What is credit rating?

Credit rating is, essentially, the opinion of the rating agency on the relative
ability and willingness of the issuer of a debt instrument to meet the debt service
obligations as and when they arise.
The basic objective of credit rating is to provide an opinion on the relative
credit risk associated with the instrument being rated. The process, in a nutshell,
involves estimating the issuers capacity to generate cash from operations and
assessing the adequacy of this estimate vis--vis the issuers debt servicing
obligations over the tenure of the instrument. Additionally, the rating process
also involves assessing the cash flow support that may be available to
supplement the operational cash flows. Such support, also termed financial
flexibility, provides an indication of an issuers ability to refinance maturing
obligations and raise finances through means such as liquidating marketable
securities and drawing group support. All factors that have a bearing on the
issuers ability to generate cash flows are considered while assigning ratings.
Conceptually, these factors may be classified as business risk, financial risk
drivers, and management related factors. ICRAs rating process places
considerable emphasis on evaluating business risks, as it does on evaluating the
financial ratios. For credit risk evaluation, stable businesses (low industry risk)
even with lower level of cash generation are viewed more favourably as
compared with businesses with higher cash generation potential but relatively
high degree of volatility associated with such cash flows (higher industry risk).
This risk analysis is complemented by a cash flow analysis that seeks to capture
the adequacy of the issuers projected cash flows vis--vis its debt servicing
obligations.

Globalization of Credit Ratings, 1970s-2000

Historical Parallels. Credit rating agencies expanded rapidly from the 1970s
through the 1990s, much as they did from 1909, when John Moody introduced
the
concept, to the 1930s. In each period, the expansion started slowly and then
gathered

steam as the early entrants became larger and new entrants appeared. Such
parallels
between the two periods of agency expansion suggest to a historian that similar
forces
may have been at work in them. What might those forces have been?

The early twentieth-century appearance and growth of rating agencies was

pretty
much a U.S. development. The main reason is that the United States, largely
because of
large-scale railroad development under corporate auspices (the governmental
role in
railroad development was larger in most other countries) created a corporate
bond market
much larger than elsewhere, and the country also had a rapidly growing state
and local
bond market.

Two additional developments contributed. One was that firms in industries other
than the railroad sector, in particular public utility and the manufacturing firms,
sought
access to the bond markets. Second, rising average levels of income and wealth
in the
United States greatly expanded the potential and actual numbers of investors. In
earlier
times only the very wealthy, a tiny minority in both Europe and America, were
interested
in bond investments, and leading investment and merchant banking houses on
both sides

of the Atlantic were capable of serving as certifiers of bond quality for that
minority. But
the old-time investment banking houses, increasingly under attack in the United
States
(the Money Trust investigation of 1912-1913, for example), were not in a good
position
to meet the demands of an expanding class of investors for certifications of
bond quality.
That was John Moodys entrepreneurial insight in 1909.

Why is credit rating necessary at all?

Credit rating is an opinion expressed by an independent professional
organisation, after making a detailed study of all relevant factors. Such an
opinion will be of great assistance to investors in making investment decisions.
It also helps the issuers of debt instruments to price their issues correctly and to
reach out to new investors. Regulators like Reserve Bank of India (RBI) and
Securities & Exchange Board of India (SEBI) often use credit rating to
determine eligibility criteria for some instruments. For example, the RBI has
stipulated a minimum credit rating by an approved agency for issue of
Commercial Paper. In general, credit rating is expected to improve quality
consciousness in the market and establish, over a period of time, a more
meaningful relationship between the quality of debt and the yield from it. Credit
Rating is also a valuable input in establishing business relationships of various
types.

Features of Credit Rating:

The ratings are expressed in code numbers which can be easily
comprehended by the lay investors.
Credit rating, as exists in India, is done for a specific security and not for
a company as a whole.

 A debt rating is not one time evaluation of credit risk, which can be
regarded as valid for the entire life of the security.
A credit rating does not create fiduciary relationship between the agency
and the users

CREDIT RATING METHODOLOGY : GENERAL CRITERIA

The criteria document identifies and briefly addresses some of the specific
factors considered by Credit Rating Agencies. Credit rating criteria enable
analysts to analyze and interpret information on a consistent approach. Credit
Rating Agencies refine rating criteria and benchmarks proactively, taking into
account changes in the market environment. Robust criteria assist in accurate
assessment of credit risk for an entity. Ratings are subjective credit opinions
based on various qualitative and quantitative factors; the robustness of ratings is
preserved through consistent application of updated rating criteria.

