Credit rating is the process of estimating a firm's ability to perform to its capacity. It also determines the financial worthiness of an organization depending on the performance of the organization in the past.
Objectives of credit rating agencies
1. Its primary objective is to provide guidance to the investors, creditors in determining the credit risk associated with debt instrument.
2. To shift the primary burden of establishing corporate credit quality from the broker/underwriter to the rating agency and thus lessen potential conflicts of interest between underwriter and investors.
3. Provide an increased disclosure, better accounting standards and improved financial information to institutional investors.
4. Encourage the direct mobilization and saving from individuals rather than from intermediary lending institution.
5. Providing benefits to the borrowing company by:
a) Reducing interest cost for higher rated companies.
b) Providing a marking tool in placing its debt obligations with an investor's base level of risk.
[...] The major ratios computed are: Coverage Ratio: Coverage ratio is a measure of how many times the issuing company earned income and how the issuing company could pay the interest charges and other cost related to the debt issue. Financial Leverage Ratio: It is a set of ratios to assess proudly what is the mix of funds source. Liquidity Ratio: To know the firms ability to pay debts currently coming due, liquidity ratios are calculated. Cash Flow Ratio: If cast flow of a company is sufficient in relation to interest payment liability and total long term debts, the debt instruments of the company may get higher rating. [...]
[...] Criteria for credit rating Past performance of the company and the prospectus Coverage Ratios Interest Cover Debt Service Coverage Ratio Net Cash Accruals to total debt Capital Structure Gearing Total debt/Tangible Net worth Total debt/Adjusted Net worth Total debt + off balance sheet funding liabilities/TNW Total debt + off B/S liabilities/Adjusted Net Worth Credit Enhancements Group Support Objectives of a credit rating company To assist investors in making investment decisions To assist issuers in raising funds from a wider investor base To provide a marketing tool to entities placing debt with clients To institutionalize a viable and market-driven system of credit rating Its rating provides a guide to the investors as to risk of timely payment of interest and principal on a particular debt instrument. [...]
[...] Healthy discipline on corporate borrowers: Higher credit rating to any credit investment tends to enhance the corporate image and visibility and hence it induces a healthy discipline on corporates. Greater credence to financial and other representation: when credit rating agency rates a security, its own reputation is at stake. So it seeks financial and other information, the quality of which is acceptable to it. As the issues complies with the demands of a credit of this is acceptable to it. [...]
[...] Credit rating process Any rating agency assign a rating entry when there is adequate information available to form a credible opinion and only after extensive quantitative, qualitative and if appropriate legal analyses are performed. The process of rating is broadly three-tier system: Receipt of information Analysis of information. Granting rating symbols. Receipts of information: Rating exercise is based on information provided by the company or agency when the issuer approaches the credit rating agencies; it is to provide relevant information to them. [...]
[...] ii) Static Study Rating is done on the present and past historic data of the company and this is only a static study. Prediction of the company's health through rating is momentary and anything can happen after assignment of rating symbols to the company. Many changes take place in economic environment, political situation, government policy framework which directly affects the working of a company. iii) Concealment of material information Rating company might conceal material information from the investigating team of the credit rating company. [...]
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