INTRODUCTION

14

PRICING OF IPO

17

IPO BASICS

18

10

NEED FOR IPO GRADING

19

11

INTRODUCTION TO IPO GRADING

20

12

GRADING PROCESS

21

13

CONTENTS OF IPO GRADING REPORTS

23

14

GRADING METHODOLGY

24

15

GRADING SCALE

27

16

GRADING CRITERIA FOR BANKS AND

FINANCIAL INSTITUTIONS
ADVANTAGES AND DISADVANTAGES OF IPO
GRADING

28

17

-8-

39

IPO Grading

18

SURVEY REPORT

44

19

CONCLUSION

50

20

RECOMMENDATION

51

21

BIBLIOGRAPHY

52

OBJECTIVE OF THE STUDY

To analyse and evaluate the complex IPO process.

To understand the concept of IPO grading.
To understand grading methodology and the process of it.
To find out how much reliable is the IPO grading.

-9-

IPO Grading

RESEARCH METHODOLOGY

Primary Data:
Primary Data consists of survey done by meeting people who are either
customers in share market or who have idea about it. The data can be collected
by laymen to find out their needs. The sample size taken consists of 20 people
who responded. It also includes case analysis of some corporate houses IPOs.

Secondary Data:
Secondary Data would consists of widely available resources through

Magazines
Newspapers
Journals
Websites
Books etc.

- 10 -

IPO Grading

LITERATURE REVIEW
1. Initial Public Offerings By Richard P. Kleeburg 3 rd Edition In Year
2005, Which Published By South Western Educational Publishing.
This valuable resource is for the executives and advisers of any firm
considering making the transition from a private to public company.
An IPO is not just a short-term financial transaction. It often marks the turning
point in the life of a company, enabling it to launch new products, enter new
markets, accelerate its growth, and attract valuable employees. If an IPO is the
way to grow, then a balanced scorecard" approach needs to be used - an honest
evaluation of the process and consideration of whether an IPO, despite its
glamour, will or will not produce the desired results. Initial Public Offerings
uncovers many of the successful approaches and common pitfalls to going
public. It helps officials decide whether an IPO or other financing alternatives
is the right strategy, determine which stock market to use, plan and execute the
IPO, and stay on track following the IPO - helping companies reach their true
potential for success.
2. Ipo: Concepts And Experiences-By Arindam Banerjee Published; ByIcfai University Press
One of the striking features that makes any capital market an attractive
investment avenue is its liquidity. In this regard, the importance and relevance
of Initial Public Offers (IPOs) go beyond explanation. Simply speaking, IPOs
serve the purpose of companies going public; the process by which the
business owned by one or several individuals is converted into a business
owned by many. Several experts are of the opinion that, IPOs strengthen the
financial architecture of the entire capital market by enhancing liquidity, while
- 11 -

IPO Grading

others say, that they bring along with it an array of fraudulent practices that
have a strong potential of eroding the investors confidence. From the
companys point of view, an IPO can even mark the turning point in an
organizations life. Following an IPO, a company can increase its growth
potential, launch its new products as well as enter new markets. IPOs are a
general feature of any booming capitalization. Of late, the global capital
markets have performed considerably well and one primary reason attributed
to the same is the surge of public offers that have flooded the markets. This
book titled IPOs: CONCEPTS AND EXPERIENCES deals with various
conceptual parameters of IPOs such as their pricing mechanisms, valuation
methods, timing of the offers, technology impact on IPOs and various other
related issues. In its entirety, the book itself is a comprehensive guide to the
various trends witnessed in the IPO market amidst the volatile environment.

FINANCIAL MARKETS AND IPO

The Financial Market is an amorphous set of players who come

together to trade in financial assets.

Financial Markets in any economic system that acts as a conduit

between the organizations who need funds and the investors who wish
to invest their money into profitable opportunity. Thus, it helps
institutions and organizations that need money to have an access to it
and on the other hand, it helps the public in general to earn savings.

Thus they perform the crucial function of bringing together the entries
who are either financially scarce or who are financially slush. This
helps generally in a smoother economic functioning in the sense that
economic resources go to the actual productive purposes. In modern
economic systems Stock Exchanges are the epicenter of the financial
activities in any economy as this is the place where actual trading in
securities takes place.
- 12 -

IPO Grading

Modern day Stock Exchanges are most of the centers to trade in the
existing financial assets. In this respect, they have come a long way in
the sense that these days, they act as a platform to launch new
securities as well as act as most authentic and real time indicator of the
general economic sentiment.

The zone of activities in the capital market is dependent partly on the

savings and investment in the economy and partly on the performance
of the industry and economy in general. In other words capital market
constitutes the channel through which the capital resources generated
in the society and made available for economic development of the
nation.

As such, Financial Markets are functionally classified as having two

parts, namely,
1. The Primary Market
2. The Secondary Market

Primary Market comprises of the new securities which are offered to the
public by new companies. It is the mechanism through which the resources of
the community are mobilized and invested in various types of industrial
securities. Whenever a new company wants to enter the market it has to first
enter the primary market.

Secondary Market comprises of further issues which are floated by the

existing companies to enhance their liquidity position. Once the new issues are
floated and subscribed by the public then these are traded in the secondary
market. It provides easy liquidity, transferability and continuous price
- 13 -

IPO Grading

formation of securities to enable investors to buy and sell them with ease. The
volume of activity in the Secondary Market is much higher compared to the
Primary Market.

PRIMARY MARKET-GENESIS AND GROWTH

When a business entity needs money the general
course of action that it follows is that it goes to the
bank. However banks may not be ready to provide
huge finance for a long time especially if the returns
are not fixed. The best way to raise money is through
offer of shares and for this: PRIMARY MARKET is
the answer.

The Primary Market deals with the new securities which were previously not
tradable to the public. The main function is to facilitate the transfer of
- 14 -

IPO Grading

resources from savers to entrepreneurs seeking to establish or to expand and

diversify existing events. The mobilization of funds through the Primary
Market is adopted by the state government and corporate sector. In other
words the Primary Market is an integral part of the capital market of a country
and together with the securities market. The development of security as well as
the scope for higher productive capacity and social welfare depends upon the
efficiency of the Primary Market.

What is an IPO?
The securities which the companies issue for the first time to the public either
after incorporation or on conversion from private to public company is called
IPO or INITIAL PUBLIC OFFERING.

- 15 -

INTIAL PUBLIC OFFERING (IPO)

The first public offer of securities by a company after its

inception is known as Initial Public Offering (IPO).
Going public (or participating in an initial public
offering or IPO) is a process by which a business
owned by one or several individuals is converted in to a
business owned by many. It involves the offering of part
ownership of the company to the public through the sale
of equity securities (stock).
IPO dilutes the ownership stake and diffuses corporate control as it provides
ownership to investors in the form of equity shares. It can be used as exit
strategy and finance strategy.
As a financing strategy, its main purpose is to raise funds for the company.
When used as an exit strategy, existing investors can offload equity holdings to
the public.