Distinguishing companies by business classification:

Credit Rating Agencies, they have broadly classified the debt issuer segments
as:
a) Manufacturing sector
b) Financial sector
c) Infrastructure sector
d) Government & Local bodies.
Within each of the segment, there could be further classifications. For e.g.:
Financial sector may include Banks, Insurance companies, Mutual Funds,
NBFCs, Micro-finance institutions and so on.
Distinguishing Issuer & Issue
Credit Rating Agencies assign two types of credit ratings: one to issuers and the
other to specific debt issues or other financial obligations. The first type is
called a counterparty credit rating. It is a current opinion of an issuer's overall
capacity to pay its financial obligations-that is, its fundamental
creditworthiness. This opinion focuses on the issuer's ability and willingness to
meet its financial commitments on a timely basis. It does not reflect any priority
or preference among obligations. "Default rating" and "issuer credit rating" are
additional ways of referring to this type of rating. Generally a counterparty
credit rating is published for all companies that have issue ratings, in addition to
those firms that have no rateable issues, but request an issuer counterparty
rating. Credit ratings are also assigned to specific issues. In fact, the vast
majority of credit ratings pertain to specific debt issues. The junior debt may be
rated below the counterparty credit rating, while well-secured debt can be rated
above.
Distinguishing Long-term & Short-term Ratings
Long-term ratings are forward-looking assessments over a two to three year
credit horizon, designed to remain stable over the course of normal business
cycles.
Short-term ratings evaluate the likelihood of a borrower's timely repayment of
obligations considered short-term in relevant markets. This definition covers
any obligation with an original maturity of one year or less, such as commercial
paper.

Distinguishing Individual Vs Structured Ratings

The criteria for rating an individual issuer / issue are different as compared to
rating of a pool for a structured product and the same may be observed in the
attachments.
Distinguishing Solicited Vs Unsolicited Ratings
The major distinction between an unsolicited and a solicited rating is that the
latter is requested and therefore paid for by the rated firm while the former is
neither of the two. Consequently, unsolicited ratings are based on publicly
available information only and also based on the internal research on industry
and peer group.
The credit rating symbol for an unsolicited rating is accompanied by the word
UNSOLICITED in bold letters to differentiate from the solicited ratings.
The broad risk factors are discussed and the discussion on parameter is included
in the segment-wise criteria.

A) Business Risk:
Each credit rating analysis begins with an assessment of the company's
environment. To determine the degree of operating risk facing a company in a
given business, Credit Rating Agencies analyses the dynamics of business.
Factors assessed include the prospects for growth, stability, or decline, and the
pattern of business cycles. It is critical to determine vulnerability to
technological change, labour unrest, or the impact of government intervention.
Industries that have long lead times in building production capacity or that
require fixed plant of a specialised nature face heightened risk. The
implications of increasing competition are obviously crucial.
B) Industry Risk:
The purpose of industry analysis is to understand the conditions in which a
business operates and the changes - cyclical, competitive, and technological that it is likely to experience. Most industries exhibit some degree of cyclical
volatility and some industries are exposed to seasonal variances, too. Such
volatility affects the operating performance and financial condition of a
company. Technological change and new competitors or substitute products
can also affect performance.
Industry risks can influence the credit rating of any company or entity in the
industry. Credit Rating Agencies assigns lower ratings to companies with
extensive participation in industries of above-average risk, regardless of how
conservative their financial postures. However, Credit Rating Agencies'
methodology emphasises the business position of the company being rated in
addition to a generic risk profile for the industry in which it operates.
C) Management Risk:
The importance of a management - competency and integrity - can not be
overstated. The ability of the commercial entitys managers to guide it, exploit
opportunities, develop and execute plans, and react to market changes is
extremely important to its financial well being. The unexpected loss of one or
two key employees can be detrimental to a company, particularly a small or
mid-size firm. Even the most experienced management teams can be
challenged by high growth, which is one of the most common reasons for
business failure. They consider the risk appetite of the company and as well
evaluate its corporate governance principles.
D) Financial Risk:
There is no substitute for rigorous analysis of financial statements. The balance
sheet, income statement, sources and uses of funds statement, and financial
projections provide essential information about the companys initial and
ongoing repayment capacity. Quantitative analysis of revenues, profit margins,
income and cash flow, leverage, liquidity, and capitalization should be
sufficiently detailed to identify trends and anomalies that may affect borrower
performance. Financial risk is portrayed largely through quantitative means,
particularly by using financial ratios. Benchmarks vary greatly by industry, and
several analytical adjustments typically are required to calculate ratios for an
individual company.
Analysis of the audited financials begins with a review of accounting quality.
The purpose is to determine whether ratios and statistics derived from financial

