1. INTRODUCTION OF CRA India was perhaps the first amongst developing countries to set up a credit rating agency in 1988. The function of credit rating was institutionalized when RBI made it mandatory for the issue of Commercial aper !C" and su#se$uently #y %&BI' when it made credit rating compulso ry for certain cat egor ies of de#e ntur es and de#t instruments. In (une 199)' RBI made it mandatory for *on+Ban,ing -inancial Companies !*B-Cs" to #e rated. Credit rating is opt ional for u#l ic %ector nder ta, ing s ! %s" #on ds and pri vat ely pl ace d non+ conve11i#le de#entures upto Rs. /0 million. -ied deposits of manufacturing companies also come unde r the purview of opt iona l credit rati ng. %ec urit ies. Credit Rating is valua#le infor ma tion' wi del y use d me asu re for the ris ,in ess of the companies and #onds. It is epensive information2 costly to o#tain. Credit Rating prediction is important for investors to estima te ris,iness of unrated compani es and forcompani es to monitor the compani es3 credit rating' predict the future rating. 4ith the increasing mar,et orientation of the Indian economy' investors value a systematic assessment of two types of ris,s' namely 5#usiness ris,6 arising out of the 5open economy6 and lin,ages #etween money' capital and foreign echange mar,ets and 5payments ris,6. 4ith a view to protect small investors' who are the main target for unlisted corporate de#t in the form of fied deposits with companies' credit rating has #een made mandatory. The first mercantile credit agency was set up in *ew 7or, in 18)1 to rate the a#ility ofmerchants to pay their financia #ligatons. ater on' it was ta,en over #y Ro#ert :un. T his agency pu#lished its first rating guide in 18/9. The second agency was esta#lished #y (on Bradstreet in 18)9 which was later merged with first agency to form :un ; Bradstreet in 19<<' whi ch #eca me the owne r of =oody3 s Investor 3s %ervic e in19>?. The hist ory of=oody3s can #e traced #ac, a#out a 100years ago. In 1900' (ohn =oody laid stone of=oody3s Investors %ervice and pu#lished his @=anual of Railroad %ecurities3. &arl y 19?03s saw the epansi on of credit rating indus tr y when the oor3s u#l ish ing Company pu#lished its first rating guide in 191>. %u#se$uently -itch u#lishing Company and %tandard %tatistics Company were set up in 19?) and 19?? respectively. oor and %tandard merged together in 19)1 to form %tandard and oor3s which was su#se$uently ta,en over #y =cAraw ill in 19>>. Between 19?) and 190' no maDor new rating agencies were set up. But since 1903s' a num#er of credit rating agencies have #een set up all over the world including countries li,e =alaysia' Thailand' Eorea' Fustralia' a,istan and hilippines etc. In India' CRI%I!Credit Rating and Information %ervices of India td." was setup in 198as the first rating agency Definition KES SHROFF COLLEGE Page 1
India was perhaps the first amongst developing countries to set up a credit rating agency in
1988. The function of credit rating was institutionalized when RBI made it mandatory for the
issue of Commercial aper !C" and su#se$uently #y %&BI' when it made credit rating
compulsory for certain categories of de#entures and de#t instruments. In (une 199)' RBI
made it mandatory for *on+Ban,ing -inancial Companies !*B-Cs" to #e rated. Credit rating
is optional for u#lic %ector nderta,ings !%s" #onds and privately placed non+
conve11i#le de#entures upto Rs. /0 million. -ied deposits of manufacturing companies also
come under the purview of optional credit rating. %ecurities. Credit Rating is valua#le
information' widely used measure for the ris,iness of the companies and #onds. It is
epensive information2 costly to o#tain. Credit Rating prediction is important for investors to
estimate ris,iness of unrated companies and for companies to monitor the companies3 creditrating' predict the future rating.
4ith the increasing mar,et orientation of the Indian economy' investors value a systematic
assessment of two types of ris,s' namely 5#usiness ris,6 arising out of the 5open economy6
and lin,ages #etween money' capital and foreign echange mar,ets and 5payments ris,6.
4ith a view to protect small investors' who are the main target for unlisted corporate de#t in
the form of fied deposits with companies' credit rating has #een made mandatory.
The first mercantile credit agency was set up in *ew 7or, in 18)1 to rate the a#ility of
merchants to pay their financia #ligatons. ater on' it was ta,en over #y Ro#ert :un. Thisagency pu#lished its first rating guide in 18/9. The second agency was esta#lished #y (onBradstreet in 18)9 which was later merged with first agency to form :un ; Bradstreet in19<<' which #ecame the owner of =oody3s Investor3s %ervice in19>?. The history of =oody3s can #e traced #ac, a#out a 100years ago. In 1900' (ohn =oody laid stone of =oody3s Investors %ervice and pu#lished his @=anual of Railroad %ecurities3.
&arly 19?03s saw the epansion of credit rating industry when the oor3s u#lishingCompany pu#lished its first rating guide in 191>. %u#se$uently -itch u#lishing Companyand %tandard %tatistics Company were set up in 19?) and 19?? respectively. oor and%tandard merged together in 19)1 to form %tandard and oor3s which was su#se$uently
ta,en over #y =cAraw ill in 19>>. Between 19?) and 190' no maDor new rating agencieswere set up. But since 1903s' a num#er of credit rating agencies have #een set up all over theworld including countries li,e =alaysia' Thailand' Eorea' Fustralia' a,istan and hilippinesetc. In India' CRI%I !Credit Rating and Information %ervices of India td." was setup in198 as the first rating agency
F credit rating assesses the credit worthiness of an individual' corporation' or even a country.
Credit ratings are calculated from financial history and current assets and lia#ilities.Typically' a credit rating tells a lender or investor the pro#a#ility of the su#Dect #eing a#le to
pay #ac, a loan. owever' in recent years' credit ratings have also #een used to adDust
insurance premiums' determine employment eligi#ility' and esta#lish the amount of a utility
or leasing deposit.
F poor credit rating indicates a high ris, of defaulting on a loan' and thus leads to high
interest rates or the refusal of a loan #y the creditor.
In countries such as the nited %tates' an individualGs credit history is compiled and
maintained #y companies called credit #ureaus. In the nited %tates' credit worthiness is
usually determined through a statistical analysis of the availa#le credit data. F common form
of this analysis is a <+digit credit score provided #y independent financial service companies
such as the -IC credit score.
The factors which may influence a personGs credit rating areH
Credit rating gives an idea to the investors a#out the credi#ility of the issuer company' and the ris, factor attached to a particular instrument. %o the investors candecide whether to invest in such companies or not. igher the rating' the more will #e thewillingness to invest in these instruments and vice+versa.
"enefit# of R&tin' Re(ie-#
The rating agency regularly reviews the rating given to a particular instrument. %o'the present investors can decide whether to ,eep the instrument or to sell it. -or e.g. if theinstrument is downgraded' then the investor may decide to sell it and if the rating ismaintained or upgraded' he may decide to ,eep the instrument until the net rating or
maturity.
A##$&n,e of S&fet/
igh credit rating gives assurance to the investors a#out the safety of the instrumentand minimum ris, of #an,ruptcy. The companies which get a high rating for their instruments' will try to maintain healthy financial discipline. This will protect them from
#an,ruptcy. %o the investors will #e safe.