Reasons For Going Public :

To raise funds for financing capital expenditure needs like expansion

diversification etc.

To finance increased working capital requirement

As an exit route for existing investors

For debt financing.

Benefits Of Going Public :

Access to Capital: The principal motivation for going public is to

have access to larger capital. A company that does not tap the public financial
market may find it difficult to grow beyond a certain point for want of capital.

Stockholder Diversification: As a company grows and becomes

more valuable, its founders often have most of its wealth tied up in the
company. By selling some of their stock in a public offering, the founders can
diversify their holdings and thereby reduce somewhat the risk of their personal
portfolios.

Easier to raise new capital: If a privately held company wants to

raise capital a sale of a new stock, it must either go to its existing shareholders
or shop around for other investors. This can often be a difficult and sometimes
impossible process. By going public it becomes easier to find new investors
for the business.

Enhances liquidity: The stock of a closely held firm is not liquid. If

one of the holders wants to sell some of his shares, it is hard to find potential
buyers-especially if the sum involved is large. Even if a buyer is located there
is no establishes price at which to complete the transaction. These problems
are easily overcome in a publicly owned company

Establishes value for the firm: This can be very useful in attracting
key employees with stock options because the underlying stock have a market
value and a market for them to be traded that allows for liquidity for them.

Image: The reputation and visibility of the company increases. It

helps to increase company and personal prestige.

Other advantages:
Additional incentive for employees in the form of the
companies stocks. This also helps to attract potential employees.

Window of opportunity.

It commands better valuation of the company.

Better situated for making acquisitions.

Disadvantages\Costs Of Going Public :

A public company, of course is not an unmixed blessing. There are several
disadvantages of going public.

Disclosure: A public company is required to disclose information to

investors and others. Hence, it cannot maintain a strict veil of secrecy over
its expansion plans and product market strategies as its non-public
counterpart can do. Management may not like the idea of reporting
operating data, because such data will then be available to competitors.

Dilution: When a company issues shares to public, existing

shareholders suffer dilution of their proportionate ownership in the firm.

Loss of Flexibility: The affairs of a public company are subject to

fairly comprehensive regulation. Hence, when a non-public company is
transformed into a public company there is some loss of flexibility.

Accountability: Understandably, the degree of accountability of a

public company is higher. It has to explain a lot to its investors.

Public Pressure: Because of its greater visibility a public company

may be pressurized to do things that it may not otherwise do.

Adverse Selection: Investors, in general, know less than the issuers

about the value of companies that go public. Put differently, they are potential
victims of adverse selection. Aware of this trap, they are reluctant to
participate in public issues unless they are significantly underpriced.

Self dealings: The owners managers of closely held companies have

many opportunities for self-transactions, although legal they may not want to
disclose to the public.

Control: Owning less than 50% of the shares could lead to a loss of

control in the management.

Costs: Apart from the cost of issuing securities, a public company

has to incur recurring costs for providing investors with periodical reports,
holding shareholder meetings communicating with institutional investors
and financial analysts, and fulfilling various statutory obligations, like filing
quarterly reports with the Securities and exchange Board of India. These
reports can be costly especially for small firms.

PRICING OF IPO
Historically, IPOs both globally and in the US have been under
priced. The effect of under pricing an IPO is to generate additional interest in
the stock when it first becomes publicly traded. This can lead to significant
gains for investors who have been allocated shares of the IPO at the offering
price. However, under pricing an IPO results in "money left on the table"
lost capital that could have been raised for the company had the stock been
offered at a higher price.
IPOs can be a risky investment. For the individual investor, it is
tough to predict what the stock will do on its initial day of trading and in the
near future since there is often little historical data with which to analyze the
company. Also, most IPOs are of companies going through a transitory growth
period, and they are therefore subject to additional uncertainty regarding their
future value.

IPO BASICS

An initial public offering (IPO) is the first sale of stock by a company

to the public.

Broadly speaking, companies are either private or public. Going public

means a company is switching from private ownership to public
ownership.

Going public raises cash and provides many benefits for a company.

The dotcom boom lowered the bar for companies to do an IPO. Many
startups went public without any profits and little more than a business
plan.

Getting in on a hot IPO is very difficult, if not impossible.

The process of underwriting involves raising money from investors by

issuing new securities.

Companies hire investment banks to underwrite an IPO.

The road to an IPO consists mainly of putting together the formal

documents for the Securities and Exchange Commission (SEC) and
selling the issue to institutional clients.

The only way for you to get shares in an IPO is to have a frequently
traded account with one of the investment banks in the underwriting
syndicate.

An IPO company is difficult to analyze because there isn't a lot of

historical info.

Lock-up periods prevent insiders from selling their shares for a certain
period of time. The end of the lockup period can put strong downward
pressure on a stock.

Flipping may get you blacklisted from future offerings.

Road shows and red herrings are marketing events meant to get as
much attention as possible. Don't get sucked in by the hype.

A tracking stock is created when a company spins off one of its

divisions into a separate entity through an IPO.

Don't consider tracking stocks to be the same as a normal IPO, as you

are essentially a second-class shareholder.

NEED FOR GRADING

If you are finding it hard to make an investment decision on the various public
issues being floated in the IPO market Sebi's primary market committee may
have just found the answer to your dilemma.
The committee is evolving a rating concept for mandatory grading of equity
offerings. Sebi will probably be the first regulator in the world to make
mandatory rating of equity offerings. At present, only debt issues are rated
ahead of offers.
The need to rate equity offerings emerges from the fact that majority of retail
investors do not read the offer document and even where they do they may not
fully comprehend the implications of all the disclosures made in the document.
Ratings from independent agencies are aimed at helping investors separate
good floats from risky ones.

IPO GRADING
In a situation where public issues are priced aggressively, retail investors often
suffer the most due to lack of knowledge and research. In order to avoid this
and restrict bogus listings (like we saw in the early 90s), the SEBI last
fortnight made it mandatory for all companies raising money through the
equity route to get their IPOs graded by an independent credit rating agency.
The views and feedback of the regulator, market participants, investors and
investor forums have been core inputs in the development of IPO grading. The
debt market has benefited on immensely from the availability of such an
assessment in the form of credit rating a representation of a relative
assessment of the fundamentals of the debt security i.e., likelihood of timely
repayment of interest and principal.
Investment decisions for IPOs are at present based on voluminous and
complex disclosure documents, which pose challenge to investors to arrive at
decisions. Though seemingly there is a lot of information available on IPOs
through free research on websites, media and other sources, investors often
look for structured, consistent and unbiased analysis to aid their investment
decisions.
Moreover, information available on new companies varies with the size of the
issue, the market conditions and the industry that the issuing company belongs
to. IPO grading aims to bridge this gap and facilitate more informed
investment decisions.

Grading includes an assessment of business and financial prospects,

management quality and corporate governance. IPO grading is based on the
assessed future performance. The assessed future is based on the business plan
of the companys management as understood by rating agency. Rating agency
will subject the business plan to extensive reality checks based on its
understanding of industry and market dynamics, future management capability
and the managements track record of translating intentions into action.

