FINANCIAL MARKET

AND INSTITUTIONS

CREDIT RATING
AGENCIES

C-32 Manish Singh

C-46 Shaik Yasmin Naaz
C-48 Shivani Dutt
C-52 Smriti Dureha
What is Credit Rating ?

• Credit Rating is a simple and easy to

understand symbolic indicator of the opinion
of a credit rating agency about the risk
involved in a borrowing programme of an
issuer with reference to the capability of the
issuer to repay the debt as per terms of the
issue.
methodology
• Long-Term Rating Scale
 All Bonds, NCDs, and other debt instruments
(excluding Public Deposits) with original
maturity exceeding one year.

AAA highest degree of safety lowest credit risk.

AA high degree of safety lowest credit risk.
A adequate degree of safety low credit risk.
BBB moderate degree of safety moderate credit
risk.
BB moderate risk of default
B high risk of default
C very high risk of default
D default or are expected to be in default soon.
• Medium-Term Rating Scale
 All Public Deposit Programmes
AAA
Highest-credit-quality Lowest credit risk.
Low credit risk.
AA High-credit-quality rating
Adequate-credit-quality
A rating. Average credit risk

Inadequate-credit-quality High credit risk.

B
rating
C Risk-prone-credit-quality Very high credit risk
rating.
D Lowest-credit-quality rating . Very low prospects of
recovery.
• Short-Term Rating Scale
 All instruments with original maturity within
one year.
A1 very strong degree of safety

A2 strong degree of safety

A3 moderate degree of safety

A4 minimal degree of safety

D expected to be in default on maturity.

 Example-
Rating criteria for software industry

• While assessing a player in the software industry, rating

agencies evaluates its
• business risk
• financial risk
•management risk .
• Business risk analysis covers
• market position :
• market position
• scale of operations
• presence in the overseas market,
• client profile
• strategy for mergers and acquisitions.
• operating efficiency :
• revenue and profitability per employee
• human resources (HR) and knowledge management,
• systems and processes
• employee utilisation rate
• offshore-onshore employee mix
• contract mix.

• Financial Risk :
• Financial Ratios
 CREDIT RATING AGENCY

 A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain
types of debt obligations.
 In most cases, these issuers are companies, non-profit organizations, or national
governments issuing debt-like securities that can be traded on a secondary market.
 A credit rating measures credit worthiness, the ability to pay back a loan which affects the
interest rate applied to loans.
 Interest rates are not the same for everyone, but instead are based on risk-based pricing, a
form of price discrimination based on the different expected costs of different borrowers.
 There exist more than 100 rating agencies worldwide.
 FUNCTIONS OF A CREDIT RATING AGENCY
Credit rating serves the following functions:
Provides Superior Information: It provides superior information on credit risk for three
reasons:
It is an independent rating agency, and is likely to provide an unbiased opinion; unlike
brokers, financial intermediaries and underwriters who have a vested interest in the issue.
Due to professional and highly trained staff, their ability to assess risk is better.
The rating firm has access to a lot of information, which may not be publicly available.
Low Cost Information: A rating firm gathers, analyses, interprets and summarizes complex
information in a simple and readily understood formal manner. It is highly welcome by most
investors who find it prohibitively expensive and simply impossible to do such credit evaluation
of their own.
Basis For A Proper Risk And Return: If an instrument is rated by a credit rating agency, then
such instrument enjoys higher confidence from investors. Investors have some idea as to what is
the risk that he/she is likely to take, if investment is done in that security.
Healthy Discipline On Corporate Borrowers: Higher credit rating to any credit investment
tends to enhance the corporate image and visibility and hence it induces a healthy discipline on
corporates.
CREDIT RATING AGENCIES
HOW ARE RATINGS ESTABLISHED
INDUSTRY METHODOLOGIES
VALUE OF CREDIT RATING AGENCIES