SEBI REGULATIONS
A credit rating agency shall make all efforts to protect the interest of
investors.
A credit rating in the conduct of its business , shall observed high degree
of integrity, dignity & fairness in the conduct of its business.
A credit rating agency shall fulfill its obligation in a prompt, ethical &
professional manner.
A credit rating agency shall at all times exercise due diligence ensure
proper care & exercise independent professional judgment in order to
achieve & maintain objectivity.
A credit rating agency shall have a reasonable & adequate basis for
performing rating evaluations, with the support of appropriate & in depth
rating researches.
A credit rating agency shall have in place a rating process that reflects
consistent & international rating standards.
A credit rating agency shall not indulge in any unfair competition nor
shall it wean away the clients of any other rating agency on assurance of
high rating.
A credit rating agency shall disclose its rating methodology to clients,
users & the public.
A credit rating agency shall, wherever necessary, disclose to the clients,
possible sources of conflict of duties & interest, which could impair its
ability to make fair, objectives & unbiased ratings.
A credit rating agency shall not make any exaggerated statement, whether
oral or written, to the client either about its qualification or its capability
to render certain services or its achievement with regard to the services
rendered to other clients.
A credit rating agency shall not make any untrue statement, suppress any
material fact or make any misrepresentations in any documents, reports,
papers or information furnished to the board, stock exchange or public at
large.

 A credit rating agency shall ensure that the board is promptly informed
about any action, legal proceeding etc.initiated against it alleging any
material breach or noncompliance by it, of any law, rules, regulations &
directions of the board or of any other regulatory body.
A credit rating agency shall ensure that there is no misuse of any
privileged information including prior knowledge of rating decision or
changes.
(a) a credit rating agency or any of his employees shall not render,
directly or indirectly any investment advice about any security in the
publicly accessible media.
(b) a credit rating agency shall not offer fee-based services to the rated
entities, beyond
credit ratings & research

Overview of Credit Rating Agency

Our financial markets have changed radically in recent years, becoming more
global, complex, and interdependent. Clearly, laws and regulations have to
change as well, and world leaders are making good progress toward creating a
new global financial architecture. The need for change includes the regulatory
framework for credit rating agencies in the U.S., Europe, Asia, and the rest of
the world. Rating agencies play an important role in the markets analysis of the
creditworthiness of issuers and financial instruments. Investors also use rating
opinions as a tool in making investment decisionsalthough it is important for
investors to realize that ratings are only one tool, and they should not be used as
a substitute for independent investment analysis.

Rating Agencies in India

Credit Rating Information Services of India Ltd. (CRISIL)

The first credit agency in India floated on January 1, 1988.

It was jointly started by ICICI and UTI with an equity capital of Rs. 4
crores.

CRISIL is the largest credit rating agency in India. CRISIL pioneered ratings in
India more than 20 years ago, and is today the undisputed business leader, with
the largest number of rated entities and rating products: CRISIL's rating
experience covers more than 23,500 entities, including 14,000 small and
medium enterprises (SMEs). As on June 30, 2010, we had more than 10,000
ratings (including 5200 SMEs) outstanding.
CRISIL's Global Analytical Centre (GAC) supports the Global Resource
Management initiative of Standard & Poor's (S&P). Under this initiative, GAC
provides resources to S&P to improve workflow efficiencies, handle end-to-end
analytical jobs, process information, and execute complex modelling
assignments.
CRISIL Ratings is trusted by issuers, investors, and intermediaries, and has
played a pivotal role in shaping India's credit market by regularly introducing
new products and services.
Rating Process
CRISIL's ratings process is designed to ensure that all ratings are based
on the highest standards of independence and analytical rigour.
From the initial meeting with the management to the assignment of the
rating, the rating process normally takes three to four weeks. However,
CRISIL has sometimes arrived at rating decisions in shorter timeframes,
to meet urgent requirements. The process of rating starts with a rating
request from the issuer, and the signing of a rating agreement. CRISIL
employs a multi-layered, decision-making process in assigning a rating.
Credit Ratings
A CRISIL rating reflects CRISIL's current opinion on the relative likelihood of
timely payment of interest and principal on the rated obligation. It is an
unbiased, objective, and independent opinion as to the issuer's capacity to meet
its financial obligations.
So far, CRISIL has rated 30,000 debt instruments, covering the entire debt
market.
The debt obligations rated by CRISIL include:
Non-convertible debentures/bonds/preference shares