E&#/ Un%e$#t&n%&0i)it/ of In(e#t+ent $o*o#&)
The rating agencies gives rating sym#ols to the instrument' which can #e easilyunderstood #y investors. This helps them to understand the investment proposal of anissuer company. -or e.g. FFF !Triple F"' given #y CRI%I for de#entures ensureshighest safety' whereas de#entures rated : are in default or epect to default on maturity.
Coi,e of In#t$+ent#
Credit rating ena#les an investor to select a particular instrument from manyalternatives availa#le. This choice depends upon the safety or ris, of the instrument.
S&(e# In(e#to$# Ti+e &n% Effo$t
Credit ratings ena#le an investor to his save time and effort in analyzing the financialstrength of an issuer company. This is #ecause the investor can depend on the rating done
#y professional rating agency' in order to ta,e an investment decision. e need not wastehis time and effort to collect and analyse the financial information a#out the credit
Credit rating helps to improve the corporate image of a company. igh credit
rating creates confidence and trust in the minds of the investors a#out the company.Therefore' the company enDoys a good corporate image in the mar,et.
owers Cost of Borrowing
Companies that have high credit rating for their de#t instruments will getfunds at lower costs from the mar,et. igh rating will ena#le the company to offer low interest rates on fied deposits' de#entures and other de#t securities. Theinvestors will accept low interest rates #ecause they prefer low ris, instruments. Fcompany with high rating for its instruments can reduce the cost of pu#lic issue toraise funds' #ecause it need not spend heavily on advertising for attracting investors.
4ider Fudience for Borrowing
F company with high rating for its instruments can get a wider audience for #orrowing. It can approach financial institutions' #an,s' investing companies. This is #ecause the credit ratings are easily understood not only #y the financial institutionsand #an,s' #ut also #y the general pu#lic.
Aood for *on+opular Companies
Credit rating is #eneficial to the non+popular companies' such as closely+heldcompanies. If the credit rating is good' the pu#lic will invest in these companies' evenif they do not ,now these companies.
Fct as a =ar,eting Tool H
Credit rating not only helps to develop a good image of the company amongthe investors' #ut also among the customers' dealers' suppliers' etc. igh credit ratingcan act as a mar,eting tool to develop confidence in the minds of customers' dealer'suppliers' etc.
elps in Arowth and &pansion
Credit rating ena#les a company to grow and epand. This is #ecause #etter credit
rating will ena#le a company to get finance easily for growth and epansion.
The information collected #y the rating agency may #e su#Dect to personal #ias of therating team. owever' rating agencies try their #est to provide an un#iased opinion of thecredit $uality of the company andKor instrument. If not' they will not #e trusted.
Improper :isclosure =ay appen H
The company #eing rated may not disclose certain material facts to the investigating
team of the rating agency. This can affect the $uality of credit rating.
Impact of Changing &nvironment
Rating is done #ased on present and past data of the company. %o' it will #e difficultto predict the future financial position of the company. =any changes ta,e place due tochanges in economic' political' social' technological' legal and other environments. Fllthis will affect the wor,ing of the company #eing rated. Therefore' rating is not aguarantee for financial soundness of the company.
ro#lems for *ew Companies
There may #e pro#lems for new companies to collect funds from the mar,et. This is #ecause' a new company may not #e in a position to prove its financial soundness.Therefore' it may receive lower credit ratings. This will ma,e it difficult to collect fundsfrom the mar,et.
:owngrading #y Rating Fgency
The credit+rating agencies periodically review the ratings given to a particular instrument. If the performance of a company is not as epected' then the rating agency
will downgrade the instrument. This will affect the image of the company .
:ifference in Rating H
There are cases' where different ratings are provided #y various rating agencies for
the same instrument. These differences may #e due to many reasons. This will createconfusion in the minds of the investor .
and industry trends. The processKprocedure followed #y all the maDor credit rating agencies in
the country is almost similar and usually comprises of the following steps.
1. R&tin' Ree#t
The rating process #egins' with the receipt of formal re$uest for rating from acompany desirous of having its issue o#ligations under proposed instrument rated #y
credit rating agencies. Fn agreement is entered into #etween the rating agency and the
issuer company. The agreement spells out the terms of the rating assignment and covers
the following aspectsH
L It re$uires the CRF !Credit Rating Fgency" to ,eep the information
confidential.
L It gives right to the issuer company to accept or not to accept the rating.
L It re$uires the issuer company to provide all material information to the CRF
for rating and su#se$uent surveillance$
2. D&t& '&te$in'5An&)/#i#
To get all the information necessary for analysis' @Credit+Rating3 agency sends
a client the letter with information re$uirementsH a list of all the information and
documents necessary for credit rating analysis. @Credit+Rating3 guarantees that your
confidential information will #e ,ept safe.
3. M&n&'e+ent Meetin'#
=eetings and consultations with client company managers and officials arevery important in the process of credit rating assignment. Fs a rule' we need two orthree meetings. In the first meeting analysts would as, $uestions a#out financial plansand further development prospects. This information helps us to remain o#Dective inassessment of client3s financial position for the long+term period.
4. R&tin' ,o++ittee5A##i'n+ent of R&tin'
Rating team of the agnecy eamines all the data' information and documents.It also considers all the points presented #y the client. The team then recommends therating.
!. A%(i,e to te Co+*&n/5 in#tittion6
The CompanyK institution are informed a#out the rating proposed #y the rating
If the CompanyK institution feel that the rating can #e improved and hasade$uate reason for it' it can appeal so to the agency. %uch appeal should #e
su#stantiated with proper reasoning and Dustification. n appeal the agency may ormay not revise the rating.
7. 0)i,&tion
:ecision a#out rating pu#lication is ta,en #y a client individually. Client maydecide not to pu#lish assigned rating. &ven if rating is not pu#lished the procedure ofcredit rating assignment remains useful as conclusions of agency analysts written inthe rating report may help to determine factors influencing client3s credi#ility. Theirimprovement in the future may lead to credit rating upgrade. Fgency may not su#mit
pu#lication of upgradesKdowngrades of once pu#lished rating to client3s approval.
8. A**e&)
If a client thin,s that in the process of rating assignment some importantfactors have not #een ta,en into consideration' client3s authorized representatives mayappeal to rating committee within the net ten days after rating assignment. Theappeal will #e accepted only if a client can #ring new data and documents that areimportant for rating procedure. Ffter eamination of these documents' credit ratingcommittee will ta,e a decision which cannot #e appealed .Fppeal procedure does not
influence on client3s rights on rating pu#lication.
9. S$(e)i&n,e &n% Ann&) Re(ie-
Rating is a dynamic activity. %o rating has to #e monitored continuously. Flso it is
CRI%I' IndiaGs first credit rating agency' is incorporated' promoted #y the erstwhile ICICI
td' along with TI and other financial institutions. The head office of the company is
located at mum#ai and it has esta#lished offices outside india. it is a glo#al analytical
company providing ratings 'research and ris, and policy advisory services.it is the largest
credit rating agency in India. CRI%I3s maDority shareholder is %TF*:FR: and R3s.
4Ith sustaina#le competitive advantage arising from their strong #rand' unmatched
credi#ility' mar,et leadership across #usinesses' and large customer #ase' they deliver
analysis' opinions' and solutions that ma,e mar,ets function #etter.
they defining trait is our a#ility to convert data and information into epert Dudgements and
forecasts across a wide range of domains' with deep epertise and complete o#Dectivity.