 Credit ratings can also speak to the credit quality of an individual debt issue, such as a
corporate note, a municipal bond or a mortgage-backed security, and the relative
likelihood that the issue may default.
 The credit rating represents the credit rating agency's evaluation of qualitative and
quantitative information for a company or government.
 Each agency applies its own methodology in measuring creditworthiness and uses a
specific rating scale to publish its ratings opinions.
 A poor credit rating indicates a credit rating agency's opinion that the company or
government has a high risk of defaulting, based on the agency's analysis of the entity's
history and analysis of long term economic prospects.
 CREDIT RATING AGENCIES IN THE US

In 1975, the U.S. Securities Exchange Commission established the

“Nationally Recognized Statistical Rating Organization” (NRSRO).
Three of best known rating agencies in the U.S. were named:
Moody’s Investor Services
Standard and Poor’s
Fitch Rating
In 2003, the SEC approved a fourth NRSRO, Dominion Bond Rating
Services (DBRS) from Canada.
 MAJOR CREDIT RATING AGENCIES
 The major agencies are either independent or owned
by non-financial companies.
 Moody's, was a subsidiary of Dun and Bradstreet,
which dominated the market for commercial credit
ratings.
 Standard and Poor's was a subsidiary of McGraw-Hill,
a major publishing company with a strong business
information focus.
 Fitch, initially a publishing company, was bought by
an independent investor group in 1989.
 Credit-rating agencies are often regarded as the
gatekeepers of the capital markets because of the
impact of their opinions on the structuring and pricing
of financial products.
 RATING CATEGORIES
Ratings are constructed to represent the risk of default; that is, a high
(low) rating implies a low (high) probability of default.
 Large companies with strong and stable cash flows are likely to be
rated higher than small companies with more volatile cash flows.
Investment grade refers to the safest levels of financial securities.
 Investment-grade securities have historically exhibited relatively low
rates of default.
Speculative grade, or non-investment grade, refers to the riskier securities.
 Debt rated BB (Ba for Moody’s) or below is non-investment grade,
and is sometimes referred to as “high yield” or “junk.”
 Default rates among these classes of securities are comparatively high.
Within the major rating categories (AA, A, etc.), credit ratings are often
modified to show relative standing within a category.
Moody’s uses numbers 1, 2, and 3, while S&P and Fitch use plus (+) and
minus (−) s
 CREDIT RATING SCALE AND MEANING
An opinion on the issuer’s capacity to meet its financial obligations on a particular issue in a timely
manner, for example long-term bonds:
AAA Highest Safety An obligor rated 'AAA' has extremely strong capacity to meet its financial
commitments. 'AAA' is the highest
AA High Safety An obligor rated 'AA' has very strong capacity to meet its financial
commitments. It differs from the highest-rated obligors only to a small
degree.
A Adequate Safety An obligor rated 'A' has strong capacity to meet its financial commitments
but is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than obligors in higher-rated
categories.
BBB Moderate Safety Adverse economic conditions or changing circumstances are more likely to
lead to a weakened capacity of the obligor to meet its financial
commitments.
BB Moderate Risk An obligor rated 'BB' is less vulnerable in the near term than other lower-
rated obligors. However, it faces major ongoing uncertainties.

B High Risk Adverse business, financial, or economic conditions will likely impair the
obligor's capacity or willingness to meet its financial commitments.

C Very High Risk An obligor rated 'CCC' is currently vulnerable, and is dependent upon
favorable business, financial, and economic conditions to meet its financial
commitments.
D Default A 'D' rating is assigned when It is believed that the default will be a general
default and that the obligor will fail to pay all or substantially all of its
obligations as they come due
 CREDIT RATING IN INDIA

