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What Is Credit Rating?

IndianMoney.com Research Team | Posted On Friday, September 28,2018, 04:58 PM

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What Is Credit Rating?

 

 

Credit rating seems a tough word to understand. It’s really simple. It’s just an assessment of the borrower be it a person, a group or a Company. A credit rating tells if a borrower can repay a loan on time. If a borrower has a good credit rating, it means he’s repaying loans on time.

You must be familiar with CIBIL which is a credit information bureau. TransUnion CIBIL collects data on your repayments vis-à-vis loans and credit card payments each month, from banks and financial institutions. Based on this information, CIBIL assigns you a score between 300 to 900. A score of 750+ is a very good score. Your loans are sanctioned in an instant. A poor score 650< is bad and banks may reject loan application.

Credit rating is very much the same thing. Credit rating gives the strength of Companies based on market share, reputation of the Company and the strength of the management. In simple words credit rating gives the credit worthiness of a Company.

Let’s understand more of credit rating. Want to know more on Corporate FD? We at IndianMoney.com will make it easy for you. Just give us a missed call on 022 6181 6111 to explore our unique Free Advisory Service. IndianMoney.com is not a seller of any financial products. We only provide FREE financial advice/education to ensure that you are not misguided while buying any kind of financial products.

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What Is Credit Rating?

You must be familiar with CRISIL. It’s the pioneer of credit rating in India and is an S&P Global Company. It rates debt instruments and is a great help for SMEs (Small and Medium Enterprises) in India.

CRISIL is a great help to lenders, investors, market intermediaries and market regulators.  It rates banks, NBFCs, PSUs, financial institutions, state Governments and even mutual funds.

What does CRISIL do?

CRISIL rates corporate sector instruments:

  • It rates bank loans.
  • Long term debt instruments like bonds, NCDs, hybrids and even preference shares.
  • It rates short term debt instruments like commercial paper (CPs) and short term NCDs.
  • It rates FDs.

CRISIL rates SMEs based on financial strength and performance. CRISIL rates a particular SME and tells you it’s credit worthiness vis-à-vis peers. A good rating means the SME can avail loans/credit really fast and at low interest.

CRISIL publishes the name of the rated agency (SME) in its journal named CRISIL SME Connect. SMEs published in the journal can easily access credit from leading banks and financial institutions.

1. Types of credit ratings:

  • CRISIL Ratings:
  • CRISIL AAA: This rating means the financial institution has the highest degree of safety when it comes to financial obligations. Companies with this rating service financial obligations in time and have lowest credit risk. (Chance of a default is very low).
  • CRISIL AA:  This rating means the financial institution has a high degree of safety when it comes to financial obligations. They have very low credit risk.
  • CRISIL A: This rating ensures adequate levels of safety vis-à-vis a Company servicing financial obligations. They have low credit risk.
  • CRISIL BBB: This rating ensures moderate degree of safety on Companies financing loan obligations. They have moderate safety.
  • CRISIL BB: This rating ensures moderate degree of default on Companies financing loan obligations. They have moderate risk.
  • CRISIL B: This rating means a high chance of default vis-à-vis timely servicing of financial obligations. There’s a high risk of default.
  • CRISIL C: There’s a very high risk of default on servicing loan obligations.
  • CRISIL D: Companies with this rating have defaulted or will soon default.

ICRA:

ICRA is a Moody’s investor service Company. ICRA does ratings, gradings and research. ICRA rates rupee denominated debt instruments which are issued by Manufacturers, commercial banks, NBFCs, PSUs and even municipalities. It also rates bonds issued by Telecom, Power and Infra Companies.

SEE ALSO: Prepaid Credit Cards- Benefits,Types

Functions of credit rating:

ICRA Rating is done for:

  • Corporate Debt Rating.
  • Corporate Governance Rating.
  • Financial Sector Rating.
  • Infrastructure Sector Rating
  • Insurance Sector Rating
  • Mutual Fund Rating
  • Project Finance Rating
  • Public Finance Rating

Credit rating process:

  1. The financial institution requests a rating by submitting a rating request form to ICRA.
  2. The rated entity then pays the rating fee and signs a rating agreement.
  3. A conflict of interest check is made and the case is assigned to an analyst.
  4. The analyst visits the Manufacturing Plant or the site and talks to the management, the bankers or even the auditors.
  5. He prepares a report after analyzing data provided by the Company and ICRA’s research on the Company and the Industry.
  6. A rating report is presented to the rating committee (RC) after the signed rating agreement is received.
  7. The rating assigned by the rating committee is presented to the Rated Company along with the rationale (reasons for such a rating).
  8. The Financial Firm accepts the rating and the process ends. (The entire process is completed within a month from date of initial communication).
  9. Rating along with the outlook and the rating rationale is published on the ICRA website.
  10. The rating is under continuous watch until withdrawn.

