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Financial Services Industry Training                     Introduction to                  Credit Rating Agencies    Saunde...
Training from Saunders Learning Group     Saunders Learning Group provides a variety     of training programs, workshops a...
Topics   1.    Meaning and Definition   2.    Role and Function of Credit Rating Agencies   3.    Moodys, Standard & Poors...
Basic TermsSaunders Learning Group, LLCSaunders Learning Group, LLC, Andover, KS
Credit Rating A credit rating estimates the credit  worthiness of an a financial security, a  corporation, local governme...
What is A Credit RatingAn opinion on the issuer‟s capacity to meet its financial obligations on aparticular issue in a tim...
Distinction Between Credit Rating and Reporting      A Credit Rating Agency (CRA) is a company that is responsible for ass...
Meaning and Definition           A Credit Rating issued by a credit rating agency is an assessment of the            cred...
Uses of credit ratings                Building                                                                         Pri...
Module 1   Role and Function of Credit         Rating AgenciesSaunders Learning Group, LLCSaunders Learning Group, LLC, An...
Credit Reporting AgenciesFunction          Provides investors with unbiased reviews and opinion as the credit risk of     ...
Functions of a Credit Rating Agency   Provide easy to understand information: Rating agencies gather information,    then...
How Credit Ratings Are Established                                         AnalysisAdjusted FinancialStatement Data       ...
Industry methodologies…Analysis                                            Key metrics                                    ...
Importance of Credit Ratings    Credit ratings establish a link between risk and return. They thus provide a yardstick    ...
Module 2 Moodys, Standard & Poors,       Fitch RatingsSaunders Learning Group, LLCSaunders Learning Group, LLC, Andover, K...
Nationally Recognized Statistical RatingOrganization In 1975, the U.S. Securities Exchange Commission  established the „N...
Major Credit Rating Agencies The major agencies were either  independent or owned by nonfinancial  companies. Moodys, a ...
Rating Scales used by Major Credit RatersThe three largest credit rating agencies each use different scales for their rati...
Value of Credit Ratings   Credit ratings can also speak to the credit quality of an    individual debt issue, such as a c...
Factors Involved in Credit Rating      Credit rating depends on several factors, some of       which are tangible/numeric...
S&P Credit Rating ProcessThis is an example of a ratingprocess:    1. The issuer of a financial product       requests a r...
Rating data flow…Company Reports                                                                  Adjusted Financial XYZ C...
Nature of Credit Rating   Rating is based on information: A rating is not based entirely on published    information and ...
Module 3              Rating MethodologySaunders Learning Group, LLCSaunders Learning Group, LLC, Andover, KS             ...
Rating Methodology   The methodology for creating a rating involves an analysis of all the factors    affecting the credi...
Business Risk AnalysisBusiness risk analysis aims at analyzing the industry risk, market position of the company,operating...
Business Risk Analysis - continued Operating efficiency: Favorable locational advantages, management and labor  relations...
Rating Methodology   Financial Analysis: Financial analysis is used to determine the financial strength of the    issuer ...
Cash Flow and Financial Analysis Cash flow analysis: Cash flow analysis is undertaken in relation to debt and  fixed and ...
Additional Analysis Geographical Analysis: Geographical analysis is undertaken to determine  the locational advantages en...
Rating scaleInvestment             Aaa                   Minimal credit risk   Grade               Aa(1-3)                ...
Rating Categories Ratings are constructed to represent the risk of default;  that is, a high (low) rating implies a low (...
Nature of Credit Rating Monitoring the already rated issues: Rating agencies monitor all outstanding debt  issues rated b...
Nature of Credit Rating Rating not applicable to equity shares: A credit rating is an opinion on the issuers  capacity to...
Module 4Advantages and Disadvantages         of RatingsSaunders Learning Group, LLCSaunders Learning Group, LLC, Andover, ...
Benefits of Ratings            For Companies                                  For Investors   Market access (gate keeping...
Advantages of Credit Rating       Benefits to Investors                           Benefits the Company      Safety of inv...
Disadvantages of Credit RatingCredit rating suffers from the following limitations:   Non-disclosure of significant infor...
Questions Saunders Learning Group, LLC, Andover, KS
Thank You !Saunders Learning Group, LLCSaunders Learning Group, LLC, Andover, KS
About the Author/Presenter                                                Floyd Saunders has worked on Wall Street       ...
Reference Material                                               Figuring Out Wall Street Consumer‟s Guide To             ...
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Intro to Credit Rating Agencies

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What is the role of credit rating agencies in our global financial system? Learn how credit ratings on securities are created and used. Part of a continuing series of introductory seminars for the financial services industry. We develop custom training, contact us for a quote or discussion of your needs.