In the Indian context, the scope of credit rating is limited generally to debt, commercial paper,
fixed deposits, mutual funds and of late IPO’s as well.
Therefore, it is the instrument, which is rated, and not the company.
In other words, credit quality is not general evaluation of issuing organization, i.e. if debt of
company XYZ is rated AAA and debt of company ABC is rated BBB, then it does not mean firm
XYZ is better than firm ABC.
However, the issuer company gets strength and credibility with the grade of rating awarded to the
credit instrument it intends to issue to the public to raise funds. Rating, in a way, reflects the
issuer's strength and soundness of operations and management.
Further, the rating will differ for different instruments to be issued by the same company, within
the same time span.
For example, credit rating for a debenture issue will differ from that of a commercial paper or
certificate of deposit for the same company because the nature of obligation is different in each
case.
Credit rating has been made mandatory for issuance of the following instruments:
As per the regulations of Securities and Exchange Board of India (SEBI) public issue of debentures
and bonds convertible/ redeemable beyond a period of 18 months need credit rating.
As per the guidelines of Reserve Bank of India (RBI), one of the conditions for issuance of
Commercial Paper in India is that the issue must have a rating not below the P2 grade from
CRISIL/A2 grade from ICRA/PR2 from CARE.
As per the guidelines of Reserve Bank of India (RBI), Non-Banking Finance Companies (NBFCs)
having net owned funds of more than Rs.2 core must get their fixed deposit programmes rated. The
minimum rating required by the NBFCs to be eligible to raise fixed deposits are FA (-) from
CRISIL/ MA (-) from ICRA/BBB from CARE. Similar regulations have been introduced by
National Housing Bank (NHB) for housing finance companies also.
As per the regulations of the Ministry of Petroleum, the parallel marketers of Liquefied Petroleum
Gas (LPG) and Superior Kerosene Oil (SKO) in India are also subjected to mandatory rating. The
three rating agencies have a common approach for such rating and the dealers are categorized into
four grades between 1 to 4 indicating good, satisfactory, low risk and high risk
India’s first credit rating agency CRISIL was set up in 29 January 1987.
It is incorporated, promoted by the erstwhile ICICI Ltd along with UTI and other financial
institutions.
The first private sector credit rating institution in India was DUFF & PHELPS CREDIT RATING
INDIA PVT. LTD formed in 1995.
 Various credit rating agencies in India are:
Credit Rating and Information Services of India Ltd. (CRISIL)
Investment information and Credit Rating Agency Ltd. (ICRA)
Credit Analysis and Research Ltd. (CARE)
Credit Information Bureau India Ltd. (CIBIL)
SME Rating Agency of India Ltd. (SMERA)
Onida Individual Credit Rating Agency of India (ONICRA)
Fitch Rating India Limited
Benchmark Ratings
 • CRISIL: • BY ICRA
• Structured Finance Ratings
• Non-convertible debentures • Asset-Backed Securitisation
• Inter corporate deposits (ABS)
• Commercial • Mortgage Backed
papers/certificates of Securitisation (MBS)
deposits/short-term debt • Collateralised Debt Obligation
INSTRUMEN • Fixed deposits
• Loans
(CDO)
• Future Flow Transaction (FFT)
TS RATED • Structured debt

BY CRISIL, • CARE
• Corporate Debt Ratings
• Manufacturing companies
CARE, ICRA • Bank Loan Ratings • Banks and financial
• Collective Investment Scheme institutions
Rating • Infrastructure sector
• Mutual Fund Credit Quality companies
Rating
• Service companies
• IPO Grading 
• Municipal and other local
bodies
• State governments
 WHAT INSTRUMENTS ARE CREDIT RATED ?