 Commercial papers/certificates of deposits/short-term debt

Fixed deposits
Loans
Structured debt
CRISIL Ratings' clientele includes all the industry majors - 23 of the BSE
Sensex constituent companies and 39 of the NSE Nifty constituent companies,
accounting for 80 per cent of the equity market capitalisation, are CRISIL's
clients.
CRISIL's credit ratings are
An opinion on probability of default on the rated obligation
Forward looking
Specific to the obligation being rated
But they are not
A comment on the issuer's general performance
An indication of the potential price of the issuers' bonds or equity shares
Indicative of the suitability of the issue to the investor
A recommendation to buy/sell/hold a particular security
A statutory or non-statutory audit of the issuer
An opinion on the associates, affiliates, or group companies, or the
promoters, directors, or officers of the issuer
CRISIL ratings are based on a robust and clearly articulated analytical
framework, which ensures comprehensiveness, standardisation, comparability,
and effective communication of the ratings assigned and of every timely rating
action. The assessment is based on the highest standards of independence and
analytical rigour.
CRISIL rates a wide range of entities, including:

 Industrial companies
Banks
Non-banking financial companies (NBFCs)
Infrastructure entities
Microfinance institutions
Insurance companies
Mutual funds
State governments
Urban local bodies
A detailed flow chart of CRISIL's rating process is as below:

Duff & Phelps

As a leading global independent provider of financial advisory and investment
banking services, Duff & Phelps delivers trusted advice, principally in the areas
of valuation, transactions, financial restructuring, dispute and taxation. The
firm's world class capabilities and resources, combined with an agile and
responsive delivery, distinguish the Duff & Phelps client experience.
Duff & Phelps was founded in 1932 to provide high quality investment research
services focused on the utility industry. Over the decades, it evolved into a
diversified financial services firm that provides financial advisory, investment
banking, credit rating and investment management services. The investment

management and credit rating businesses were acquired by Virtus Investment

Partners and Fitch, respectively. The firms current management team acquired
Duff & Phelps financial advisory and investment banking business in 2004.
The following year, Duff & Phelps strengthened its valuation capabilities with
the acquisition of Standard & Poor's Corporate Value Consulting business.

Since then, Duff & Phelps has continued to expand and develop its core
services. In 2006, it acquired specialty investment bank Chanin Capital
Partners, LLC. The following year, it formed a strategic alliance with Tokyobased Shinsei Bank, Ltd. and added property tax management services through
the acquisition of Rash and Associates, LP to complement its tax business. In
2008, it grew its dispute and legal management consulting services with the
acquisitions of Dubinsky & Company, P.C. and Lumin Expert Group. It also
enhanced its valuation offerings by acquiring Kane Reece Associates, Inc., a
valuation consulting firm that specializes in the communications, entertainment
and media industries.

ICRA
ICRA information products, Ratings, and solutions reflect independent,
professional and impartial opinions, which assist businesses enhance the
quality of their decisions and help issuers access a broader investor base and
even lesser known companies approach the money and capital markets. ICRA
Ratings Code of Conduct is aligned with the Code of Conduct Fundamentals for
Credit Rating Agencies issued by the Technical Committee of the International
Organization of Securities Commissions to the extent it is within the applicable
Statutes in India. The ICRA Ltd. has been promoted by IFCI at New Delhi. It is
an independent company Ltd by shares with an authorised share capital of Rs.10
crore against 5 crore is paid up. IFCI holds 26%of the share capital &74% is
contributed by UTI, LIC,GIC,PNB,CBI, Bank of Baroda,UCO Bank & HDFC
Ltd.

