Complexity level of Rated instruments

The advantage of rating symbols is their simplicity, which facilitates universal understanding. Rating companies also publish explanations for their symbols used as well as the rationale for the ratings assigned by them, to facilitate deeper understanding.

Credit rating is an opinion expressed by an independent professional organization, after making a detailed study of all relevant factors. Such an opinion will be of great assistance to investors in making investment decisions. It also helps the issuers of debt instruments to price their issues correctly and to reach out to new investors. Regulators like Reserve Bank of India (RBI) and Securities & Exchange Board of India (SEBI) often use credit rating to determine eligibility criteria for some instruments. For example, RBI has stipulated a minimum credit rating by an approved agency for issue of Commercial Paper. Credit ratings are also used for determination of risk weights for calculation of Capital Adequacy for Banks as per Basel II guidelines in India. In general, credit rating is expected to bridge information asymmetry in the market and establish, over a period of time, a more meaningful relationship between the quality of debt and the yield from it. Credit Rating is also a valuable input in establishing business relationships of various types.

It does not. The reason is that some factors, which are of significance to an investor in arriving at an investment decision, are not taken into account by rating agencies. These include reasonableness of the issue price or the coupon rate, secondary market liquidity and pre-payment risk. Further, different investors have different views regarding the level of risk to be taken and rating agencies can only express their views on the relative credit risk.

A credit rating is a professional opinion given after studying all available information at a particular point of time. Nevertheless, such opinions may prove wrong in the context of subsequent events. Further, there is no privity of contract between an investor and a rating agency and the investor is free to accept or reject the opinion of the agency. Nevertheless, rating is essentially an investor service and a rating agency is expected to maintain the highest possible level of analytical competence and integrity. In the long run, the credibility of a rating agency has to be built, brick by brick, on the quality of its services.

To answer the second question first, it is neither possible nor even desirable, to totally eliminate the subjective element. Ratings do not come out of a pre-determined mathematical formula, which fixes the relevant variables as well as the weights attached to each one of them. Rating agencies do a great amount of number crunching, but the final outcome also takes into account factors like quality of management, corporate strategy, economic outlook and international environment. To ensure consistency and reliability, a number of qualified professionals are involved in the rating process. Ratings are assigned by Committees, not individuals. Rating agencies also ensure that the rating process is insulated from any possible conflicts of interest.

The answer to both the questions is yes. In the well-developed capital markets, debt issues are, more often than not, rated by more than one agency. And it is only natural that the opinions given by two or more agencies will vary, in some cases. But it will be very unusual if such differences are very wide. For example, a debt issue may be rated DOUBLE A PLUS by one agency and DOUBLE A or DOUBLE A MINUS by another. It will indeed be unusual if one agency assigns a rating of DOUBLE A while another gives a TRIPLE B.

A rating is an opinion given on the basis of information available at a particular point of time. As time goes by, many things change, affecting the debt servicing capabilities of the issuer, one way or the other. It is, therefore, essential that as a part of their investor service, rating agencies monitor all outstanding debt issues rated by them. In the context of emerging developments, the rating agencies often put issues under credit watch and upgrade or downgrade the ratings as and when necessary. Normally, such action is taken after intensive interaction with the issuers.

Yes. In a situation where an issuer is unhappy with the rating assigned, he may request for a review, furnishing additional information, if any, considered relevant. Such representations are placed before the External Review Committee (ERC), which consists of at least 1/3rd external, independent members. The ERC undertakes a review and thereafter indicates its final decision.

The rating process is a fairly detailed exercise. It involves, among other things, analysis of published financial information, visits to the issuer’s office and works, intensive discussion with the senior executives of issuer, discussions with auditors, bankers, etc. It also involves an in-depth study of the industry itself and a degree of environment scanning. All this takes time and a rating agency may take two or three weeks to arrive at a decision, subject to availability of all the solicited information. It is of paramount importance to rating companies to ensure that they do not, in any way, compromise on the quality of their analysis, under pressure from issuers for quick results. Issuers would also be well advised to approach the rating agencies sufficiently in advance so that issue schedules can be adhered to.

It is possible, but rating companies do not and should not indulge in competitive generosity. Any attempt by issuers to play one agency against another will have to be discouraged by all the rating companies. It may, however, be pointed out here that two rating companies may, and often do, arrive at different conclusions on the same issue. This is only natural, as perceptions differ.