Ft the core of their credi#ility' #uilt up assiduously over the years' are our valuesH Integrity'
Independence' Fnalytical Rigour' Commitment and Innovation.
CRI%I launches &ducation Arading' #eginning with #usiness schools
CRI%I Rating enhances access to funding for %=&s2 Fnnounces ?0'000th %=&
Rating CRI%I Ratings launches %olar grading
CRI%I Research launches Aold and Ailt Inde
CRI%I Alo#al Research ; Fnalytics receives *F%%C= &emplary Talent
ractices Fward
CRI%I was set up in the year 198 in order to rate the firms and then entered into the field
of assessment service for the #an,s. ighly s,illed mem#ers manage the agency. =s. RoopaEudva who acts as the =anaging :irector and Chief &ecutive fficer of the company heads
it. The company has set up large num#er of committees to loo, after dispersal of various
services offered #y the company for eample' investor grievance committee' investment
committee' rating committee' allotment committee' compensation committee and so on. The
head office of the company is located at =um#ai and it has esta#lished offices outside India
also.
CRI%I Ratings is the only ratings agency in India to operate on the #asis of sectoral
specialization. CRI%I Ratings plays a leading role in the development of the de#t mar,ets
in India. CRI%I has also spearheaded the formation of the Cari CRI%' the worldGs first
Instruments with this rating areconsidered to have the highestdegree of safety regarding timelyservicing of financial o#ligations.%uch instruments carry lowest creditris,.
CRISIL A1
CRISIL AA
:Hi' S&fet/;
Instruments with this rating areconsidered to have high degree ofsafety regarding timely servicing offinancial o#ligations. %uchinstruments carry very low creditris,.
CRISIL A2
CRISIL A
:A%e&te S&fet/;
Instruments with this rating areconsidered to have ade$uate degreeof safety regarding timely servicingof financial o#ligations. %uchinstruments carry low credit ris,.
CRISIL A3
CRISIL """
:Mo%e$&te S&fet/;
Instruments with this rating areconsidered to have moderate degreeof safety regarding timely servicingof financial o#ligations. %uch
instruments carry moderate creditris,.
CRISIL A4
CRISIL ""
:Mo%e$&te Ri#>;
Instruments with this rating areconsidered to have moderate ris, ofdefault regarding timely servicing offinancial o#ligations.
CRISIL D
CRISIL "
:Hi' Ri#>;
Instruments with this rating areconsidered to have high ris, ofdefault regarding timely servicing of
financial o#ligations.
CRISIL C
:e$/ Hi' Ri#>;
Instruments with this rating areconsidered to have very high ris, ofdefault regarding timely servicing offinancial o#ligations.
(anuary ?9H CRI%I' IndiaGs first credit rating agency' is incorporated' promoted #y the erstwhile ICICI td' along with TI and otherfinancial institutions.
=r. * Maghul and =r. radip %hah are CRI%IGs first Chairman and
=anaging :irector' respectively.
1988
(anuary 1H CRI%I commences operations within a year of its
incorporation. The #usiness environment is far from promising for theone+year old + the lending rates are fied' and India has no such thingas a corporate #ond mar,et as yet. Fnd' whatGs more' credit rating is
an idea thatGs far ahead of its times.
1990 The CRI%ICFR: %ervice + providing comprehensive information
and analytical opinion on IndiaGs corporate entities + is launched.
1991
:espite the odds' and the initial lac, of mar,et acceptance of credit
ratings' CRI%IGs operations are now well esta#lished. It #egins toac$uire #rand identity' with a reputation for analytical rigour andindependence.
199?
CRI%I offers technical assistance and training to help set up Rating
Fgency =alaysia Berhad' and =FFT' the Israeli securities ratingcompany.
199< CRI%IGs I is a whopping success + its ?0' 00'000 shares' sold at a
premium of Rs.)0 per share' are oversu#scri#ed #y ?.) times.
199)
=r. R Ravimohan ta,es over as CRI%IGs =anaging :irector.
CRI%I diversifies #usiness portfolio with a strategic entry into
advisory services' and wins its first maDor mandate in theinfrastructure policy advisory domain.
199/ In partnership with the *ational %toc, &change of India td
!*%&I"' CRI%I develops and launches the CRI%I/00 &$uityInde' helping investors clue in on stoc, price movements.
199> CRI%I forges a strategic #usiness alliance with %tandard ; oorGs
!%;" Ratings Aroup. The tie+up is part of CRI%IGs strategy todevelop its s,ills and processes.
199
%; ac$uires a 9.>8 per cent sta,e in CRI%I. The alliance with the
worldGs leading rating agency adds a new dimension to CRI%IGs
methodologies. It provides CRI%I with eposure to the internationalrating mar,ets and to %;Gs rating processes.
1998 CRI%I sets up India Inde %ervices td !II%"' a Doint venture with
*%&I' to provide a variety of indices and inde+related services and products to IndiaGs capital mar,ets.
1999
CRI%IGs proprietary Ris, Fssessment =odel !RF=" #ecomes the
#an,ing industry standardH given the heightened regulatory focus onthe #an,sG ris, management practices' RF= serves as a customisedcredit rating model for the #an,s.
?000
CRI%I ac$uires the #usiness' and #rand' I*-FC' of Information
roducts and Research %ervices !India" vt td. I*-FC is a leading provider of research to IndiaGs financial sector. The ac$uisitionstrengthens CRI%IGs research #usiness' and ma,es it IndiaGs leading
provider of integrated research.
CRI%I launches the CRI%I Composite erformance Ran,ing
!CRI%INCR" to provide performance evaluation standards andinvestment decision support to mutual fund houses' distri#utors' andinvestors.
?001
CRI%I sets up su#sidiary' Alo#al :ata %ervices of India td' to
standardize pu#lished financial data for analysis.
CRI%I launches =utual -und Fwards in association with C*BC+
TM18 + a #enchmar, award for IndiaGs #est performing mutual funds.
CRI%I launches the CR*S*L +oung ,-oug-t Leader .C+,L/
0ard + to attract outstanding talent and provide a platform to IndiaGsfuture #usiness leaders to showcase their views.
?00?
CRI%I sets upH The Centre for &conomic Research + to apply economic principles to
live #usiness situations
CRI%I =ar,et 4ire + to provide real+time financial news services to
help clients ma,e pricing+ and investment+related decisions
?00<
CRI%I sets up its investment and ris, management services group to
offer integrated ris, management solutions and advice to #an,s andcorporates.
CRI%I follows it up with its first overseas ac$uisition +
&cono=atters td !later the Aas %trategies Aroup"' a ondon+#asedcompany providing natural gas related consulting' information andtraining' and conference+organizing services.
?00) CRI%I epands its glo#al reach further with an e$uity investment in
the worldGs first regional rating agency' the Cari##ean Information andCredit Rating %ervices imited !CariCRI%"' which CRI%I also helps
It is the only ratings agency in India with sectoral specialization It has played a
critical role in the development of the de#t mar,ets in India. The agency has developednew ratings methodologies for de#t instruments and innovative structures across sectors.CRI%I Ratings provides technical ,now+how to clients all over the world and has helpedset up ratings agencies in =alaysia !RF="' Israel !=FFT" and in the Cari##ean.
Re#e&$,
It provides research' analysis and forecasts on the Indian economy' industries andcompanies to over /00 Indian and international clients across financial' corporate' consulting
and pu#lic sectors.