Objectives Of ICRA
To provide information & guidance to institutional & individual investor.
To enhance the ability of the borrower/issuers to access the money market
& the capital market for large volume of resources from investing public
To assist the regulators in promoting the transparency in the financial
market.

In addition to being a leading credit rating agency with expertise in virtually

every sector of the Indian economy, ICRA has broad-based its services for the
corporate and financial sectors in India and currently offers its services under
the following banners:
Rating Services
Information services
Advisory Services

Rating Services Includes.

Credit Assessment
General Assessment
Bank Lines of Credit Rating
Credit Assessment For Small Scale & Medium Scale Industries.
Insurance Company Paying Rating.
Information Services Includes
Equity Grading
Equity Assessment

 Corporate Review
Money & Finance
Investment Information Publications
Corporate Reports

What ICRAs Ratings Convey

ICRAs credit ratings are symbolic representations of its current opinion on the
relative
credit risks associated with the rated debt obligations/issues. These ratings are
assigned
on an Indian (that is, national or local) credit rating scale.. ICRA ratings may be
understood as relative rankings of credit risk within India. ICRA ratings are not
designed
to enable any rating comparison among instruments across countries; rather
these address
the relative credit risks within India.
Unless stated otherwise, ICRAs ratings (other than Structured Finance Ratings)
in the
investment grade convey the relative likelihood of default, that is, the possibility
of the
debt obligation not being met as promised. All other ratings, including
Structured Finance
Ratings, reflect both the probability of default and the severity of loss on
default, that is,
the expected loss against the rated debt obligation.

Long term Debentures Bonds and Preference shares-Rating Symbols

LAAA: Highest Safety
LAA: High Safety
LA: Adequate Safety
LBBB: Moderate Safety

LBB: Inadequate Safety

LB: Risk prone
LC: Substantial Risk
LD: Default, Extremely speculative

Limitations of ICRA Ratings

ICRA ratings are only an opinion on the relative ranking of credit risk, and they
do not
reflect other investment risks arising out of changes in market conditions, viz.
interest
rates or liquidity. Hence, even the debt obligations rated in the highest category
carry a
certain degree of credit risk, although such risk would be the lowest when
compared with
the credit risks associated with obligations rated in the lower rating categories.
These
rating categories group debt obligations with similar but not necessarily
identical credit
risks.
ICRAs credit ratings reflect the issuers inherent credit quality, which in many
cases
may not remain constant at all times. Consequently, ICRA ratings are not
always constant
and are subject to change. While ICRA in its analysis endeavours to incorporate
the
factors that impact the issuers prospective credit quality, there may be
situations in
which the actual developments would significantly differ from ICRAs
expectations.
Such changes in turn may warrant an upward or downward revision in the
ratings
previously assigned. Given this possibility, all ICRA ratings are subjected to
regular
monitoring or surveillance. Rating and timely updates on live ICRA ratings are
available

through
ICRAs
rating
releases,
publications
and/or
website
(www.icraratings.com,
www.icra.in).
For assigning ratings, ICRA relies on all relevant information (such as audited
statements) made available to it by the issuer company, as well as on other
sources of
information (opinions of legal and other experts, for instance) that ICRA
considers
reliable. While ICRA takes reasonable care to ensure that all such information is
reliable,
it makes no representation or warranty, express or implied, as to the accuracy,
authenticity, timeliness or completeness of any such information. Further, ICRA
ratings
are not to be construed as recommendation to buy, sell, or deal in the rated
instruments.
Credit Analysis & Research Ltd. (CARE Ratings)
Overview
Credit Analysis & Research Ltd.
(CARE Ratings) is a full service rating
company that offers a wide range of
rating and grading services across
sectors. CARE has an unparallel depth
of expertise. CARE Ratings
methodologies are in line with the best
international practices.
CARE Ratings has completed over
7654 rating assignments having
aggregate value of about Rs.23121
billion (as at March 2010), since its
inception in April 1993. CARE is
recognised by Securities and Exchange
Board of India (Sebi), Government of
India (GoI) and Reserve Bank of India
(RBI) etc.