THE GRADING PROCESS

Agency starts the IPO Grading process on receipt of a formal request

from the issuer company.

Agency then sends a questionnaire seeking information on the

companys existing operations as well as proposed projects.

This is followed by the site visits and discussions with the key
operating personnel of the company concerned.

Apart from official of the company, agency also meets its bankers,
auditors, merchant bankers, and appraisal authority (if any).

If the case so merits, agency also obtain the views of independent

expert agencies on critical issues like, for instances, the technology
proposed to be used.

Once all required information has been obtained, agencys team of

analysts presents a detailed Grading Report to agencys Rating
Committee which assigns the Grade.

Usually, the assignment of Grade takes three to four weeks after all the
necessary information has been provided to agency.

Once the Grade is assigned, the issuer company is required to disclose

the same and also publish it in the Red Herring Prospectus (RHP),
which is filed with SEBI and other statutory authorities.

Agency does not carry out unsolicited Grading; the process involves
the full cooperation of, and the interaction with, the issuer company
concerned. IPO Grading is one a one-time exercise, not subject to
subsequent surveillance.

CONTENTS FOR IPO GRADING REPORTS

The report for each IPO grading will contain a summary and a detailed report.

Summary- One page report highlighting the key elements of analysis

Detailed report- Comprehensive commentary on the assessment

parameters.

This report will be a one-time assessment based on the information disclosed

in the draft prospectus filed with Securities Exchange Board of India (SEBI);
rating agency understanding of the industry and company fundamentals; and
interactions with the issuer management and other stakeholders.
The report will comprise our assessment on the following parameters:

Management quality

Business prospects: Industry and company

Financial performance

Corporate governance

Project related factors

Other factors:
Compliance track record
Litigation history
Capital history.

IPO GRADING METHODOLOGY

IPO grading is a service aimed at facilitating assessment of equity issues

offered to the public. The Grade assigned to any individual IPO is a symbolic
representation of Credit rating agencys assessment of the fundamentals of
the issuer concerned on a relative grading scale. IPO Grades are assigned on
five point scale, where IPO Grade 5 indicates the highest grading and IPO
Grade 1 indicates the lowest grading, i.e. a higher score indicates stronger
fundamentals. An IPO Grade is not an opinion on the price of the issue, pre- or
post-listing.

GRADING METHODOLOGY
The emphasis of the IPO Grading exercise is on evaluating the prospects of
the industry in which the company operates, the companys competitive

strengths that would allow it to address the risks inherent in the business and
effectively capitalize on the opportunities available as well as the companys
financial position. In case the IPO proceeds are planned to be used to set up
projects, either Greenfield or Brownfield, agency evaluates the risks inherent
in such projects, the capacity of the companys management to execute the
same and likely benefits accruing from the successful completion of the
projects in the terms of profitability and returns to shareholders. Due weight
age is given to the issuer companys management strengths and weakness and
issues, if any, from the corporate governance perspective. Normally, grading
agencies methodology examines the following key variable:

Business and Competitive Position

Industry prospects: Typical factors which are assessed here includes the
growth prospects of the industry, the extend of cyclicality, competitive
intensity, vulnerability to technological changes and regulatory risks inherent
in the business.
Market position: A companys Market position is indicated by its ability to
increase/ protect market share, command differential pricing and maintain
margins at par with, or superior to its peers. Factors evaluated would include
the sources of competitive advantages like brand equity, distribution network,
proximity to key markets and technological superiority.
Operating efficiency: The emphasis here is on evaluating the factors which
could give rise typically includes areas like access to raw material sources,
superior technology, and favorable cost structure and so on.

New Projects-Risks and Prospects

Key issues evaluated here are the companys ability to successfully execute
the project that is being undertaken and the potential upside to the
shareholders on completion and commissioning of the project. Agency carries
out a detailed risk assessment of the project with respect to issue like
availability of finances, technology tie-ups in place, ability to execute the
project without time or cost overrun, market risks arising from capacity
additions and the mitigates in place to counter those risks.

 Financial Position and Prospects

Ability to generate sustained shareholders value as reflected by trends in
profitability margins, EPS growth, Returned on Cpatital Employed (RoCE)
and the Return on Net Worth (RoNW) are evaluated by the grading agency.
While the absolute levels and the trends are important, agency also compares
it with peers operating in the same industry to understand a companys relative
position. Complementing this is an analysis of the companys ability to
generate free cash flows in the long term. The capital structure for
shareholders and the financial risks associated with higher leverage.

Management Quality
The assessment is designed to evaluate a companys management depth, the
profile of its key operating personnel, the adequacy of the organization
structure and systems in place as well as the managements stated plans and
policies towards earnings growth and shareholder returns.
Grading agency also evaluates the managements approach towards risks and
long term business plans in place.

Corporate Governance practices

While IPO grading is not intended to be detailed evaluation of a companys
corporate governance practices, broad issues like apparent quality of
independent directors, quality of accounting policies and type of transactions
with subsidiaries and associates is looked into.

Compliance and Litigation History

The IPO Grade assigned is the outcome of a detailed evaluation of each of the
factors listed, and is a comment on the fundamentals of the company
concerned and its growth prospects from a long term perspective. The
assessment involves combination of both quantitative factors as reflected in
financial numbers, market shares etc as well as qualitative factors like risks

associated with new projects, or the managements ability to deliver on the

promises made.
A grading agency IPO Grade does not comment on the valuation or pricing of
the issue that has been Graded, nor does it seek to indicate the likely returns to
shareholders from subscribing to the IPO.

IPO GRADING SCALE

IPO Grade 5: Strong fundamentals
IPO Grade 4: Above-average fundamentals

IPO Grade 3: Average fundamentals

IPO Grade 2: Below-average fundamentals

IPO Grade 1: Poor fundamentals

IPO Grade Is Not:

It is NOT a recommendation to buy sell or hold the securities Graded.

It is NOT a comment on the valuation or pricing of the IPO Graded.

It is NOT an indication of the likely listing price of the IPO Graded.

It is NOT a certificate of statutory compliance.

A forensic exercise that can detect fraud.

An audit of the issuer.

GRADING CRITERIA FOR BANKS AND

FINANCIAL INSTITUTION AS PER CRISIL
Market position
CRISIL factors in the size of an entity in the financial sector and looks at its
positioning in the industry. A larger size enables the entity to withstand

systematic shocks and determines the extent of system support that can be
expected for the entity. Diversity in product portfolio, business lines and
customer base are also positively factored in by CRISIL.
The CRAMEL model comprises the following:

Capital adequacy

Resource-raising ability

Asset quality

Management and systems evaluation

Earnings potential

Liquidity/Asset liability management

No one factor has an overriding importance or is considered in isolation and

all the six factors are viewed in conjunction before assigning a rating.