CRI%I -und %ervicesH It provides fund evaluation services and ris, solutions to the
mutual fund industry. The Centre for &conomic ResearchH It applies economic principles to live #usiness
applications and provide #enchmar,s and analyses for IndiaGs policy and #usinessdecision ma,ers.
Investment Research utsourcingH CRI%I added e$uity research to its wide
#ou$uet of services' #y ac$uiring Irevna' a leading glo#al e$uity research andanalytics company. Irevna offers investment research services to the worldGs leading
investment #an,s and financial institutions.
A%(i#o$/
CRISIL Inf$&#t$,t$e A%(i#o$/6
It provides policy' regulatory and transaction level advice to governments andleading organizations across sectors.
In(e#t+ent &n% Ri#> M&n&'e+ent Se$(i,e#6
CRI%I Ris, %olutions offers integrated ris, management solutions andadvice to Ban,s and Corporates #y leveraging the eperience and s,ills of CRI%I inthe areas of credit and mar,et ris,.
7.2. ICRA : In(e#t+ent Info$+&tion &n% C$e%it R&tin' A'en,/ of
ICRF imited !formerly Investment Information and Credit Rating Fgency of India imited"was set up in 1991 #y leading financialKinvestment institutions' commercial #an,s andfinancial services companies as an independent and professional Investment Information andCredit Rating Fgency.
Today' ICRF and its su#sidiaries together form the ICRF Aroup of Companies !AroupICRF". ICRF is a u#lic imited Company' with its shares listed on the Bom#ay %toc, &change and the *ational %toc, &change.
ICRA@S G$&%in' of IO
ICRFGs Arading of Initial u#lic fferings !Is" is a service aimed at facilitating
assessment of e$uity issues offered to the pu#lic. The Arade assigned to any individual I
is a sym#olic representation of ICRFGs assessment of the GfundamentalsG of the issuer
concerned on a relative grading scale. I Arades are assigned on a five+point point scale'
where I Arade / indicates the highest grading and I Arade 1 indicates the lowestgrading' i.e. a higher score indicates stronger fundamentals. Fn ICRF I Arade does not
comment on the valuation or pricing of the issue that has #een graded' nor does it see, to
indicate the li,ely returns to shareholders from su#scri#ing to the I. The emphasis of the
I Arading eercise is on evaluating the prospects of the industry in which the company
operates' the companyGs competitive strengths that would allow it to address the ris,s
inherent in the #usinesses and effectively capitalize on the opportunities availa#le as well as
the companyGs financial position. In case the I proceeds are planned to #e used to set up
proDects' either Areenfield or Brownfield' ICRF evaluates the ris,s inherent in such proDects'
The capacity of the companyGs management to eecute the same' and the li,ely #enefits
accruing from the successful completion of the proDects in terms of profita#ility and returns
to shareholders. ICRFGs five point I Arading %cale is as followsH
I Arade / %trong fundamentals
I Arade ) F#ove+average fundamentals
I Arade < Fverage fundamentals
I Arade ? Below+average fundamentals
I Arade 1 oor fundamentals
The company changed its name to ICRF imited' and went pu#lic on 1< Fpril 199'with a listing on the Bom#ay %toc, &change and the *ational %toc, &change.=oodyGs continues to #e the largest single shareholder in ICRF. ICRF has a pan+India presence and has offices in 8 locations. Fpart from the four metros' it hasoffices in une' Fhmeda#ad' Bangalore and ydera#ad.
emerged as the leading agency for covering many rating segments li,e that for #an,s' su#+
sovereigns and I gradings.
CFR& Ratings provides the entire spectrum of credit rating that helps the corporates to raise
capital for their various re$uirements and assists the investors to form an informed
investment decision #ased on the credit ris, and their own ris,+return epectations. ur
rating and grading service offerings leverage our domain and analytical epertise #ac,ed #y
the methodologies congruent with the international #est practices. 4ith maDority
shareholding #y leading domestic #an,s and financial institutions in India' CFR&3s intrinsic
strengths have also attracted many other investors.
CFR& was registered #y %&BI as per %ecurities ; &change Board of India Regulations
1999.%ervices offered #y CFR& The various services offered #y CFR& includeH
R&tin' Se$(i,e#64ith regard to rating services offered #y CFR& or Credit Fnalysis ; Research td' the
agency carries out rating of the following de#t instrumentsH
%tructured o#ligations
Commercial paper
:e#entures
-ied deposits
Bonds
C$e%it Re*o$t#
In addition to rating industrial houses' Credit Fnalysis ; Research td !CFR&" also doesrating of financial institution' state governments' municipalities' special purpose vehicles.Credit Fnalysis ; Research td !CFR&" also prepares credit reports. These credit reports areavailed of #y different corporate houses. The credit reports wor,ed out #y CFR& areinstrumental in ma,ing decisions pertaining to colla#orations' Doint ventures' mergers'
ac$uisitions.
&)&tion#
CFR& conducts enterprise evaluations for #ig investors' #usiness partners !eisting partnersas well as prospective partners"' managements of #ig companies. The Indian governmentGs
:isinvestment Commission had availed the services of CFR& for carrying out evaluation ofstate owned enterprises' which were ?0 in num#er .
Credit Fnalysis ; Research td !CFR&" also assists non #an,ing companies and different #an,s in setting up or #ringing a#out modifications in the credit appraisal.
Re(ie-in' De0t M&$>et6
In order to remain a#reast with the prevailing mar,et conditions' CFR& pu#lishes a #ulletinevery month. The #ulletin is called :e#t mar,et review. This #ulletin contains informationregarding the latest developments in the de#t mar,ets. It also pu#lishes information regardingchanges in the economic structure of the country.
• A #>e)et&) ot)ine of te i+*o$t&nt #e$(i,e# offe$e% 0/ C$e%it An&)/#i# <
Re#e&$, Lt% :CARE;6
A%(i#o$/ #e$(i,e#
reparing credit reportsConducting studies in differentsectors.
R&tin' #e$(i,e#
:ifferent ,inds of de#t+Converti#le #ondsBonds:e#enturesCommercial paper
Certificates of depositsfied depositsInter corporate depositsuasi de#ts
G$&%in' #e$(i,e# I !initial pu#lic offer" gradings.
7.4. DCR: Dff < e)*# ,$e%it $&tin' in%i& )i+ite%;
It was founded in 19<? to provide high $uality investment research services focused on the
utility industry. ver the decades' it evolved into a diversified financial services firm that
provides financial advisory' investment #an,ing' credit rating and investment management
services. The investment management and credit rating #usinesses were ac$uired #y Mirtus
Investment artners and -itch' respectively. The firm3s current management team ac$uired
Fc$uired =CR' greatly epanding our presence in the E
Fc$uired R%= Richter3s financial restructuring practice in
TorontoFc$uired age mill artners
&pert witness regarding the =ad off &state
2B12 Fdministrator for Rangers in the largest foot#all clu# insolvencyin E history
7.!. Oni,$& C$e%it R&tin' A'en,/ of in%i& )i+ite%
nicra Credit Rating Fgency is one of the leading Credit and erformance Rating agencies inIndia. It provides ratings' ris, assessment and analytical solutions to Individuals' =%=&sand Corporates.
These services ena#le the lender or service provider to ma,e smart' value #ased decisions on
the Individuals' =%=&s and corporates #y providing them essential information thatincludes financial' operational' productivity and <>0 degree analysis' thus providing a holisticview a#out the entity.