CARE was promoted by major Banks/FIs (financial institutions) in India. The

three largest shareholders of CARE are IDBI Bank, Canara Bank and State
Bank of India. CARE, is set-up with two divisions:
CARE Ratings:
The ratings division of CARE has over a decade long experience in rating debt
instruments/Enterprise ratings covering the full spectrum of Universe
comprising:
Industrial Companies
Service companies
Infrastructure companies
Banks
Financial Institutions (FIs)
Non-Bank Finance companies(NBFCs)
Public Sector Undertakings (PSUs)
State Government Undertakings
Municipal Corporations
Structured Finance Transactions
Securitization Transactions
SMEs
SSI
Micro Finance Institutions
In addition to debt ratings CARE Ratings has experience in providing the
following specialized grading/rating services:
Corporate Governance ratings

 IPO grading
Mutual Fund Credit quality Ratings
Insurance Claims Paying Ability Ratings
Issuer Ratings
Grading of Construction entities
Grading of Maritime training institutes
LPG/SKO Ratings
CARE Ratings is well equipped to rate all types of debt instruments like
Commercial Paper, Fixed Deposit, Bonds, Debentures, Hybrid instruments,
Structured Obligations, Preference Shares, Loans, Asset Backed
Securities(ABS), Residential Mortgage Backed securities(RMBS) etc.
CARE Ratings has been recognized by statutory authorities and other agencies
in India for rating services. The authorities/agencies include: Securities and
Exchange Board of India (Sebi), Reserve Bank of India (RBI), Director
General, Shipping and Ministry of Petroleum and Natural Gas (MoPNG),
Government of India (GoI), National Housing Bank (NHB), National Bank for
Agriculture and Rural development (NABARD), National Small Scale
Industries Commission (NSIC). CARE Ratings has also been recognized by
RBI as an Eligible Credit Rating Agency (ECRA) for Basel II implementation
in
India.
CARE Ratings has significant presence in all sectors including Banks / FIs,
Corporate, Public finance. Coverage of CARE Ratings has extended to more
than 2811 entities over the past decade and is widely accepted by investors,
issuers and other market participants. CARE Ratings have evolved into a
valuable tool for credit risk assessment for institutional and other investors, and
over the years CARE has increasingly become a preferred rating agency.
CAREs Credit Rating is an opinion on the relative ability and willingness of an
issuer to make timely payments on specific debt or related obligations over the
life of the instrument. CARE rates rupee denominated debt of Indian companies

and Indian subsidiaries of multinational companies. CARE ratings are not

recommendations
to
buy/sell
or
hold
any
security.
CARE Research : The Research and Information division of CARE provides
contemporary research and information covering various industries and
financial markets. Publications include Industry Research Reports with Updates,
Debt Market Review, Budget Analysis, other policy impact analysis, and special
commentaries
on
topical
issues.
CARE Research offers both subscription based reports and also customised
reports on request. The division has an established network of primary and
secondary sources, which enable the analyst to form unbiased opinion on the
industry segments. It has also developed different methodologies for forecasting
the future demand-supply situation in a particular industry.
Rating Criteria/Methodology
CARE undertakes rating exercise based on
information provided by the company
In-house database and data from other sources that CARE considers
reliable. CARE does not undertake unsolicited ratings.
The primary focus of the rating exercise is to assess future cash
generation capability and their adequacy to meet debt obligations in
adverse conditions.
The analysis attempts to determine the long-term fundamentals and the
probabilities of change in these fundamentals, which could affect the
credit-worthiness of the borrower.
The analytical framework of CARE's rating methodology is divided into
two interdependent segments. The first deals with the operational
characteristics and the second with the financial characteristics.
Besides quantitative factors, qualitative aspects like assessment of
management capabilities play a very important role in arriving at the
rating for an instrument.
The relative importance of qualitative and quantitative components of the

analysis vary with the type of issuer.