Capital adequacy
An entitys capital provides it with the necessary cushion to withstand credit
risks and other risks in its business. While assigning a rating, CRISIL analyses
the capital adequacy level and its sustainability in the medium to long term.
This assessment is significantly influenced by the perception of relative
profitability, the entitys risk profile and its asset quality. The analysis
encompasses the following factors:

Size of capital
The absolute size of capital imparts flexibility to a bank/FI to withstand shocks
and thus, an entity with higher absolute capital is viewed favorably.

Quality of capital (Tier I capital)

The proportion of Tier-I capital or core capital is the primary indicator of the
quality of a bank or FIs capital. The level of Tier-I capital is given primary
importance when assigning a rating on the capital adequacy parameters.
Although the presence of Tier II capital does provides some cushion in the

short to medium term, such capital needs to be periodically replenished.

CRISIL also analyses other issues, like the presence of hidden reserves and the
percentages of the investment portfolio that is marked to market. These issues
help in streamlining accounting policy differentials across various entities and
have a bearing on the capitals quality.
Sustainability of capital ratios and flexibility to raise Tier I capital
An entity has the flexibility to raise Tier I capital either through internal
accruals or through the capital markets. The rated entitys ability to access the
capital markets to meet its Tier I capital needs and its ability to service the
increased capital base is considered while evaluating its flexibility to raise
capital. A bank or FIs ability to support the increased asset base through
earnings is an important parameter in assigning the sustainability of its capital
adequacy. An entity that is able to sustain asset growth through internal
generation without impairing capital adequacy is viewed favorably.
Growth plans
CRISIL factors the rated bank and FIs future growtrh plans while analyzing
its capital adequacy (even if it at high levels currently) would be regarded as
unsustainable if the entity purses a high-growth strategy.

Resource-raising ability
CRISIL analyses the resources position of the bank/FI in the terms of its
ability to maintain a low-cost, stable resource base. In the domestic context,
the resource composition of banks and FIs is very different. Banks are
significantly deposit-funded whereas FIs have to depend on wholesale funds.
Although some FIs do raise retail funds, compared to the banking sector, they
are at a natural disadvantage while raising retail deposits in terms of the
restrictions on the minimum tenure and interest rates, the absence of a chequeissuing facility and a relatively smaller branch network. In general, the
dependence on wholesale funding attaches a degree of risk to the funding
profile of FIs. These risks (especially stability of resources) are partly
mitigated by the access that the All India Financial Institutions (AIFIs) have to

resources from provident funds and the insurance sectors. Such resources have
a retail origin.
Given this basic distinction in their funding profiles, the funding risk profile of
baks and FIs too are evaluated distinctively.
The following issues are considered while analyzing the resources position of
a bank:
Size of deposit base
A large deposit base provides stability to a bankers resources position by
diversifying the depositor base and ensuring a continuous stable source of
funds.
Diversity in deposit base and the geographical spread
The diversity of the deposit base in the terms of the number of small deposits,
the geographical spread and the optimal rural/urban mix lends stability to the
resources position of a bank. The number of branches and their geographical
spread lend diversity to its deposit base. Thus, a bank with a large number of
branches dispersed all over India and with an optimal rural/urban mix is
viewed favorably.
Deposit mix
A banks deposit mix has an impact on its cost of deposits. A high proportion
of savings and current deposits lead to a low-cost resource base. CRISIL also
analyses the trends to in deposit mix to form an opinion on future stability and
costs.
Growth in deposits
Accretion to deposits in the main source of funding asset growth and
managing liquidity risks in banks. CRISIL compares the growth in deposit of a
bank with industry trends to make relative judgments.
Cost of deposits
Cost of deposits is a function of the banks deposit mix, its region of
operations and its ability to attract deposits at lower rates. Banks that have a
low cost of resources not only benefit through higher profitability but also
have greater flexibility to increase deposit rates in order to maintain their
resources position.

 Asset quality
A bank or FIs asst quality is a measure of its ability to manage credit risks.
Besides studying the banks credit appraisal mechanisms, portfolio monitoring
procedures and problem asset resolution strategies, CRISIL analyses asset
quality on the basis of the following parameters:
Geographical diversity and diversity across industries
Geographical diversity of asset base and diversity across industries, along with
single risk concentration limits, are important inputs in determining the assert
quality of banks/FIs. Regional banks with limited operations and branch
network have lesser flexibility to diversify their advances portfolio than banks
with a national presence and are thus susceptible to adverse economic
conditions in a particular region.
The industry exposure and single risk concentration is monitored by the
central bank, that is the Reserve Bank of India (RBI), through exposure
guidelines. However, some banks/FIs show a high degree of exposure to
certain industries, making themselves vulnerable to downturns in those
industries. To ascertain the importance of individual borrowers, CRISIL
reviews the rated banks largest credit exposures.
Client profile of the corporate asset portfolio
The credit quality of a banks corporate portfolio (funded as well as nonfunded) is an important input in analyzing asset quality. CRISIL analyses the
profile of clients in the asset portfolio to make a judgment on portfolio quality.
The ability of a bank/FI to attract better credit quality clients is an important
indicator of its future credit quality. The size (of capital) of a financial sector
entity lends considerably flexibility in attracting larger and better quality
clients given its sheer ability to take on larger exposures on its balance sheet.
Also, a bank or FIs ability to attract and retain good quality clients by
providing value-added services would enhance asset quality in future.
Quality of non-industrial lending
Banks in India have an obligation to lend a proportion of their funds to the
priority sector that primarily encompasses agriculture and small-scale

industries. To this extent, FIs are better placed than banks because they do not
have any such obligations. CRISIL analyses the credit quality of this nonindustrial portfolio in arriving at a judgment on the overall asset quality of a
bank. The credit quality of the asset portfolio is also indicated by the segmentwise non-performing asset (NPA) levels of the portfolio, revealing the
performance of the bank in each segment. This helps in gauging the banks
relative strength in each of its loan segments.
In recent times, banks as well as FIs are increasingly focusing on retail
consumer loans, primarily vehicle and housing loans. CRISIL looks at the
quality of retail consumer credit growth, the underwriting standards and
recovery mechanisms to arrive at the asset quality implications of the retail
foray.
NPA levels
The asset quality of a bank depends not only on the credit quality of its clients
but also on its ability to manage its asset portfolio. The gross NPA level helps
to benchmark the bank/FIs ability to manage its asset portfolio on a relative
scale. Gross NPA levels are an indicator of the inherent quality of the entitys
asset portfolio and thus, of its credit appraisal capabilities. Net NPA levels are
an indicator of the balance-sheet strength of the bank, the proportion of
earning assets held by it and the potential credit loss. The proportion of
earning assets and the potential credit loss would have a bearing on the banks
future earnings capability.
Movement of provisions and write-offs
Some banks/FIs follow a practice of writing off a large portion of their bad
loans in order to clean up their balance sheets. Thus, the present NPA numbers
are not a true indicator of the inherent credit quality of a banks asset portfolio.
Hence, NPA levels alone cannot be a criterion to assess a banks future asset
quality. Average provisioning, including write-offs, over a five-year time
frame is an indicator of the level of cleaning up done by a bank over a period
of time. This average provisioning level and its movement is an indicator of
the portfolios credit risk and the expected future write-offs and provisioning,
which would further affect the banks earnings capability.
Growth in advances

High growth rates in the financial sector bring the risks associated with the
establishment of collection systems, tracking of asset quality and lack of
seasoning of the lending portfolio. CRISIL closely analyses the pattern and
nature of such growth, studying entities with higher growth rates more
carefully to look at nature of the growth, the reasons for it and its implications
on the asset quality. An entity that has grown by attracting good quality clients
from its competitors would be viewed more favorably than one that has grown
just by increasing its geographical presence or diluting credit criteria.

