“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

• Timely repayments can help demonstrate a borrower’s creditworthiness and can influence its ability to borrow money in the future.
• These ratings provide a measurement of company solvency and their future financial obligations. It simply tells the risk-return ratio for a debt instrument
• Investors may hesitate to invest or lend to such companies that are not able to roll-over (refinance) their existing debt.
• A higher credit rating provides a margin of safety and confidence to investor’s means they tell the level of risks associated with the company/debt instruments. For example, investing in company deposits it is suggested to go with a rating of AAA or AA at least.
• Very high-risk ratings like D generally do not appeal to investors, importantly in case of investment-grade ones (BBB- or above).
• A rating helps the companies to evaluate their risks and overcome with measures that can enhance their corporate image. It is like an alarm clock for the company to lower the debt and manage the efficiency of the firm
• The higher the credit rating, the lower is the rate of interest offered to the organization/entity. Good-rated credit ratings can borrow money at more favourable interest rates.

• There is no standard formula to calculate the credit rating. different agencies could come to different conclusions and give different ratings i.e. they use their judgment to rate the debt instrument
• These rating agencies are paid by the same companies and here a conflict of interest may arise, as their businesses come from the very same companies hence, they could be more favourable to give better ratings
• We have seen many times inaccurate ratings and their evaluation of creditworthiness was a big blow to the investors. For example – rating failures during the subprime crisis 2008 (mortgage-backed securities)
• Reliability- In India more than 70 companies are the highest rated while the USA has about a few companies only. Reliance has AAA's highest rating by CRISIL at the domestic level whereas at the international level it is BBB+ by S&P.