Rating determination is a matter of experienced and holistic judgement,
based on the relevant quantitative and qualitative factors affecting the
credit quality of the issuer.
Definition of Default
CARE defines default as any missed payment on its rated instrument. As an
exception, however, cases of missed payments attributable to technical reasons
e.g. procedural delays caused by government machinery etc. which are likely to
be rectified within a short time, are not placed in the default grade immediately.
If, however, such delays are not rectified within a short time, ratings are placed
in the default grade.
WHAT RATINGS DO NOT MEASURE
It is important to emphasise the limitations of credit ratings. They are not
recommendations to invest. They do not take into account many aspects which
influence an investment decision. They do not, for example, evaluate the
reasonableness of the issue price, possibilities for capital gains or take into
account the liquidity in the secondary market. Ratings also do not take into
account the risk of prepayment by issuer. Although these are often related to the
credit risk, the rating essentially is an opinion on the relative quality of the
credit risk.
Common FAQs on Ratings
Why do rating agencies use symbols like AAA, AA, rather than give marks
or descriptive credit opinion?
The great advantage of rating symbols is their simplicity, which facilitates
universal understanding. Rating companies also publish explanations for their
symbols used as well as the rationale for the ratings assigned by them, to
facilitate deeper understanding.
Does credit rating constitute an advice to the investors to buy?
It does not. The reason is that some factors, which are of significance to an
investor in arriving at an investment decision, are not taken into account by
rating agencies. These include reasonableness of the issue price or the coupon
rate, secondary market liquidity and pre-payment risk. Further, different

investors have different views regarding the level of risk to be taken and rating
agencies can only express their views on the relative credit risk.
What kind of responsibility or accountability will attach to a rating agency
if an investor, who makes his investment decision on the basis of its rating,
incurs a loss on the investment?
A credit rating is a professional opinion given after studying all available
information at a particular point of time. Nevertheless, such opinions may prove
wrong in the context of subsequent events. Further, there is no privity of
contract between an investor and a rating agency and the investor is free to
accept or reject the opinion of the agency. Nevertheless, rating is essentially an
investor service and a rating agency is expected to maintain the highest possible
level of analytical competence and integrity. In the long run, the credibility of a
rating agency has to be built, brick by brick, on the quality of its services.
Do rating companies undertake unsolicited ratings?
Not in India, at least not yet. There is however, a good case for undertaking
unsolicited ratings. It will be relevant to mention here that any rating based
entirely on published information has serious limitations and the success of a
rating agency will depend, to a great extent, on its ability to access privileged
information. Co-operation from the issuers as well as their willingness to share
even confidential information are important pre-requisites. On its part, the
rating agency has a great responsibility to ensure confidentiality of the sensitive
information that comes into its possession during the rating process.
How reliable and consistent is the rating process? How do rating agencies
eliminate the subjective element in rating?
To answer the second question first, it is neither possible nor even desirable, to
totally eliminate the subjective element. Rating does not come out of a predetermined mathematical formula, which fixes the relevant variables as well as
the weights attached to each one of them. Rating agencies do a great amount of
number crunching, but the final outcome also takes into account factors like
quality of management, corporate strategy, economic outlook and international
environment. To ensure consistency and reliability, a number of qualified
professionals are involved in the rating process. The Rating Committee, which
assigns the final rating, consists of professionals with impeccable credentials.
Rating agencies also ensure that the rating process is insulated from any
possible conflicts of interest.
Is it customary to have the same issue rated by more than one rating
agency? Do the ratings for the same instrument vary from agency to
agency?

The answer to both the questions is yes. In the well-developed capital markets,
debt issues are, more often than not, rated by more than one agency. And, it is
only natural that the opinions given by two or more agencies will vary, in some
cases. But it will be very unusual if such differences are very wide. For
example, a debt issue may be rated DOUBLE A PLUS by one agency and
DOUBLE A or DOUBLE A MINUS by another. It will indeed be unusual if one
agency assigns a rating of DOUBLE A while another gives a TRIPLE B.
Why do rating agencies monitor the issues already rated?
A rating is an opinion given on the basis of information available at a particular
point of time. As time goes by, many things change, affecting the debt servicing
capabilities of the issuer, one way or the other. It is, therefore, essential that as a
part of their investor service, rating agencies monitor all outstanding debt issues
rated by them. In the context of emerging developments, the rating agencies
often put issues under credit watch and upgrade or downgrade the ratings as and
when necessary. Normally, such action is taken after intensive interaction with
the issuers.
Do issuers have a right of appeal against a rating assigned?
Yes. In a situation where an issuer is unhappy with the rating assigned, he may
request for a review, furnishing additional information, if any, considered
relevant. The rating agency will, then, undertake a review and thereafter
indicate its final decision. Unless the rating agency had overlooked critical
information at the first stage, (which is unlikely), chances of the rating being
changed on appeal are rare.
How much time does rating take?
The rating process is a fairly detailed exercise. It involves, among other things,
analysis of published financial information, visits to the issuers office and
works, intensive discussion with the senior executives of issuer, discussions
with auditors, bankers, etc. It also involves an in-depth study of the industry
itself and a degree of environment scanning. All this takes time and a rating
agency may take three to four weeks or more to arrive at a decision, subject to
availability of all the solicited information. It is of paramount importance to
rating companies to ensure that they do not, in any way, compromise on the
quality of their analysis, under pressure from issuers for quick results. Issuers
would also be well advised to approach the rating agencies sufficiently in
advance so that issue schedules can be adhered to.
Is it possible that not satisfied with the rating assigned by one rating
agency, an issuer approaches another, in the hope of getting a better result?