Rating of structured Rating of debt obligations Bond Fund ratings Collective investment schemes
obligations
Opinion regarding the capacity Debentures Opinion of the quality of bond Fund House Reputation
and willingness to make timely Preference shares funds underlying portfolio Fund Manager Track Record
payments of financial holdings.
Deposits Investment Process
obligations on rated
CD’s commercial papers Focus on fixed income
instruments.
securities
Structured obligations of
Factors considered
• manufacturing
• finance companies • Credit associated with the
• banks, financial institutions securities
• the systems and procedures
followed by the funds
• management quality and
expertise
 • Country Rating
• Whenever a loan is to be extended or some major investment is to be made in it by
international investor
• Factors considered are growth rate, industrial and agricultural production, government
policies, inflation, fiscal deficit etc.
• Any upgrade movement in such—ratings has a positive impact on the stock markets.
• Morgan Stanlay, Moodys etc. give country ratings.
• Rating of Real Estate Builders and Developers
• Objective of helping and guiding prospective real estate buyers
RATING OTHER • Scrutinizes the sale deed papers, sanctioned plan, lawyers’ report government clearance
certificates

THAN DEBT • Factors considered - Past experience of the builder, number of properties built by the builder,
financial strength, time taken for completion

INSTRUMENTS • Chit Funds

• Rated on the ability to make timely payment of prize money to subscribers.
• The rating helps in better marketing of their fund
• Helps in widening of the subscriber's base.
• This service is provided by CRISIL.
• Rating of States
• Helps the State to attract investors both from India and abroad to make investments
• Foreign companies set up projects in states with positive rating.
• Economic parameters considered are industrial and agricultural growth of the State,
availability of raw material, labor etc. and political parties' agenda with respect to industry,
labor etc., relation between Centre and State and freedom
• States like Maharashtra, Madhya Pradesh, Tamil Nadu, Andhra Pradesh and Kerala have
already been rated by CRISIL.
Credit Rating
Scale
• Rating (Recommendation) for Equities
• Analysts specialise in equity ratings
• A forecast of the stock prices of a company.
• Trend of sales, operating profits considered for a forecast of the earning capacity and profitability position
• Financial statement analysis tools like ratio analysis, trend analysis, fund flow analysis and cash flow analysis
• Analysts suggests a target price
The following are some of the recommendations made by the equity analysts for its investors:
• Buy:
• Buy on Declines
• Long-term Buy
• Strong Buy
• Out-performer
• Overweight
• Hold
• Sell/Dispose/Sub-Standard/Under-weight
• Grading of health care institutions:
• The grading is an opinion on the relative quality of health care delivered to the patients.
• Grading is done taking into account facilities, quality , consistency in delivering the service etc.
• Bank loan rating:
• The creditworthiness of bank’s borrower is assessed
• Likelihood of repayment of loans
• Considers the borrowers underlying assets liquidity
• Risk management initiative
• For NBFC quality of assets , loans and investment.
• Infrastructure Sector Ratings
• Debt programmes of issuers in the power, roads, telecommunications
• Huge funding requirement
• Private sector initiatives given the growing inability of the Government.
• Infrastructure projects are capital intensive highly leveraged
• Long gestation period
• Projects require innovative structuring to make them bankable
• Assessment of the fundamental viability of the project
• Analysis of political, legal, regulatory environment affecting the sector
• credit enhancement by issuer for a higher Rating compared with the one that would have otherwise achieved.   
• Rating of Banks
• CRISIL and ICRA
• C – Capital Adequacy
• A - A stands for asset quality.
• M - M stands for management evaluation.
• E – Earnings
• L - L indicates liquidity position
• S - S stands for Systems and Control.
IPO GRADING

• Qualitative Analysis
• Industry analysis and market position.
• Analysis of the operating environment. Grading Category Definitions
• Management quality and parentage. Ind-Ra IPO Grade 5 Strong fundamentals
• Corporation governance
Ind-Ra IPO Grade 4 Above average
• Quantitative Analysis fundamentals
• Past financial performance
• growth, earnings, Ind-Ra IPO Grade 3 Average fundementals
• profitability, cash flow analysis,
Ind-Ra IPO Grade 2 Below average
• capital structure, fundementals
• liquidity, and working capital.
• Future financial prospects Ind-Ra IPO Grade 1 Poor fundementals
• investment,
• capital expansion,
• acquisition plans and utilisation of IPO
proceeds,
 • The security issuer’s ability to service its debt. In order, they
calculate the past and likely future cash flows and compare with
fixed interest obligations of the issuer.
• The volume and composition of outstanding debt.
• The stability of the future cashflows and earning capacity of
company.