Management and systems

evaluation

CRISIL believes that the quality of management can be an important

differentiating factor in the future performance of a bank/FI. The management
is evaluated on the following parameters:
Goals and strategies
A banks future goals and strategies are evaluated to take view on its
managements vision. The banks ability to adapt to the changing environment
ant its ability to manage credit and market risks, especially in a scenario of
increasing deregulation of the financial markets, assumes critical importance.
CRISIL also has extensive discussions with the banks managements on their
philosophy with regards to diversification, asset growth and maintenance of
capital, provisioning and liquidity levels.
Systems and monitoring
CRISIL studies credit appraisal systems and the systems and the systems for
managing and controlling credit and market risks at a portfolio level.
Significant emphasis is laid on risks monitoring. Most Indian banks face the
challenges of enhancing the coverage and quality of their information systems
and reporting. The degree of acceptance of new systems and procedures in the
bank, data monitoring systems and the extent of computerization is gauged on
the basis of the extent of business covered by computerization,
computerization in branches and of the money market and foreign exchange
desks.

CRISIL attaches significance to the operating systems for data capturing and
MIS reporting in a bank. A banks balance sheet that has a large volume of
transactions pending reconciliation reflects its lack of operating systems and is
viewed negatively. CRISIL also analyses expenses made on technology during
the recent period and the banks strategy of using technology effectively as a
delivery platform to reduce costs and improve service levels.
Appetite for risk
CRISIL also analyses the bank managements attitude towards risk and the
level of interest rate, foreign exchange and equity risks in the balance sheet. A
high risk propensity typically reflects in higher volatility in earnings in both
the fund-based and the fee businesses. A management with a higher propensity
to take risks is viewed cautiously.
Motivation levels of the staff
Employee motivation levels could be a function of remuneration, management
involvement and job satisfaction. Such motivation levels would directly affect
a banks service levels, which is a key success factor in a market-driven
environment.

Earning potential

CRISIL analyses a bank/FIs earning on the basis of the level, diversity and
stability of earnings.
Level of earnings
The level of earnings as measured by the return on total assets (ROTA)
provides the bank/FI a cushion for its debt servicing and also increases its
ability to cover its asset risk. ROTA is a function of interest spreads expense
levels, provisioning levels and the non-interest income earned by the bank.
The size of net profit is also factored in while raring the entitys earnings.
Earnings of banks/FIs have been affected due to volatility in interest rates.
Thus, the trend in profitability at gross profit levels is examined over the past
years to take a view on the sustainability of earnings. The various elements
leading to profitability like interest spread, fees levels, expense levels and

provisioning levels are also analyzed to take a view on the profitability trend
and the sustainability of profits in the future.
Diversity of income sources
Diversity of income sources is an important input in analyzing the stability of
earnings. Diversity in fund-based income is achieved by focusing on different
borrower segments like industries, trade and retail. Banks also diversify their
income streams through non-interest or fee income like guarantees, cash
management facility, service charges from retail customers and trading
income. Fee income provides a cushion to probability, especially in times of
pressure on interest spreads.
CRISIL also views the composition of interest revenue streams while
analyzing the earnings position of a bank/FI. Banks relying on short-term,
non-repetitive income sources like bills financing and trading income are
viewed less favorably than banks with long term credit relationships with
companies through cash credit or term loan exposures and the like. CRISIL
also analyses the composition of the non-interest income while evaluating a
bank/FIs earnings. Non-interest income also includes income from trading
activities, which tend to be volatile. A closer analysis of the competition of
revenue streams helps in forming an opinion on the sustainability of the
earnings.
Efficiency measures
CRISIL looks at the levels and trend of operating expenses and degree of
automation in the bank/FI. CRISIL looks at salary expenses and total noninterest expenses as a proportion of total income and average assets.

Liquidity/Asse

t liability management

CRISIL assesses the asset liability maturity profile of the rated entity to form
an opinion on the liquidity risk as well as the interest rate risk. The entitys
general philosophy of asset and liability management is discussed.
Liquidity risk

The liquidity risk rating factors in the banks resources strength and the
liquidity support available to it in the form of access to recall/repo borrowings
and the extent of refinance available from the RBI. Banks are the primary
channelisers of retail savings into the economy. Most public sector banks
having a widespread branch network act as conduits for mobilizing retail
savings. CRISIL views most of the public sector banks favorably on these
parameters due to stable accretion to deposits and the liquidity support
available to them.
An FIs liquidity position is a position is a function of its managements policy
of maintaining treasury portfolios to meet asset and liability side liquidity
demands. However, on account of their significance to the domestic financial
sector, FIs enjoy a high degree of financial flexibility that reduces liquidity
risks too fairly low levels.
The specific liquidity parameters analyzed by CRISIL are:
Liquid assets/ Total assets
To arrive at this ratio, CRISIL looks at the percentage of sovereign
investments in an entitys books to its total assets. This can also be roughly
derived from the credit-deposit ratio.
Proportion of small deposits
CRISIL looks at the proportion of deposits below Rs. 150 million to the banks
total deposit base. This small sized retail deposits tend to be inherently more
stable.
Interest rate risk
The rating factors in the volatility of the bank/FIs earnings to interest rate
changes. CRISIL analyses the entitys asset liability maturity profile to judge
the level of interest rate risk carried by it. In the Indian banking systems, the
interest rate and maturity profile of the assets and liabilities have an inherent
mismatch. The floating rate advances portfolio (linked to prime lending rates)
and the relatively long duration investment portfolio are funded through short
to medium tenure liabilities, which exposes the bank to an element of interest
rate risk.

FIs score over banks in this regard due to the wholesale nature of their
operations and policies that link the nature of borrowing (fixed/floating) with
correspondingly matched lending. On an overall basis, FIs carry relatively
fewer interest rate risks compared to banks.

Government

support

CRISIL positively factors in government support for specialized entities in the

financial sector, which have a policy role to play in the national economy.
Further, public sector banks benefit from the high likelihood of support arising
from government ownership. In CRISILs opinion, the likelihood of support is
underpinned by strong economic and moral imperatives provide assistance,
given the role that the banking system plays in the Indian economy. Banks are
primary agencies for channeling of savings in the economy and the
government has used the banking system as a vehicle to fulfill its economic
and social agenda through priority sector lending.
While the authorities have stepped in to rescue troubled private sector banks in
the past, CRISIL believes that the support to public sector banks would
unquestionably be of a higher order. The assets of public sector banks
represent 80% of the banking system. Moreover, government ownership and
control of banks is a politically sensitive issue and the government will find it
difficult to deny support to public sector banks in the event of difficulty. In
fact, the government has made substantial capital infusions into banks during
the 1990s. This is evident from the fact that the government not only made
substantial capital infusions into banks during the 1990s but it also continues
to have a capitalization programme for some weak banks.

