"Credit Rating Process" What Is A Rating

Download as docx, pdf, or txt
Download as docx, pdf, or txt
You are on page 1of 9

Credit Rating Process What is a Rating: Grade summarizing the willingness and ability to repay.

Ability to pay-quantitative Willingness to pay-qualitative Letter Grades Sub-categories of grades Major Credit Rating Companies: S & P, Moodys,Fitch etc. Locally:JCR-VIS & PACRA Why Credit Rating???

A rating is NOT: A judgment or statement regarding any aspect of public policy. A political statement in favor of or against a particular person or administration. A dictate of which should be done or how a matter should be handled.

Why bother a rating/rating agency: Increase investor acceptance. -----Increase investor acceptance. Current economic environment. -----Current economic environment. Current capital market environment. ----Current capital market environment. BOTTOM LINE: Lower Interest Cost. ----BOTTOM LINE: Lower Interest Cost.

Types of Credit Ratings: Sovereign Ratings:

Assess the country Credit riskand is used as a point of reference for countryborrowings from WB, IMF, ADB, IDB etc Entity Ratings: Risk ratings of Corporate entities. Instrument Ratings: Ratings of the Bonds issued bydifferent corporations and municipalities.

Rating Terminologies Long Term: AAAAAA AA+AA+ AAAA AA-AAA+A+ AA A-ABBB+BBB+ BBBBBB BBB- etc BBB- etc Rating Terminologies Short Term: A1+:A1+: Obligations supported by the highest capacity for timelyObligations supported by the highest capacity for timelyrepayment.repayment. A1:A1: Obligations supported by a strong capacity for timelyrepayment. A2:

Obligations supported by a satisfactory capacity for timelyrepayment, although such capacity may be susceptible toadverse changes in business, economic, or financial conditions. A3: Obligations supported by an adequate capacity for timelyrepayment. Such capacity is more susceptible to adversechanges in business, economic, or financial conditions than for obligations in higher categories. B: Obligations for which the capacity for timely repayment issusceptible to adverse changes in business, economic, or financial conditions. C: Obligations for which there is an inadequate capacity toensure timely repayment. D: Obligations which have a high risk of default or which arecurrently in default. Sectors where Credit Rating Plays a VitalRole:Role: Commercial Banks: Mutual Funds: Investment Banks: Leasing Companies: Insurance Companies: Bonds & Securitization etc.

The Rating Process: Step I: Decision and documents Step II: Rating Presentations meetings, conferencecalls, and /or site visits Step III: Rating Committee, communication, pressrelease, report Appeal process, if necessary Surveillance

Rating Methodology Following major factors are assessed in the Credit RatingProcess: Industry Risk Market Position Ownership & Support Earning & Performance Cash FlowsManagement Evaluation Capital & Debt Structure Funding & Flexibility Corporate Governance Additional Factors for Financial Institutions

I - Industry Risk Economic importance of the industry to the country. Potential for support. Employment significance. Industrial relations record. Significance of legislation: protective and harmful, relationship withgovernment. Maturity of the industry. International competition. Barriers to entry. Competitive situation domestically: monopoly, oligopoly, fragmentation. Nature of the industry: capital intensity, product lifespan, marketingrequirements. Cyclic factors: demand, supply, implications for price volatility.

Industry cost and revenue structure: susceptibility to energy prices,interest rate levels, government policies. Important developments and trends in the industry.

II - Market Position:

Competitive position within the industry: size, market share &trend, price-setting ability. Major product importance. Product lives and competition. Degree of product diversification. Significance of R&D expenditure and of new productdevelopment. Geographic diversity of sales and production. Significance of major customers. Dependence on major suppliers and access to alternatives. Marketing needs. Distribution network, control and susceptibility to externalfactors.

What are the growth trends, and sources of growth?

III Ownership & Support The specific issues include: Ownership of the entity. Relationship with owners, autonomy, control. Financial strength of owner (s). Potential for support or for funds withdrawals. Structure of ownership.

Other benefits: access to technology, products. Access to capital markets.

IV- Earnings & Performance The specific issues include: Consistency and trend of core earnings. Earnings mix by activity and geography. Exceptional and extraordinary items: non-recurring impacts onpast earnings levels. True earnings levels available for cash flow: equity accounting,restrictions on profit repatriation. Internal growth versus acquired earnings.

Contd IV- Earnings & Performance Profitability and protection measures. Profit margins. Interest & pre-tax coverage measures. Dividend cover, payment levels and future policy. Taxation situation: effective tax rate, specific relief. Sufficiency of retained earnings to finance growth internally.

V Cash Flows Relationship of cash flow to leverage and ability to internally meet all cash requirements is evaluated. The volatility of cash flow over time and the impact of seasonality on cash flow is alsoassessed. The specific issues include: Adequacy of cash flow to maintain the operating capacity of the business: working capital levels, replacement of fixed assets. Contribution from cash flow towards expansion: major capital spending projects, acquisitions.

Discretionary spending included in cash flow including advertising, exploration, research & development expenditure.

contd V Cash Flows Volatility of cash flow over time. Relationship between cash flow and total debt. Restrictions on cash flow : limits on repatriation, potentialtaxation effects, access to dividends from subsidiaries. Liquidity levels and fluctuations: seasonality, sensitivities. Working capital management and measurements.

VI Management Evaluation The specific issues include: Record to date in financial terms. Corporate goals and outlook: aggressive stance, attitude to risk. Experience, background, credibility. Depth of management: key individuals, succession. Record compared with peers.

VII Capital & Debt Structure The specific issues include: Debt/Equity measures: historic, present and projected. Leverage (total liabilities/equity) measures: historic, present andprojected Sensitivity Analysis on projected levels

Seasonal variations Coverage measures on interest & leasing Adjustments for off-balance sheet items. Appropriateness of capital structure for the business: over-reliance on short term funding, sensitivity to interest ratechanges. Debt Structure: Type, maturity, currency, service schedule,covenants, security, default clause.

VIII Funding & Flexibility The specific issues include: Flexibility of planned financial needs : capital spending, dividendlevels, acquisitions. Ability to raise additional financing under stress. Back-up and standby lines of credit : periods and covenants of underwriting facilities and committed lines, bank relationshipsgenerally. Ability to attract capital : shareholder make-up, access to equitymarkets. Capital commitments.

Cont..

VIII Funding & Flexibility Margin of safety in present and planned gearing/leverage levels. Asset make-up : nature of assets and potential for reductions or disposals under stress, scalable units. Off-balance sheet assets and liabilities : goodwill or other intangibles written off, undervalued assets, pension under funding.

IX Corporate Governance The independence and effectiveness of the board of directorsOversight of related party transactions that may lead to conflicts of interest. Board oversight of the audit function. Executive and director remuneration. Complex holding company structures. Ownership by private individuals and families. Also examine other aspects of corporate governance whose impact onbondholders is less clear cut; these include equity ownership byexecutives and directors

X Additional Factors for Financial Institutions Quality of the asset portfolioStability of earningSources and cost of fundsAsset / liability structureCapital adequacy and liquidityMarket environment and strategyProspects

The House is Open to Any Number of QuestionsThe House is Open to Any Number of Questions ThanksThanks

You might also like