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“If you don't take good care of your credit, then your credit won't take good care of you.” ― Tyler Gregory
What you should know about credit rating?
You might have heard that XYZ rating agency downgraded or upgraded the rating of ABC Corporation or Moody's downgraded India ratings.
AAA, BBB, C, CCC.... However, what do these symbols mean?
Credit rating is nothing assessment of the reliability of an obligor of a particular financial instrument or entity. However, it is a subjective thing and rating is given after assessing qualitative and quantitative assessment on the risks involved and calculating the probability of default of payments on a debt instrument. It is not a recommendation to buy, hold, or sell rather it provides an additional input to investors to decide his own opinion before arriving at any investment decisions. It is rather a grade given by a credit rating agency to a particular financial instrument or a country. In simple words, these agencies rate the ability and willingness of the issuer that timely payments of financial obligations are met in a manner.
SEBI Regulations, 1999 of the Securities and Exchange Board of India Act, 1992, regulate credit rating agencies in India. Top credit agencies in India are viz, CRISIL, CARE, ICRA, SMREA, Brickwork Rating, and India Rating and Research Pvt. Ltd.
Note- Assessment of all financial and non-financial parameters, the study of economy and other factors are taken into account. Every financial parameter is benchmarked within its industry peers.
History of Credit Rating Agencies
The concept of rating agencies originated in the United States in the early 1900s. Lewis Tappan created the first viable credit reporting service in America (New York) Tappan's Mercantile Agency, in 1841.
Henry Varnum Poor (Standard & Poor’s later) wrote and published in 1860 "History of Railroads and Canals in the United States" comes first in this case, and this formed the basis of securities analysis and reporting that developed over the next century.
John Bradstreet – Established in 1849, Published Rating Guideline – 1857
John Moody is the one who started Moody's and published an analysis of the tangled and uncertain world of railway finances, which added analytical information about the value of securities. John Knowles Fitch is the man who founded the Fitch Publishing Company in 1913. He later published financial statistics for use in the investment industry via "The Fitch Stock and Bond Manual" and "The Fitch Bond Book".
New rating agencies were formed in subsequent years; however, the original rating agencies are Fitch, Moody’s, and Standard and Poor.
Credit rating agencies in India is relatively a new concept and do not have much past. S&P global company (CRISIL) came into existence in 1987s.
Rating Methodology?
Evaluating a credit risk, rating agencies typically use frameworks or mathematical models, or a combination of the two. Analysts to grade a financial instrument uses different methods to conclude any decision. For example, CAMEL, rating scale, CAMELS, etc.
Credit rating scale
Here is a look at the rating symbols used by the three credit rating agencies for a financial instrument (For long-term debt instruments). A different symbol is used to rate different financial instruments like Long-term, Short-term, Fixed Deposit (FD), structured finance ratings, corporate credit ratings.
Sovereign credit rating
A sovereign credit rating is an independent assessment of the creditworthiness of a country or sovereign entity such as a national government.it indicates the risk level ecosystem of investing in that country and includes political risk, regulatory risk, and other factors to determine the probability of default. A good rating shows the willingness of the national government in creating fair practices and levels of transparency in an economy. There are many agencies, which offer sovereign credit rating most prominent ones are Standard & Poor's, Fitch, and Moody's.
Top Credit Rating Agencies in India are:
(CRISIL) - Credit Rating Information Services of India Limited It is the First credit rating company in India. Its headquarter is based in Mumbai. The main shareholder in CRISIL is S&P (Standard & Poor)
ICRA Limited - Investment Information and Credit Rating Agency It is the Second oldest credit rating agency and was set up in 1991. This was formed as a joint venture of Moody’s and Indian financial entities. The headquarter is based in Gurugram, Haryana.
Credit Analysis and Research Limited (CARE) - It was established in 1993 and is India’s second-largest credit rating agency. It has its headquarters in Mumbai and regional offices in different locations. The main promoters are Industrial Development Bank of India (IDBI), Unit Trust of India (UTI) Bank, Canara Bank, and others.
India Rating and Research Pvt. Ltd. - It is a 100% owned subsidiary of the Fitch Group. The headquarters is in Mumbai and was founded in 1995
Importance of credit rating
A credit score is a numerical value given to an individual based on credit history. Each time you apply for a loan or credit, the credit provider like Banks or lending institutions contacts agencies like EXPERIAN, EQUIFAX, TRANSUNION, with your personal information and the amount of credit you have applied for. These agencies process this information and then create your credit report. The credit score is calculated based on what is in your credit report and is the first criterion to be checked by the credit provider. A lower CIBIL attracts a higher rate of interest and vice versa. CIBIL score normally ranges between 300 to 900 and a score of above 700 is good CIBIL, however other factors also depends while credit provider takes while lending. Timely payments of loan or credit translate into a good score.
A credit report is just a collection of data relating to your borrowing history. For example, personal loan, Vehicle loan, credit card payments, etc.
DIFFERENT USERS OF CREDIT RATING
Different investors, intermediaries, and businesses, and financial institutions use credit ratings.
Investors- Investors use ratings in addition to their analysis to make investment division i.e. managing their portfolio understanding their threshold limits for credit risk.
Intermediaries – Intermediaries like Investment banks use credit ratings for comparison of different debt issues as well as to set the initial level price for the debt issues they structure and the anticipated interest rate. Sometimes they construct SPV (special purpose vehicle) such as a mortgage or home loans or structured finance product and sell it to investors.
Debt issuers – Sovereign governments, cities, corporations, municipalities, etc., use credit ratings as a tool for an unbiased evaluation of their creditworthiness and credit risk that may arise with their debt issues.
Businesses and corporations use to evaluate businesses and measure the risk involved that may arise due to counterparty transaction e.g. partnerships or Joint ventures (JVs) with other businesses.
Conclusion
How one should respond to credit rating?
Credit rating should not be a single basis for investment decisions. These ratings are not constant and can change any time during your investment horizon. You should be able to judge whether you should purchase a debt instrument at a certain interest rate for a certain price. You should be able to do fundamental and quantitative analysis while investing in security. You should properly analyze the level of Risks involved associated with that security.
The rating is supposed to be the unbiased, professional, and independent opinion of a CRA (Credit rating agency). A rating is valid until the debt obligations are fully paid for that financial instrument and are subjected for timely review for the validity of the same. Credit ratings can be used to find the viability of the securities whether these are speculative or investment opportunities. Lower graded securities are considered speculative as well as higher graded are investment grade.
These ratings have played an important role in the financial world and the economy. They have helped investors level of risks associated, the creditworthiness of the borrower otherwise, the investor’s community would have been in a world of oblivion and it would have been difficult to track different levels of risk and set appropriate interest rate. It is important to note that SEBI does not have any direct role for assessment made by credit rating agencies.
In the end, credit ratings are just opinions after assessing different risks by these agencies.
Kundan Kishore
Curator of A Complete Course on the Indian Stock Market.