Factors Affecting • Their interest coverage ratio i.e. how many number of times the
issuer can meet its fixed interest obligations.

Assigned Ratings • Ratio of current assets to current liabilities (i.e. current ratio (CR)) is
calculated to assess the liquidity position of the issuing firm.
• The value of assets pledged as collateral security and the security’s
priority of claim against the issuing firm’s assets.
• Market position of the company products is judged by the demand
for the products, competitors market share, distribution channels
etc.
• Operational efficiency is judged by capacity utilisation, prospects of
expansion, modernisation and diversification, availability of raw
material etc.
• Track record of promoters, directors and expertise of staff also
affect the rating of a company.
WIDESPREAD
RAMIFICATION
• ICRA and India Ratings and Research, downgraded IL&FS's non-convertible debentures (NCDs) and long-term loans.
• The downgrade has had a ripple effect - share prices of its group companies dropped
• Debt mutual fund schemes have exposure to the company. 
• Downgrading hampers borrowing capacity
• Debt mutual fund scheme : Rating downgraded for aa security held, Nav negatively impacted, higher the exposure, stronger
the negative impact on scheme’s Nav
• Rating not the only base, keeps changing, an outstanding rating may be put on Rating Watch 
• Mergers and acquisitions
• De-merger of some business
• Action by regulators
 • A suffix of 'r' indicates investments carrying non-credit risk.
• The terms specify that the payments will not be fixed, linked to external
variables such as commodity prices, equity indices, or foreign exchange rates.
• The risk of such adverse movements in price/value addressed by rating.
• 'NM' (Not Meaningful) – Factors present which render the outstanding rating
meaningless. These include
• reorganisation
• liquidation of the issuer

Suffixes and • the obligation being under dispute in a court of law

• A prefix of 'PP-MLD’ - principal-protected market-linked debenture.
Prefixes • Terms indicate promise to pay back the principal of the instrument
• The coupon rates not fixed
• Linked to external variables s
• commodity prices, equity share prices, indices, or foreign exchange rates.
• A prefix of 'Provisional' indicates
• rating factors in the completion of documentation by the issuer for the
instrument
• without these the rating would either have been different or not
assigned ab initio.
Turbulence of IIFL(India Infoline
Finance Limited)
What is IIFL?
• Its is an investment management company.
• It has customers base in India
• It is a demerged entity from the parent company IIFL Finance
• Registered company on NSE and BSE
Product range includes
Four Subsidiaries Major Share Holders

• IIFL Capital • Promoters- 26%

• IIFL Facilities Services • Fairfax- 35.4%
• IIFL Management Services • Others- 40.6%
• IIFL Insurance Brokers
 Reasons for Turbulence in IIFL stock

• The board of directors of the company, at their meeting held on 31st

Jan 2018, had approved the reorganization of IIFL Group, into three
listed entities(Demerger of IIFL) :-
• IIFL Securities
• IIFL Wealth Management
• IIFL Finance
 Owns 7 shares
For every 1 Allot 1 share of IIFL Securities
share

IIFL holdings Limited For every 7 Allot 1 share of IIFL Wealth

shares

For every 1 share Allot 1 share of IIFL Finance

 IIFL Securities locked in upper Circuit
• What is meant by upper/lower circuit?
• Upper Circuit is the limit above which a stock price cannot trade on a particular trading
day. On the other hand, the lower circuit is the limit below which a stock price cannot
trade on a particular trading day. These are also called circuit limits.
• In upper circuit only buyers are present.
• In lower circuit only sellers are present in the stock.

• Reasons to control circuit-

• To control the volatility- for very high volatility circuit limits are revised for the stock
• To control speculative activities
• To avoid extreme movement of stock
• To protect the interest of the retail investor
• Reason for locking of IIFL stock in upper circuit