What if the rating agency doesn’t accept the rating?

  • The rated firm appeals against the rating.
  • The rating is published as unaccepted on the ICRA website if acceptance or appeal for a review is not received within 5 days from the date of communication of the assigned rating.

CARE

CARE undertakes credit rating of debt instruments which can be long and medium term debentures, bonds, FDs and also short-term debt.  CARE also rates commercial paper.

Banks use ratings to determine risk weights for loan exposure and use bank loan ratings (BLRs). CARE rates fund based and non-fund based facilities which have been sanctioned by banks. This includes cash credit, working capital loans, bill discounting and project loans among others.

CARE also does recovery rating. You must be familiar with the SARFAESI Act which helps banks recover NPAs, a big problem these days. According to this act, there are 3 methods of recovering NPAs which are securitization, asset reconstruction and enforcement of security.

Securitization Companies and ARCs (Asset Reconstruction Companies) issue SRs (Security Receipts) under the SARFAESI Act. Security Receipts are acquired by QIBs (Qualified Institutional Buyers). The value of SRs is measured by NAV. The NAV is arrived at depending on the rating by credit rating agencies, so that QIBs can value their investment. Credit rating agencies do recovery rating which gives the probability of recovery and not the chance of default.

2. Importance of credit rating

Lenders:

  • Banks do not like lending to risky clients. Banks and financial institutions use credit rating to make wise investment decisions. This is very important to sanction loans or purchase bonds.
  • A high credit rating means the money invested is safe and interest would be paid on time.

Borrowers:

  • A borrower with a high credit rating can get loans easily sanctioned. Good credit rating assures lower interest rates.

3. Advantages of credit rating:

  • A good rating lowers Company borrowing costs.
  • The image of the Company improves.
  • Helps with investment decisions.
  • Assures safety of capital and interest payments.
  • A CRISIL AAA rating for debentures means highest safety and D for debentures means chances of default are high.
  • An investor doesn’t waste time on research and can easily gauge the financial strength of a Company.
  • A good marketing tool.
  • Credit rating helps non popular Companies.
  • A Company gets borrowing opportunities across banks and financial institutions.

4. Disadvantages of credit rating:

  • There’s no uniformity among credit rating agencies in India.
  • An average investor struggles to understand credit rating by rating agencies like ICRA, CARE and CRISIL.
  • Lack of standardization of the credit rating. One agency may deem a bond risky and the other safe.
  • No standard fee structure among rating agencies.
  • The ratings make it difficult to distinguish between equity instruments and mutual funds.
  • Credit rating agencies have assigned a good credit rating to Companies which have failed. Take the IL&FS case for example:

IL&FS Debt Fiasco: A black swan moment for credit rating agencies in India:

The IL&FS fiasco is a black swan moment for credit rating agencies. The best of the credit rating agencies failed to spot the financial crisis at IL&FS which is struggling to service $12.6 Billion worth of debt.

IL&FS established in 1967 is a conglomerate which funds major infra projects in India. The Chenani- Nashri tunnel, which is India’s longest road tunnel was financed by IL&FS which has raised billions of dollars from India’s corporate debt market.

IL&FS is a big borrower accounting for 2% of outstanding commercial paper, 1% of the debentures and 0.7% of loans in the banking system. In June IL&FS Transportation Networks Ltd which is a subsidiary of IL&FS, defaulted on debt obligations. This was followed by defaults in group subsidiaries in August and September.

ICRA, CARE and other rating agencies cut their rating for IL&FS from AAA- (Investment Grade) to D, default status in real quick time. Rating agencies failed to notice cost overruns in IL&FS construction projects, roads, ports and also problems in land acquisition and approvals.

What could be the reason for this? Indian credit rating firms follow the issuer-pays model which is common in USA. A firm which issues a financial instrument, pays credit analysts upfront. Credit agencies greed for profits is being blamed for this mess. Many people believe IL&FS could be India’s Lehmann moment as stock markets crash. Shares of IL&FS hit 52 week lows as IL&FS share prices crashed heavily. IL&FS shares are firming up as LIC extends support to IL&FS.

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