Informed public opinion will be the touchstone on which the rating companies have to be assessed and the success of a rating agency should be measured by the quality of the services offered, consistency and integrity. Cumulative Default Rates (CDR) give historical default rates for various instruments rated by CARE. Apart from this Rating transition study which presents information on how ratings have changed over a period of time, also can be seen to evaluate the stability/migration of its ratings. CDR and Transition studies are available on CARE website in regulatory disclosures.

Both. Rating of instruments would consider instruments’ specific characteristics like maturity, credit enhancements specific to the issue etc. Issuer ratings consider the overall debt management capability of an issuer on a medium-term perspective, typically three to five years. While issuer ratings are more often than not, one-time assessments of credit quality, instrument ratings are monitored over the life of the instrument.

By definition, credit rating is an opinion on the issuer's capacity to service debt. In the case of equity, there is no pre-determined servicing obligation, as equity is in the nature of venture capital. So, credit rating in the conventional sense does not apply to equity shares.

A credit rating is a professional opinion on the ability and willingness of an issuer to meet debt servicing obligations. It is an opinion on future debt servicing capabilities given on the basis, inter-alia, of past performance and all available information (from audited financial statements, interaction with company management, banks and financial institutions, statutory auditors, etc.) at a particular time. While rating agencies make all possible efforts to project corporate business prospects, industry trends and management capabilities, many events are unpredictable. Hence, such opinions may prove wrong in the context of subsequent events. On the occurrence of such an event, a rating agency can only review and make appropriate changes in the rating. In other words, credit quality (and credit rating) is dynamic, not static and all rating agencies review their ratings periodically and make changes, wherever considered appropriate. Such changes are reported widely through the media. It is the experience of all rating agencies that some instruments initially rated as investment grade fall below investment grade or go into default, over a period of time. Having said this, CARE’s ratings philosophy is based on the concept of ‘through the cycle’ assessment of credit risk. That is, the ratings assigned by CARE are aimed at withstanding normal industry cycles. Abnormal situations or unforeseen events which may impact the credit risk of an entity may, however, have an impact on the rating.

s Further, it must be noted that there is no privity of contract between an investor or a lender and a rating agency and the investor is free to accept or reject the opinion of the agency. A credit rating is not an advice to buy, sell or hold securities or investments and investors are expected to take their investment decisions after considering all relevant factors and their own policies and priorities. A credit rating is not a guarantee against future losses. Credit ratings do not take into account many aspects which influence investment decisions. They do not, for example, evaluate the reasonableness of the issue price, possibilities for capital gains or take into account the liquidity in the secondary market. Ratings also do not take into account the risk of prepayment by issuer, or interest or exchange risks. Although these are often related to the credit risk, the rating essentially is an opinion on the relative quality of the credit risk, based on the information available at a given point of time.

'SO/CE’ symbol is attached in case of any arrangement or structuring as a result of which there is a “credit enhancement” which enhances the standalone credit quality of an issuer. ‘CE’ is attached only as long as the above arrangement/structure is from external, explicit from third party e.g. guarantee, letter of comfort, pledge of shares etc.

When a rating is assigned pending execution of certain critical documents or steps to be taken, the rating is a ‘Provisional’ rating indicated by prefixing ‘Provisional’ before the rating symbol. On execution of the critical documents to the satisfaction of CARE Ratings Ltd., the final rating is assigned.

CARE’s credit ratings are opinions on credit risk and are not recommendations to buy, sell or hold any security. Credit Ratings do not take into account many aspects which influence the investment decision such as:

• Whether any particular rated securities are suitable investments for a particular investor or group of investors;
• Whether the expected return of a particular investment is adequate compensation for the risk;
• Whether a rated security is in line with the investor’s risk appetite;
• Whether the price of the security is appropriate or even commensurate with its credit risk;
• Whether factors other than credit risk should influence that market price, and to what extent.
• Whether there will be a secondary market for the security;
• Whether there is a prepayment risk on the security etc.

CARE’s ratings are based on information obtained from sources believed by it to be accurate and reliable. CARE does not, however, guarantee the accuracy, adequacy or completeness of such information and is not responsible for any errors or omissions or for the results obtained from the use of such information. CARE does not perform an ‘audit’ in connection with the rating exercise nor does it undertake a forensic exercise to detect fraud. On occasions, CARE may rely on unaudited financial information. Moreover, most entities whose bank facilities/instruments are rated by CARE have paid a credit rating fee, based on the amount and type of bank facilities/instruments.