ADVANTAGES OF IPO GRADING

guidance tool

powerful

Sebi's proposal to make the IPO assessment available to investors is a step in

the right direction.
Though the move to make IPO assessment mandatory has drawn some critical
comments, the need for a tool to help investors make better-informed
decisions and judge the quality of issues hitting the market is undisputed.
An IPO assessment brings four major pluses. Firstly, it improves information
content through a professional and independent assessment.
Secondly, it is relief for individual investors from information overload.
Thirdly, it provides disincentives for weak companies to come to the market in
the hope of raising easy capital. And fourthly, it brings about greater level of
investor sophistication.

Professional and independent assessment

The public issue report, which is part of the IPO assessment will provide
focused company information to investors and will create awareness about the
fundamental strengths and weaknesses of the company.
Dissemination of fundamental information will help investors allocate
resource better. The report will be a key input in the investment decision, in a
manner similar to what a credit rating is for a debt investor.

Relief from information overload

In a situation where issues are bunched in the pursuit of optimum market
timing and disclosures are voluminous and complex, a service that analyses
and interprets these disclosures independently, quickly and in manner that
facilitates a comparative study will be extremely useful in cutting through the
clutter.
The usefulness would be particularly high for small investors as it will serve
as a guide on the strengths of the company coming out with the issue.

Disincentives

for weak companies

Given the improved quality of information content in the marketplace after the
introduction of IPO assessments, there will be a stratification of the market on
fundamental lines.
Fundamentally sound companies will command commensurate valuations,
while companies whose fundamentals are not very strong will be impeded in
building up speculative demand among investors, and will need to offer
pricing, which will adequately compensate investors for the risks they take.

Increased

investor sophistication

In today's markets, with free pricing, it is just as easy to lose money on listing
as it is to make it.
An independent and informed opinion on the fundamental quality of the
company, along with clear and concise information, will go a long way
towards making the process far more scientific. With a clear view on the
quality and risk drivers of the company the investor is getting into, he can
choose the level of risk he is comfortable with.
He will then take investment decisions, which reflect his outlook on factors
such as product prices and input costs and are in line with his target portfolio
composition. Such analysis is today beyond all but the most sophisticated
investors.
The assessment is not a recommendation to buy - or not buy - a stock. It is,
instead, a powerful tool to assist the investor in making up his mind about the
quality of a company offered as an IPO investment option.

DISADVANTAGES TO IPO GRADING

However, there are several arguments against the proposal. Equity, by its very
nature, is risk investment'. 'Caveat emptor' or 'buyers beware' hold true
especially for equity investments.
Pricing of shares is the most critical factor in evaluating IPOs. By refusing to
comment on pricing, the rating's value is immediately diminished. Markets do
not always take the rating on its face value. For example, in the case of debt
instruments, instruments with same ratings have different prices/YTMs.

Issuers to pay
A strong case exists for reducing issue expenses drastically right from the
preparation of the offer document (prospectus) to the allotment stage.
Regulatory measures since the advent of SEBI in the early 1990s have in fact
taken note of the disproportionately large bill that issuers of capital have to
meet. At the same time, insistence on fuller disclosures, a key area of
regulation, cannot be wished away.
Simplification of the offer document and incorporating its key provisions in an
easy-to-read format in the application form has been major steps forward. But
it is difficult to see how a rated IPO will enhance investor protection further.
However, it appears that all major investor associations have pitched for
equity ratings. Initial opposition, according to them, is mainly from merchant
bankers and others who are now directly involved with the public issue. Their
role could be threatened by the new development.
A rating exercise is specific to a scheme or instrument. The company issuing
the security is not rated. Its fixed deposit schemes, debentures and other debt
instruments are. It will be wrong to read larger meanings applicable to the
whole company from the rating for any of its schemes.
Debt instruments are more amenable to rating. Safety of the money invested in
a particular scheme and correspondingly the company's ability to repay the
debt are two of the key factors covered by the rating exercise.

Different

exercise

Though by no means fool proof, rating agencies have over time acquitted
themselves creditably in rating debt instruments. Although it was regulatory
rules that provided the impetus for the rating of debt instruments, the facts is
that the grading given 5, 4 and so on are now easily recognized by
investors.
Rating agencies will naturally have to go through the learning curve before
they get a handle on rating equities. Starting with the IPO, rating of a
company's equity issue is likely to be a continuous affair. Hence secondary
market investors too can use the rating in their decisions.
Even granted that rating agencies can equip themselves soon, the question
remains whether (a) a rating so arrived at is of much relevance to investors and
(b) they will not induce a sense of false complacency among investors.
There is no way that a grading will obviate the need for looking at the offer
document and the various disclosures, especially in issues by new promoters.
For blue chip issues, there will be no need to look at either the disclosures or
the rating.

Realty sector

SEBI is on much stronger ground in asking real estate companies accessing

the capital market to disclose more about the land they claim to possess. Land
banks, as they are called, have been the key determinants in valuation of these
companies. There has been considerable opacity about the professed extent of
land holding as also the nature of ownership.
Often real estate developers include in the prospectus agreements to buy as
proof of ownership. In most cases, they are at best part owners. From now on,
real estate companies will be forced to disclose full details of such agreements.
These will presumably be included as material contracts and open to public
inspection.
One should not forget the larger picture. SEBI is already applying the brakes
on some real estate companies' unrealistic valuations as the property market in
the big metros is showing signs of a bubble. The Reserve Bank of India has for

long been cautioning banks against reckless lending to the real estate sector. It
has also asked them to treat lending to special economic zones as exposure to
commercial property and incorporate more onerous terms in loan agreements.

Short selling

Short selling by institutions is an idea whose time has come. Institutions can
go short if they are convinced that the price of a particular share will go down.
At lower levels, they can buy the share and square the position. This is of
course the opposite of what an investor does when he is betting on a higher
price: he will borrow money, take a position and hopefully come out when the
price is right.
SEBI has made it mandatory for short-sellers to back their actual action by
borrowing the relevant shares. That presupposes the existence of a vibrant
stock lending mechanism to be operated by a depository or a custodian.
Beneficial owners of the shares will of course be compensated.
Institutional short selling, according to its critics, will aggravate, not minimize,
volatility and will further tighten the hold institutions have in today's share
market. Like many other recent moves of SEBI, this one too will need to be
examined in detail. Conceptually, however, it looks extremely sound.