Third party credit and performance rating and assessment helps to create 5trust6 #etween
players in mar,ets that underpins transactions.
*ICRF plays a central and critical role in collecting and analyzing a variety of financial'operational' industry and mar,et information' synthesizing that information' and providingautonomous' relia#le assessments of the entity' there#y providing sta,eholders with animportant input into their decision ma,ing process.
To realize our goal we have committed ourselves to providing the sta,eholders witho#Dective' timely' independent and forward+loo,ing credit and performance opinions. Thefoundation of that dedication is em#edded in several core principles S o#Dectivity' $uality'independence' integrity and transparency.
=ilestones nicra operates as a financial services organisation. Its products and servicesinclude Individual Credit Rating' %=& rating' &mployee Bac,ground %creening' Customerrofiling ; Rating !CR"' Fssociate Rating and IT solutions' across the telecom' #an,ing'health' insurance' education and auto sectors.
The company has #een ac,nowledged as pioneers in this field #y the =inistry of -inance inthe &conomic %urvey !199<199)". It is recognised and empanelled #y the li,es of *%IC!*ational %mall Industries Corporation td.' and the IBF !Indian Ban,s Fssociation"' for
performance and financial ratings. The &mployee Bac,ground %creening division is certified #y *F%%C= and *:=F.
The company operates with a networ, of over 1) #ranches' covering more than /00locations pan+India with the help of over ?/00 -leet on %treet personnel.
=ilestone 4hy onicra
2B12 • Conducted first of its ,ind study in agriculture sector
2BB9=11 • aunched &ducation Rating Business + Conducted %trength' wea,ness
opportunity and threat analysis !%4T" and Training *eed Fnalysis !T*F"for engineering colleges under the Technical Education Quality
Improvement Program (TEQIP)
•
aunched Mendor Rating Business
• Tied with %tate Aovernment for Rating Business
• aunched Fssociate Rating Business
• %inged =emorandum of understanding with ?0 Ban,sK-inancial Institutions
2BB • aunched Rating Business
2BB!•
Registration with *ational %mall Industries Corporation !=inistry of =icro'%mall and =edium &nterprises' Aovernment of India " to underta,e =icro'%mall and =edium &nterprises Ratings
2BB2 • *ationwide Infrastructure set up
8. SE"I=REGULATOR
The capital mar,et regulator regulates rating agencies in most regions. In India' the capitalmar,ets regulator' the %ecurities and &change Board of India !%&BI"' regulates the rating
agencies in the country. %&BI laid down an etensive set of regulations for rating agencies in
1999.
SE"I I##e% Gi%e)ine# to C$e%it R&tin' A'en,ie#
%&BI vide CIRK=IR%:KCRFK>K?010 dated =ay <' ?010 has provided for certain
transparency and disclosure norms for the Credit Rating Fgencies !5CRFs6". ThemaDor measures ta,en in this regard are summarized #elowH
CRFs should maintain records of the rating committee' including voting details and
notes of dissent' for a period of five years.
It has #een made mandatory for CRFs to pu#lish information a#out the historical
default rates of their rating categories and whether the default rates of these categories
have changed over time.
CRFs should ensure that its analysts do not participate in any ,ind of mar,eting and
#usiness development' including negotiations of fees with the issuer whose securitiesare #eing rated. Flso' the employees involved in the credit rating process and theirdependants cannot own shares of the issuer.
CRFs while rating structured finance products' are #arred from providing
consultancy or advisory services regarding the design of the structured financeinstrument. This prohi#ition would apply to the su#sidiaries of CRFs too. 4hile
pu#lishing the ratings of structured finance products and their movements' CRFsapart from following all the applica#le re$uirements in case of non+structured ratingsshould also disclose the trac, record of the originator and details of nature ofunderlying assets while assigning the credit rating.
In case of unsolicited credit ratings !the credit ratings not arising out of theagreement #etween the CRFs and the issuer"' credit rating sym#ol should #eaccompanied #y the word 5*%ICIT&:6 in the same font size.
CRFs should also disclose
1. the policies' methodology and procedures in detail followed #y them regarding
?. the history of credit rating of all outstanding securities'
<. the general nature of its compensation arrangements with the issuers and
). the details of any relationship it has with the issuer whose securities are #eing ratedand any of its associate of such issuer and the CRFs or its su#sidiaries.
The ,$e%it $&tin' &'en,ie# in In%i& mainly include ICRF and CRI%I. ICRF was formerly
referred to the Investment Information and Credit Rating Fgency of India imited. Their
main function is to grade the different sector and companies in terms of performance and
offer solutions for up gradation.
9. GUIDELINES FOR CREDIT RATING AGENCIES IN
INDIA
The %ecurities and &change Board of India !Credit Rating Fgencies" Regulations'
1999 offers various guidelines with regard to the registration and functioning of the
credit rating agencies in India. The registration procedure includes application for the
esta#lishment of a credit rating agency' matching the eligi#ility criteria and providing
otherwise #e shut out altogetherH small governments' startup companies' hospitals' and
universities
1B.1. R&tin'# #e 0/ 0on% i##e$#
Issuers rely on credit ratings as an independent verification of their own credit+worthinessand the resultant value of the instruments they issue. In most cases' a significant #ondissuance must have at least one rating from a respected CRF for the issuance to #e successful!without such a rating' the issuance may #e undersu#scri#ed or the price offered #y investorstoo low for the issuerGs purposes". %tudies #y the Bond =ar,et Fssociation note that manyinstitutional investors now prefer that a de#t issuance have at least three ratings.
Issuers also use credit ratings in certain structured finance transactions. -or eample' acompany with a very high credit rating wishing to underta,e a particularly ris,y research
proDect could create a legally separate entity with certain assets that would own and conductthe research wor,. This Uspecial purpose entityU would then assume all of the research ris,and issue its own de#t securities to finance the research. The %&Gs credit rating li,ely would
#e very low' and the issuer would have to pay a high rate of return on the #onds issued.
owever' this ris, would not lower the parent companyGs overall credit rating #ecause the%& would #e a legally separate entity. Conversely' a company with a low credit rating might
#e a#le to #orrow on #etter terms if it were to form an %& and transfer significant assets tothat su#sidiary and issue secured de#t securities. That way' if the venture were to fail' thelenders would have recourse to the assets owned #y the %&. This would lower the interestrate the %& would need to pay as part of the de#t offering.
The same issuer also may have different credit ratings for different #onds. This differenceresults from the #ondGs structure' how it is secured' and the degree to which the #ond is
su#ordinated to other de#t. =any larger CRFs offer Ucredit rating advisory servicesU thatessentially advise an issuer on how to structure its #ond offerings and %&s so as to achieve agiven credit rating for a certain de#t tranche. This creates a potential conflict of interest' ofcourse' as the CRF may feel o#ligated to provide the issuer with that given rating if the issuer followed its advice on structuring the offering. %ome CRFs avoid this conflict #y refusing to
rate de#t offerings for which its advisory services were sought.