It is possible, but rating companies do not and should not indulge in competitive
generosity. Any attempt by issuers to play one agency against another will have
to be discouraged by all the rating companies. It may, however, be pointed out
here that two rating companies may, and often do, arrive at different
conclusions on the same issue. This is only natural, as perceptions differ.
Who rates the rating companies?
Informed public opinion will be the touchstone on which the rating companies
have to be assessed and the success of a rating agency should be measured by
the quality of the services offered, consistency and integrity.
Is the rating assigned for an instrument or for the Issuer Company?
Both. Rating of instruments would consider instruments specific characteristics
like maturity, credit reinforcements specific to the issue etc. Issuer ratings
consider the overall debt management capability of an issuer on a medium term
perspective, typically three to five years. While issuer ratings are more often
than not, one time assessments of credit quality, instrument ratings are
monitored over the life of the instrument.
Why are equity shares not rated?
By definition, credit rating is an opinion on the issuers capacity to service debt.
In the case of equity, there is no pre-determined servicing obligation, as equity
is in the nature of venture capital. So, credit rating in the conventional sense
does not apply to equity shares. However, of late, credit rating agencies offer
grading of IPOs which take into account the fundamentals of the issuer.
If a rating is downgraded, how would it "benefit" (or compensate ) the
investor?
A credit rating is a professional opinion on the ability and willingness of an
issuer to meet debt-servicing obligations. It is an opinion on future debt
servicing capabilities given on the basis, inter-alia, of past performance and all
available information (from audited financial statements, interaction with
company management, banks and financial institutions, statutory auditors, etc.)
at a particular time. While rating agencies make all possible efforts to project
corporate business prospects, industry trends and management capabilities,
many events are unpredictable. Hence, such opinions may prove wrong in the
context of subsequent events. On the occurrence of such an event, a rating
agency can only review and make appropriate changes in the rating. Moreover,
when there are recessionary trends in certain segments of the economy,
companies in such segments or with large exposures to such segments are
adversely affected and their credit ratings get downgraded. Such
downgradations are a natural consequence of the recessionary trends. In other

words, credit quality (and credit rating) is dynamic, not static and all rating
agencies review their ratings periodically and make changes, wherever
considered appropriate. Such changes are reported widely through the media. It
is the experience of all rating agencies that some instruments initially rated as
investment grade fall below investment grade or go into default, over a period
of time.
Further, it must be noted that there is no privity of contract between an investor
or a lender and a rating agency and the investor is free to accept or reject the
opinion of the agency. A credit rating is not an advice to buy, sell or hold
securities or investments and investors are expected to take their investment
decisions after considering all relevant factors and their own policies and
priorities. A credit rating is not a guarantee against future losses. Please also
note that credit ratings do not take into account many aspects which influence
investment decisions. They do not, for example, evaluate the reasonableness of
the issue price, possibilities for capital gains or take into account the liquidity in
the secondary market. Ratings also do not take into account the risk of
prepayment by issuer, or interest or exchange risks. Although these are often
related to the credit risk, the rating essentially is an opinion on the relative
quality of the credit risk, based on the information available at a given point of
time.

BIBLIOGRAPHY
Books referred
1. Indian Financial System by Bharati Pathak
2. Capital Markets in India by Rajesh Chakrabarti and Sankar De
Websites referred
www.icra.in
www.crisil.com
www.duffandphelps.com
www.careratings.com
www.investopedia.com