Survey of IPO grading of the investors

QUESTIONS

1. What is your age ?

25 years & above

25-40 years

40-60 years

Retired

2. What is your preferred area of Investment ?

Mutual Funds

Share / Equity

Banks

Real Estate

Others

3. Do you invest in Equity Shares ?

YES

NO

4. Do you know about IPO ?

YES

NO

5. From where you get the information about IPO and

other investment options ?
Website

Study

Broker

Market

Others

6. Does IPO grading help for investing in IPO?

YES

NO

7. Which credit agency you think is reliable in grading?

CRISIL

CARE

ICRA

FITCH

8. Do investors really follow the grading done by the

agency?
YES

NO

9. Does IPO grading helps to investor at the time when

there are many IPO issued in the market, in order to
reduce confusion?
YES

NO

10. Do you think that IPO grading should be mandatory?

YES

Comments:

NO

SURVEY ANALYSIS
Q.1) WHAT IS YOUR AGE?
25 Years and Below
40-60 Years

25-40 Years
Retired

PARTICULARS
25 Years and Below
25-40 Years
40-60 Years
Retired
TOTAL

RESPONSE
11
16
12
11
50

TOTAL RESPONSE

25 Years and Below

25-40 Years
40-60 Years
Retired

Out of the responded almost 32% of them were from the age group of 2540 years. Fewer almost 22% were from the age group of below 25 years
and above 65 years almost on retirement age.
Q.2) WHAT IS YOUR PREFERRED AREA OF INVESTMENT?
Mutual Funds

Shares/Equity

Banks

Real Estate

Gold

Others

PARTICULARS
Mutual Funds
Shares/ Equity
Banks
Real Estate
Gold
Others
TOTAL

RESPONSE
8
11
10
6
12
3
50

TOTAL RESPONSE

Mutual Funds
Shares / Equity
Banks
Real Estate
Gold
Others

Most of the responded around 24% preferred in Traditional Investment

avenue of banks and gold and fewer in Share Market.
Q.3) DO YOU INVEST IN EQUITY SHARES?
Yes

PARTICULARS
Yes
No
TOTAL

No

RESPONSE
40
10
50

YES

NO

0%

10%

20%

30%

40%

50%

60%

70%

80%

From the survey conducted of 50 people, about 80% of them invest in

Equity Shares. So there is a huge market available for targeting those
80% where the products are available.

Q.4) DO YOU KNOW ABOUT IPO?

Yes

No

PARTICULARS
Yes
No
TOTAL

RESPONSE
23
27
50

90%

TOTAL RESPONSE

YES
NO

Almost 46% responded that they know about IPO and rest had no idea.

Q.5) FROM WHERE YOU GET INFORMATION ABOUT IPO AND

OTHER INVESTMENT OPTIONS?
Website

Study

Broker

Market

Others

PARTICULARS
Website
Study
Broker
Market
Others
TOTAL

RESPONSE
7
8
15
17
3
50

TOTAL RESPONSE
Others
Market
Broker
Study
Website
0.00%

5.00%

10.00% 15.00% 20.00% 25.00% 30.00% 35.00% 40.00%

Investor and Trader generally obtain information from market about

Equity as 35% from survey indicates it. 29% get news and information
from their own broker. Rest of them get it from websites , study and other
sources. Website may play major role in future as internet user are
increasing in millions per year in India.
Q.6) DOES IPO GRADING HELP FOR INVESTING IN IPO?
Yes
PARTICULARS
Yes
No
TOTAL

No
RESPONSE
40
10
50

TOTAL RESPONSE

YES

NO

Majority of the investors think that IPO Grading helps an investor in

order to invest in an IPO of any company. IPO Grading avoids bogus
IPO, is the main reason investor chooses option Yes.

Q.7) WHICH CREDIT RATING AGENCY YOU THINK IS RELIABLE

IN RATINGS?
CRISIL

ICRA

CARE

FITCH

PARTICULARS
CRISIL
ICRA
CARE
FITCH
TOTAL

RESPONSE
25
18
3
4
50

TOTAL RESPONSE
25
20
15
10
5
0

CRISIL

ICRA

CARE

FITCH

CRISIL- This agency has experience of more than a decade in this

business. It provides ongoing analysis on the Indian economy and
industry analysis on 45 key industry, infrastructure and service sectors in
India. It stands first in India and fifth in world, have more experience. So
the report given by CRISIL is more reliable than any others.
ICRA- After CRISIL in India ICRA took active participation in this
business.
CARE- New player in this field.
FITCH- Very few people think it is reliable.
Q.8) DOES INVESTOR REALLY FOLLOW THE RATING DONE FOR
THE INVESTMENT PURPOSE?
Yes

PARTICULARS
Yes
No
TOTAL

No

RESPONSE
31
19
50

TOTAL RESPONSE

35
30
25
20
15
10
5
0
NO

YES

YES It tells the real scenario of the company.

NO Since investor still believes investing in IPO on tips basis.

Q.9) DOES IPO GRADING HELPS INVESTOR AT THE TIME WHEN

THERE ARE MANY IPO ISSUED IN THE MARKET, IN ORDER TO
REDUCE CONFUSION?
Yes

No

No Comments

PARTICULAR
Yes
No
No Comments
TOTAL

RESPONSE
29
6
15
50

TOTAL RESPONSE
30
25
20
15
10
5
0
YES

NO

NO COMMENTS

YES After grading is published, an investor can take its decision as per
the companys report. And finally go for that companys IPO whose
report is satisfactory according to investor.
NO Because investors think that they can too analyze as per their
knowledge.

Q.10)

DO

YOU

THINK

THAT

IPO

GRADING

SHOULD

MANDATORY?
Yes

PARTICULARS
Yes
No
TOTAL

No

RESPONSE
45
5
50

TOTAL RESPONSE

YES

NO

YES Because it will reduce an amount of bogus IPO issues in the

market.
NO Investor thinks that they are smart enough to take correct decision
for investing in an IPO of a particular company.

SECONDARY DATA
IPO grading: Help or hindrance?
BS Smart Investor Bureau | May 10, 2004
Q: Do you want comment on that?
Tandon: I have no doubt that any rating agency, with their track record,
and with their own experience of various markets, will find ways of rating
new companies. My fear is exactly is that is that the goalpost that we are
trying to set for ourselves, is it the job of the rating agency to decide
whether or not the business which you should invest in? As I said you
come back to the basic purpose; purpose is to simplify give a one point yes or no investment decision to the common man (aam aadmi).
Ravimohan: No, thats not the agenda and cant be the agenda because if
you take a very simplistic view all I am saying is all of this research that

we all put is leading to very simplest some idea of the EPS and there are
two investors with completely different outlook, different confidence
levels, different philosophy of life, different liquidity position would come
up with completely different PE ratios by with which you multiple the EPS
to come to the valuation.
I personally think valuation is dependent on so many factors other than
fundamentals, fundamental is one part and where we are getting to with
the IPO grading is to get a realistic estimation of where the fundamentals
are and then leave it to the market to judge whether the EPS or the
valuations that they want to put on that fundamentals to their own
judgment. So we cannot go to the end result, which is where we are today
which is to say whether to buy or not.
I think it is so customized, that even I will add one more twist to the
question that raised Anand raised that its a great company but is the
valuations stretched and then let say we have a third question that it is a
great company valuation is not stretched but I still may not be right
investor in that entity because I am a widow and I want to be more
concerned about monthly income rather than equity upsides. So I think we
cannot simplify equity investment process to a single point agenda it is a
complex issue and I think more that we disintegrate into its components fundamentals, valuations and investment advice I think we are better off
and I think we will be able to give better service to the investors at large.