1B.2 R&tin'# #e 0/ 'o(e$n+ent $e')&to$/
Regulators use credit ratings as well' or permit ratings to #e used for regulatory purposes. -or eample' under the Basel II agreement of the Basel Committee on Ban,ing %upervision'
#an,ing regulators can allow #an,s to use credit ratings from certain approved CRFs !calledU&CFIsU' or U&ternal Credit Fssessment InstitutionsU" when calculating their net capitalreserve re$uirements. In the nited %tates' the %ecurities and &change Commission !%&C"
permits investment #an,s and #ro,er+dealers to use credit ratings from U *ationallyRecognized %tatistical Rating rganizationsU !*R%R" for similar purposes. The idea is that
#an,s and other financial institutions should not need ,eep in reserve the same amount ofcapital to protect the institution against !for eample" a run on the #an,' if the financial
institution is heavily invested in highly li$uid and very UsafeU securities !such as .%.government #onds or short+term commercial paper from very sta#le companies".
CRF ratings are also used for other regulatory purposes as well. The % %&C' for eample' permits certain #ond issuers to use a shortened prospectus form when issuing #onds if the
issuer is older' has issued #onds #efore' and has a credit rating a#ove a certain level. %&Cregulations also re$uire that money mar,et funds !mutual funds that mimic the safety andli$uidity of a #an, savings deposit' #ut without -ederal :eposit Insurance Corporation insurance" comprise only securities with a very high *R%R rating. i,ewise' insuranceregulators use credit ratings to ascertain the strength of the reserves held #y insurancecompanies.
In ?008' the % %&C voted unanimously to propose amendments to its rules that wouldremove credit ratings as one of the conditions for companies see,ing to use short+formregistration when registering securities for pu#lic sale.
This mar,s the first in a series of upcoming %&C proposals in accordance with :odd+-ran,to remove references to credit ratings contained within eisting Commission rules andreplace them with alternative criteria.
nder #oth Basel II and %&C regulations' not Dust any CRFGs ratings can #e used forregulatory purposes. !If this were the case' it would present a moral hazard" Rather' there is avetting process of varying sorts. The Basel II guidelines !paragraph 91' et al."' for eample'descri#e certain criteria that #an, regulators should loo, to when permitting the ratings froma particular CRF to #e used. These include Uo#Dectivity'U Uindependence'U Utransparency'Uand others. Ban,ing regulators from a num#er of Durisdictions have since issued their owndiscussion papers on this su#Dect' to further define how these terms will #e used in practice.!See The Committee of &uropean Ban,ing %upervisors :iscussion aper' or the %tate Ban,of a,istan &CFI Criteria".
In the nited %tates' since 19/' *R%R recognition has #een granted through a U*o FctionetterU sent #y the %&C staff. -ollowing this approach' if a CRF !or investment #an, or
#ro,er+dealer" were interested in using the ratings from a particular CRF for regulatory purposes' the %&C staff would research the mar,et to determine whether ratings from that particular CRF are widely used and considered Urelia#le and credi#le.U If the %&C staffdetermines that this is the case' it sends a letter to the CRF indicating that if a regulatedentity were to rely on the CRFGs ratings' the %&C staff will not recommend enforcement
action against that entity. These U*o FctionU letters are made pu#lic and can #e relied upon #y other regulated entities' not Dust the entity ma,ing the original re$uest. The %&C has sincesought to further define the criteria it uses when ma,ing this assessment' and in =arch ?00/
pu#lished a proposed regulation to this effect.
n %eptem#er ?9' ?00>' % resident Aeorge 4. Bush signed into law the Credit RatingReform Fct of ?00>. This law re$uires the % %ecurities and &change Commission toclarify how *R%R recognition is granted' eliminates the U*o Fction etterU approach andma,es *R%R recognition a Commission !rather than %&C staff" decision' and re$uires
*R%Rs to register with' and #e regulated #y' the %&C. % ; protested the Fct on thegrounds that it is an unconstitutional violation of freedom of speech In the %ummer of ?00
the %&C issued regulations implementing the act' re$uiring rating agencies to have policies to
prevent misuse of nonpu#lic information' disclosure of conflicts of interest and prohi#itionsagainst Uunfair practicesU.
Recognizing CRFsG role in capital formation' some governments have attempted to Dump+
start their domestic rating+agency #usinesses with various ,inds of regulatory relief or
encouragement. This may' however' #e counterproductive' if it dulls the mar,et mechanism
#y which agencies compete' su#sidizing less+capa#le agencies and penalizing agencies that
devote resources to higher+$uality opinions
1B.3 R&tin'# #e in #t$,t$e% fin&n,e
Credit rating agencies may also play a ,ey role in structured financial transactions. nli,e aUtypicalU loan or #ond issuance' where a #orrower offers to pay a certain return on a loan'structured financial transactions may #e viewed as either a series of loans with differentcharacteristics' or else a num#er of small loans of a similar type pac,aged together into aseries of U#uc,etsU !with the U#uc,etsU or different loans called UtranchesU". Credit ratingsoften determine the interest rate or price ascri#ed to a particular tranche' #ased on the $ualityof loans or $uality of assets contained within that grouping.
Companies involved in structured financing arrangements often consult with credit ratingagencies to help them determine how to structure the individual tranches so that each
receives a desired credit rating. -or eample' a firm may wish to #orrow a large sum of
money #y issuing de#t securities. owever' the amount is so large that the return investorsmay demand on a single issuance would #e prohi#itive. Instead' it decides to issue threeseparate #onds' with three separate credit ratingsSF !medium low ris,"' BBB !mediumris,"' and BB !speculative" !using %tandard ; oorGs rating system".
The firm epects that the effective interest rate it pays on the F+rated #onds will #e much lessthan the rate it must pay on the BB+rated #onds' #ut that' overall' the amount it must pay forthe total capital it raises will #e less than it would pay if the entire amount were raised from asingle #ond offering. Fs this transaction is devised' the firm may consult with a credit ratingagency to see how it must structure each trancheSin other words' what types of assets must
#e used to secure the de#t in each trancheSin order for that tranche to receive the desiredrating when it is issued.
There has #een criticism in the wa,e of large losses in the collateralized de#t o#ligation !C:" mar,et that occurred despite #eing assigned top ratings #y the CRFs. -or instance'losses on O<)0. million worth of C:s issued #y Credit %uisse Aroup added up to a#out
O1?/ million' despite #eing rated FFF or Faa #y %tandard ; oorGs' =oodyGs Investors%ervice and -itch Aroup.
The rating agencies respond that their advice constitutes only a Upoint in timeU analysis' thatthey ma,e clear that they never promise or guarantee a certain rating to a tranche' and thatthey also ma,e clear that any change in circumstance regarding the ris, factors of a particular tranche will invalidate their analysis and result in a different credit rating. In addition' someCRFs do not rate #ond issuances upon which they have offered such advice.
Complicating matters' particularly where structured finance transactions are concerned' therating agencies state that their ratings are opinions !and as such' are protected free speech'granted to them #y the UpersonhoodU of corporations" regarding the li,elihood that a givende#t security will fail to #e serviced over a given period of time' and not an opinion on thevolatility of that security and certainly not the wisdom of investing in that security. In the
past' most highly rated !FFF or Faa" de#t securities were characterized #y low volatility andhigh li$uiditySin other words' the price of a highly rated #ond did not fluctuate greatly day+to+day' and sellers of such securities could easily find #uyers.
owever' structured transactions that involve the #undling of hundreds or thousands of
similar !and similarly rated" securities tend to concentrate similar ris, in such a way that even
a slight change on a chance of default can have an enormous effect on the price of the
#undled security. This means that even though a rating agency could #e correct in its opinionthat the chance of default of a structured product is very low' even a slight change in the
mar,etGs perception of the ris, of that product can have a disproportionate effect on the
productGs mar,et price' with the result that an ostensi#ly FFF or Faa+rated security can
collapse in price even without there #eing any default !or significant chance of default". This
possi#ility raises significant regulatory issues #ecause the use of ratings in securities and
#an,ing regulation !as noted a#ove" assumes that high ratings correspond with low volatility
$uality of de#t o#ligation of different companies and assist individual and institution
investors in ma,ing investment.
In this contet' the credit rating information services of India limited was in 198.
following this' investment information and credit rating agencies of India was promoted in
1991 and credit analysis and research limited was floated in199<. all the credit rating
agencies have #een approved #y the R&%&RM& BF*E - I*:IF.
12. CRITICISM
Credit rating agencies have #een su#Dect to the following criticismH
Credit rating agencies do not downgrade companies promptly enough. -or
eample' &nronGs rating remained at investment grade four days #efore thecompany went #an,rupt' despite the fact that credit rating agencies had #eenaware of the companyGs pro#lems for months. r' for eample' =oodyGs gave-reddie =ac preferred stoc, the top rating until 4arren Buffett tal,ed a#out-reddie on C*BC and on the net day =oodyGs downgraded -reddie to one tic,a#ove Dun, #onds.P11Q %ome empirical studies have documented that yield spreadsof corporate #onds start to epand as credit $uality deteriorates #ut #efore a ratingdowngrade' implying that the mar,et often leads a downgrade and $uestioning theinformational value of credit ratings.P1?Q This has led to suggestions that' rather
than rely on CRF ratings in financial regulation' financial regulators should
instead re$uire #an,s' #ro,er+dealers and insurance firms !among others" to usecredit spreads when calculating the ris, in their portfolio.
arge corporate rating agencies have #een criticized for having too familiar arelationship with company management' possi#ly opening themselves to undueinfluence or the vulnera#ility of #eing misled. P1<Q These agencies meet fre$uentlyin person with the management of many companies' and advise on actions thecompany should ta,e to maintain a certain rating. -urthermore' #ecauseinformation a#out ratings changes from the larger CRFs can spread so $uic,ly!#y word of mouth' email' etc."' the larger CRFs charge de#t issuers' rather thaninvestors' for their ratings. This has led to accusations that these CRFs are
plagued #y conflicts of interest that might inhi#it them from providing accurateand honest ratings. Ft the same time' more generally' the largest agencies!=oodyGs and %tandard ; oorGs" are often seen as promoting a narrow+mindedfocus on credit ratings' possi#ly at the epense of employees' the environment' orlong+term research and development. These accusations are not entirelyconsistentH on one hand' the larger CRFs are accused of #eing too cozy with thecompanies they rate' and on the other hand they are accused of #eing too focusedon a companyGs U #ottom lineU and unwilling to listen to a companyGs eplanationsfor its actions.
4hile often accused of #eing too close to company management of their eisting
clients' CRFs have also #een accused of engaging in heavy+handed U#lac,mailUtactics in order to solicit #usiness from new clients' and lowering ratings for thosefirms . -or instance' =oodyGs pu#lished an UunsolicitedU rating of annover Re'with a su#se$uent letter to the insurance firm indicating that Uit loo,ed forward tothe day annover would #e willing to payU. 4hen annover managementrefused' =oodyGs continued to give annover Re ratings' which were downgradedover successive years' all while ma,ing payment re$uests that the insurerre#uffed. In ?00)' =oodyGs cut annoverGs de#t to Dun, status' and even thoughthe insurerGs other rating agencies gave it strong mar,s' shareholders wereshoc,ed #y the downgrade and annover lost O1/ million %: in mar,etcapitalization.
The lowering of a credit score #y a CRF can create a vicious cycle and self+
fulfilling prophecy' as not only interest rates for that company would go up' #utother contracts with financial institutions may #e affected adversely' causing anincrease in epenses and ensuing decrease in credit worthiness. In some cases'large loans to companies contain a clause that ma,es the loan due in full if thecompaniesG credit rating is lowered #eyond a certain point !usually a UspeculativeUor U Dun, #ondU rating". The purpose of these Uratings triggersU is to ensure that the
#an, is a#le to lay claim to a wea, companyGs assets #efore the company declares
#an,ruptcy and a receiver is appointed to divide up the claims against the
company. The effect of such ratings triggers' however' can #e devastatingH under aworst+case scenario' once the companyGs de#t is downgraded #y a CRF' thecompanyGs loans #ecome due in full2 since the trou#led company li,ely isincapa#le of paying all of these loans in full at once' it is forced into #an,ruptcy!a so+called Udeath spiralU". These rating triggers were instrumental in the collapse
of &nron. %ince that time' maDor agencies have put etra effort into detecting thesetriggers and discouraging their use' and the .%. %ecurities and &changeCommission re$uires that pu#lic companies in the nited %tates disclose theireistence.
Fgencies are sometimes accused of #eing oligopolists' #ecause #arriers to mar,et
entry are high and rating agency #usiness is itself reputation+#ased !and thefinance industry pays little attention to a rating that is not widely recognized". fthe large agencies' only =oodyGs is a separate' pu#licly held corporation thatdiscloses its financial results without dilution #y non+ratings #usinesses' and itshigh profit margins !which at times have #een greater than /0 percent of grossmargin" can #e construed as consistent with the type of returns one might epectin an industry which has high #arriers to entry.