Q: How does that work exactly, doesnt that leave more gray
for an investor when you talk about the management quality
or corporate governance, which might be great, the brand
which might be great but the price might be completely out
of
whack?
Ravimohan: I hope that is something, which will evolve faster. The fact of
the matter is that fundamentals are one area which today gets subsumed in
the overall equity research including the valuations.
Whereas what I am saying is that once you have a good indications for
where the fundamentals are. If the pricing goes out of whack, that is a
good indication for investors to stay away from that issue at the IPO grade
and hope to pick it up if he thinks the price is too high and is likely to fall
after the listing and pick it up in the secondary market.

Q: Who is deciphering that for him because the investment

banker isnt, the rating agency isnt, infact it seems the
agency has no liability once its rated, so does that leave it
clear
for
a
retail
investor?
Tandon: If the idea is to simplify the investment decision, then you are
talking about investors who are not ready to read the fine print or able to
understand it. So if you get to a stage where you have a grading from say 5
to 1; 5 being the best and 1 being the worst, then it is relatively easy to
say that if it means 1, then on various hygiene factors, it is not good
enough and want to leave it out.

But what does 5 mean - does 5 mean that it is a good investment? So my

fear is that overtime, it is likely that one will use that as a marketing ploy
as well as it will become a simple rule to say, its a great issue, and
CRISIL has graded it '5' and CRISIL is a great company, which means you
should buy it. This brings us to the point that what happens to the price?
Great companies dont necessarily make great stocks and vice-versa.
In fact if it works this way, then what will happen is a company, which is
in a transition stage and looking to raise capital for its new business will
probably attract an E rating but will therefore command a price, which is
so attractive that it will make a great stock.

Q: What about things like new generation businesses, which

do not have great earnings records or track records, which
people buy on the strength of the prospect like retail
companies which probably would be making losses, do not
have much by way of return ratios or profitability track
records? How do you grade them and do you think rating
agencies can therefore have the expertise to look forward
into unfolding business with not too much of a historic track
record?
Ravimohan: I will come to that in a moment but I think Anand made a
great point. Say, Crisil has graded it five but dont you think even for a
grade of five, the big pricing that Anand made - if let say, the prices over
stretched. I think its a great way to analyze given one more benchmark
and that is exactly the utility that I hope the grading will bring to. And over
time, if you are able to establish some linkages between our grading, our
correlation grading and EPS, then it is really the price earnings valuation
that the collective wisdom of the market gives that will determine the IPO
pricing. Therefore I think there will greater discipline to the market done,
the fear that Anand raised.
As far as the new sectors are concerned, we had a similar paradigm about
five years back when mobile telephony was introduced into the market. At
that time, we were asked to grade or rate their credit worthiness and we
had fairly challenging first year where we were put to a lot of difficulty not
only because it was a new sector and there has been no past history, but
also the regulatory situation in the country was evolving. But I think we
handled it well; there were transitions in our ratings, if you take our Bharti
Airtel rates, we actually been rating it for the past seven years.
And its a great story to answer your question that as clarity about this
sector emerges, we at CRISIL use macro economic long-term trends and
juxtapose it with micro competitive strengths to get a sense of what the
long-term prospects are and whats likely to happen between now and then
for these various companies. We are hoping to use a lot of these learnings
for new sectors like retail, biotech. This morning, there was a news item
about Mumbai University wanting to get listed. So we will figure out good
ways of finding fundamental strengths in these businesses

(Note: Above discussion on IPO Grading: Help or hindrance? Is between

Mr. R. Ravimohan Managing Director and Region Head, South Asia of
Standard & Poor's and Mr. Anand Tandon of Gryffon Investment Advisor)

IPOS NEED TO BE RATED BEFORE LAUNCH

THE TIMES OF INDIA
22 Mar 2007, 2359 hrs IST , TNN MUMBAI

SEBI is taking steps to change the way companies tap investors for funds,
way institutions trade and at cut down on cost and time for a number of
market participants,
M Damodaran, chairman, SEBI said.

On Thursday, SEBI made it compulsory for companies going for IPOs to

have their issue graded by one of the three rating agencies CRISIL, ICRA
and CARE.

This decision was taken to avoid situations like in the 1990s when a large
number of companies had tapped the IPO market for funds but soon the
companies as well as its promoters vanished leaving investors with
worthless

papers.

SEBI proposed for a change of rules that will make disclosure norms for
valuing land banks of real estate companies more detailed and strict.

The SEBI chief also said the board had given its nod for institutions to
short sell in the market and soon detailed guidelines will be in place.

SEBI has also tried to take future projections and subjectivity out of realty
IPOs. Of late a number of real estate companies have been rushing with
their IPO plans, valuing their shares much higher than their listed peers.

SEBI chief said real estate companies going for IPOs should value their
land bank at present prices and not at prices going forward.

SEBI also said that it was putting a cap on the regulatory charges that
market transactions like large IPOs and big-size mergers & acquisitions
attract.

CONCLUSION

Price is an important factor for any investment. What this means is that a
company listing at 10-15 times its price earning can be a good investment,
but the same company at 40-50 price times earning can be a terribly bad
investment.

Secondly, a fundamentally strong company neither means too much of

capital appreciation, nor absolute safety of investment in the market.

If we look at the recent history of the IPO market, all real estate companies
got huge responses at the time of the issue, but the sector could not sustain
these high valuations. Price plays an important role in investments and the
market itself throws enough clues periodically. It is necessary to catch
these in time.

RECOMMENDATIONS

After making the project, I would like to say SEBI is playing very
important role in regulating the risk and financial aspects of the investors.
Also the DIP guideline is framed in such a manner, which can be
understood by any individual. Overall the process and the various
intermediaries, which are involved in IPOs or initial public offering, are
doing very important task.

I found the following points very important from the investor point of view
while doing this project:
The IPOs should be consumer friendly: Any investor should be
able to analyze the IPO in its simplest form and should be able to
understand of whether to apply for it or not.
IPOs should be graded which is already started. But I think such
kind of grading is not enough because it doesnt give enough
information about the company; it only says what the level of
grade that a company deserves is.
I would suggest shortening the time between application and
allocation or listing. We know SEBI and other intermediaries has
done great job in doing so in the past, but looking at the current
scenario we think its very important to do so. This would help
investor in investing the same money in other IPOs if he is not
allotted shares in that particular company.

BIBLIOGRAPHY

Internet websites
www.crisil.com
www.capitalmarket.com
www.goggle.com
www.icra.com
www.moneycontrol.com

Magazines
Capital Market
India Today
Dalal Street

Newspapers
The Times Of India
The Financial Express