Credit Rating Fgencies have made errors of Dudgment in rating structured
products' particularly in assigning FFF ratings to structured de#t' which in alarge num#er of cases has su#se$uently #een downgraded or defaulted. The actual
method #y which =oodyGs rates C:s has also come under scrutiny. If defaultmodels are #iased to include ar#itrary default data and URatings -actors are #iasedlow compared to the true level of epected defaults' the =oody3s PmethodQ willnot generate an appropriate level of average defaults in its default distri#ution
process. Fs a result' the perceived default pro#a#ility of rated tranches from ahigh yield C: will #e incorrectly #iased downward' providing a false sense ofconfidence to rating agencies and investors.U ittle has #een done #y ratingagencies to address these shortcomings indicating a lac, of incentive for $ualityratings of credit in the modern CRF industry. This has led to pro#lems for several
#an,s whose capital re$uirements depend on the rating of the structured assetsthey hold' as well as large losses in the #an,ing industry. FFF rated mortgage
securities trading at only 80 cents on the dollar' implying a greater than ?0Vchance of default' and 8.9V of FFF rated structured C:s are #eing consideredfor downgrade #y -itch' which epects most to downgrade to an average of BBBto BB+. These levels of reassessment are surprising for FFF rated #onds' whichhave the same rating class as % government #onds. =ost rating agencies do notdraw a distinction #etween FFF on structured finance and FFF on corporate orgovernment #onds !though their ratings releases typically descri#e the type ofsecurity #eing rated". =any #an,s' such as FIA' made the mista,e of not holdingenough capital in reserve in the event of downgrades to their C: portfolio. Thestructure of the Basel II agreements meant that C:s capital re$uirement roseGeponentiallyG. This made C: portfolios vulnera#le to multiple downgrades'
essentially precipitating a large margin call. -or eample under Basel II' a FFF
rated securitization re$uires capital allocation of only 0.>V' a BBB re$uires ).8V'a BB re$uires <)V' whilst a BB!+" securitization re$uires a /?V allocation. -or anum#er of reasons !fre$uently having to do with inade$uate staff epertise and thecosts that ris, management programs entail"' many institutional investors reliedsolely on the ratings agencies rather than conducting their own analysis of the
ris,s these instruments posed. !Fs an eample of the compleity involved inanalyzing some C:s' the F$uarius C: structure has /1 issues #ehind the cashC: component of the structure and another 1?9 issues that serve as referenceentities for O1.) #illion in C:% contracts for a total of 180. In a sample of Dust )0of these' they had on average >/00 loans at origination. roDecting that num#er toall 180 issues implies that the F$uarius C: has eposure to a#out 1.? millionloans." imco founder 4illiam Aross urged investors to ignore rating agency
Dudgments' descri#ing the agencies as Uan idiot savant with a full command of themathematics' #ut no idea of how to apply them.6
=any of the structured financial products that they were responsi#le for rating'
consisted of lower $uality GBBBG rated loans' #ut were' when pooled together intoC:s' assigned an FFF rating. The strength of the C: was not whollydependent on the strength of the underlying loans' #ut in fact the structureassigned to the C: in $uestion. C:s are usually paid out in a GwaterfallG stylefashion' where income received gets paid out first to the highest tranches' with theremaining income flowing down to the lower $uality tranches i.e. WFFF. C:swere typically structured such that FFF tranches which were to receive first lien!claim" on the BBB rated loans cash flows' and losses would tric,le up from the
lowest $uality tranches first. Cash flow was well insulated even against heavylevels of home owner defaults. Credit rating agencies only accounted for a N/Vdecline in national housing prices at worst' allowing for a confidence in rating themany of these C:s that had poor underlying loan $ualities as FFF. It did nothelp that an incestuous relationship #etween financial institutions and the creditagencies developed such that' #an,s #egan to leverage the credit ratings off oneanother and GshopG around amongst the three #ig credit agencies until they foundthe #est ratings for their C:s. ften they would add and remove loans ofvarious $uality until they met the minimum standards for a desired rating' usually'FFF rating. ften the fees on such ratings were O<00'000 + O/00'000' #ut ran upto O1 million.
It has also #een suggested that the credit agencies are conflicted in assigning
sovereign credit ratings since they have a political incentive to show they do notneed stricter regulation #y #eing overly critical in their assessment ofgovernments they regulate.
Fttempts to regulate more strictly credit rating agencies in the wa,e of the
&uropean sovereign de#t crisis have #een rather unsuccessful. %ome &uropeanfinancial regulation eperts have argued that the hastily drafted' unevenly
transposed in national law' and poorly enforced & rule on rating agencies!RXglement C& nY 10>0K?009" has had little effect on the way financial analysts and economists interpret data or potential conflict of interests created #y thecomple contractual arrangements #etween credit rating agencies and theirclientsU
13.RATING METHODOLOGY FOR RIMARY
DEALERS
1. C&*it&)
The RBI norms stipulate a minimum capital of Rs. /00 million for the standalone :
operations and a Capital Fde$uacy Ratio !CFR" of 1/V of the ris,+weighted assets.
Currently' all :s meet the norm on CFR easily as the assets held #y them are primarily in government securities' which carry zero credit ris, weight. The ratio
would #ecome important when the de#t mar,ets widen and the :s increase their
corporate de#t !non+government securities" eposure' which have a 100V credit ris,
weight age associated with it. ICRF analyses the financial capa#ility of a : in terms
of *et worth or own funds. ICRF epects the capital re$uirements to increase with
increase in the scale of operations of the :. Flso' in view of the inherent ris,s in a
: #usiness' a high net worth acts as a #uffer. ICRF' while placing high importance'
views the networth of a : as a very strong #uffer against insolvency.
The mar,et ris,' one of the inherent ris,s in the : #usiness' is epressed #y the
decline in the mar,et value of its assets. ICRF analyses the portfolio of the : and
su#Dects the same to stress analysis under varying interest rate scenarios. Fs the
potential loss is determined #y the duration of the portfolio' ICRF studies the a#ove
stress test for different duration and the gearing levels of the :. ICRF views the net
worth to potential loss as an important ratio while evaluating the :. In case of
erosion of the a#ove cover' ICRF epects the :s to scale down its operations or
infuse more capital in form of e$uity. ICRF also studies the mar,et ris, models used
#y the :' if any' for their operations and evaluates the :s contingency plans.
3. C$e%it Ri#>
%ince the :s primarily deal in government securities' the credit ris, is negligi#le.
owever' with the :s gradually increasing their eposure to corporate de#t paper to
its improve yields and margins' the credit ris, would assume a greater importance.
ICRF evaluates the internal norms and the control systems used to measure the credit
ris, #y the :.
4. Fn%in' &n% Le(e$&'e
Currently the funding profile for a :s is s,ewed in favour of call money and
repo #orrowings. Fs a : is #asically a trader' it #orrows from the short+term call
mar,et and deploys them in government securities' there#y earning an interest spread.
4ith the #orrowings on call money and repo #eing repriced daily and the associated
volatility with the call mar,ets' a lower leverage would mitigate the interest rate ris,s
for the : on the lia#ility side. ICRF epects the :s funding profile to change infavour of the term money mar,et once the de#t mar,et in the country deepens. F
higher proportion of the own funds in the funding profile provides comfort.
!. M&n&'e+ent &n% S/#te+#
This is one of the important factors while evaluating the ris, profile of a :.
Currently as most of the :s are #ac,ed #y strong promoters' ICRF factors in the
implicit support of the parent while evaluating the :. ICRF views a sta#le and
eperienced management to manage the interest rate and li$uidity ris, profile of the
#usiness #etter. The a#ility of the management to retain ,ey operating personnel is an
important factor in this line of #usiness. ICRF also evaluates the internal operating
guidelines and ris, management systems such as the prudential norms and Malue at
Ris, !MFR" set in place #y the management. The adherence and efficient usage ofsuch systems #y the management are construed as a comforting factor. ICRF
appreciates that due to eternal mar,et environment' there could #e periods when the
internal norms were #reached. ICRF studies and analyses such nstances and the
actions ta,en #y the : to rectify the same. In addition' ICRF evaluates :s
performance as regards conformity regulatory norms in respect ofthe primary mar,et and secondary mar,et operations in terms of #idding
commitments and turnover ratios. Though confirming to these norms are not a
pro#lem for the :s currently with a fewer num#er of : operating and steadily
growing government #orrowings programmes' ICRF feels that this could #ecome
important with entry of more players in the : #usiness and the any changes in the
regulatory norms.
. $ofit&0i)it/
The financial performance of a : is largely dependent on eternal environment
such as the economic cycle' government #orrowing programme and the interest rates
movements. The profita#ility is seen over a meaningful period of time to understand
the income sta#ility of a : with respect to its peers. 4hile considering the
performance of the : in terms of revenues' gearing and Return on *etworth' ICRF
notes the profita#ility is dependent on the aggressiveness of the :. The a#ility of the
management to $uic,ly adapt to the changing environment provides comfort in form
of a relatively lower volatility in income. There are low li$uidity ris,s for a :s as
most of their assets are in government securities' which are highly li$uid. Fs their
main #usiness revolves around trading' their investments in non government
securities are usually in instruments that carry high credit rating !rating of FF and
e$uivalent and a#ove". The growing repo mar,et for government securities andli,ely introduction of repo on corporate #onds further alleviates any li$uidity