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  • Benefits to InvestorsSafety of investments. Credit rating gives an idea in advance to the investors about the degree of financial strength of the issuer company. Based on rating he decides about the investment. Highly rated issues gives an assurance to the investors of safety of Investments and minimizes his risk.Recognition of risk and returns. Credit rating symbols indicate both the returns expected and the risk attached to a particular issue. It becomes easier for the investor to understand the worth of the issuer company just by looking at the symbol because the issue is backed by the financial strength of the company.Freedom of investment decisions. Investors need not seek advise from the stock brokers, merchant bankers or the portfolio managers before making investments. Investors today are free and independent to take investment decisions themselves. They base their decisions on rating symbols attached to a particular security. Each rating symbol assigned to a particular investment suggests the creditworthiness of the investment and indicates the degree of risk involved in it.Wider choice of investments. As it is mandatory to rate debt obligations for every issuer company, at any particular time, wide range of credit rated instruments are available for making investment. Depending upon his own ability to bear risk, the investor can make choice of the securities in which investment is to be made.Dependable credibility of issuer. Absence of any link between the rater and rated firm ensures dependable credibility of issuer and attracts investors. As rating agency has no vested interest in issue to be rated, and has no business connections or links with the Board of Directors. In other words, it operates independent of the issuer company, the rating given by it is always accepted by the investors.Easy understanding of investment proposals. Investors require no analytical knowledge on their part about the issuer company. Depending upon rating symbols assigned by the rating agencies they can proceed with decisions to make investment in any particular rated security of a company.Benefits to CompanyEasy to raise resources. A company with highly rated instrument finds it easy to raise resources from the public. Even though investors in different sections of the society understand the degree of risk and uncertainty attached to a particular security but they still get attracted towards the highly rated instruments.Reduced cost of borrowing. Investors always like to make Investments in such instrument, which ensure safety and easy liquidity rather than high rate of return. A company can reduce the cost of borrowings by quoting lesser interest on those fixed deposits or debentures or bonds, which are highly rated.Reduced cost of public issues. A company with highly rated instruments has to make least efforts in raising funds through public. It can reduce its expenditure on press and publicity. Rating facilitates best pricing and timing of issues.Rating builds up image. Companies with highly rated instrument enjoy better goodwill and corporate image in the eyes of customers, shareholders, investors and creditors. Customers feel confident of the quality of goods manufactured, shareholders are sure of high returns, investors feel secured of their investments and creditors are assured of timely payments of interest and principal.Rating facilitates growth. Rating motivates the promoters to undertake expansion of their operations or diversify their production activities thus leading to the growth of the company in future. Moreover highly rated companies find it easy to raise funds from public through new issues or through credit from banks and FIs to finance their expansion activities.Recognition to unknown companies. Credit rating provides recognition to relatively unknown companies going for public issues through wide investor base. While entering into market, investors rely more on the rating grades than on ‘name recognition’
  • Non-disclosure of significant information : Firm being rated may not provide significant or material information, which is likely to affect the investor’s decision as to investment, to the investigation team of the credit rating company. Thus any decisions taken in the absence of such significant information may put investors at a loss.Static study : Rating is a static study of present and past historic data of the company at one particular point of time. Number of factors including economic, political, environment, and government policies have direct bearing on the working of a company. Any changes after the assignment of rating symbols may defeat the very purpose of risk indicativeness of rating.Rating is no certificate of soundness : Rating grades by the rating agencies are only an opinion about the capability of the company to meets its interest obligations. Rating symbols do not pinpoint towards quality of products or management or staff etc. In other words rating does not give a certificate of the complete soundness of the company. Users should form an independent view of the rating symbol.Rating may be biased : Personal bias of the investigating team might affect the quality of the rating. The companies having lower grade rating do not advertise or use the rating while raising funds from the public. In such a case the investors cannot get the true information about the risk involved in the instrument.Rating under unfavorable conditions : Rating grades are not always representative of the true image of a company. A company might be given low grade because it was passing through unfavorable conditions when rated. Thus, misleading conclusions may be drawn by the investors which hampers the company’s interest.Difference in rating grades : Same instrument may be rated differently by the two rating agencies because of the personal judgment of the investigating staff on qualitative aspects. This may further confuse the investors.Improper Disclosure May Happen : The company being rated may not disclose certain material facts to the investigating team of the rating agency. This can affect the quality of credit rating. Impact of Changing Environment : Rating is done based on present and past data of the company. So, it will be difficult to predict the future financial position of the company. Many changes take place due to changes in economic, political, social, technological, legal and other environments. All this will affect the working of the company being rated. Therefore, rating is not a guarantee for financial soundness of the company. Problems for New Companies : There may be problems for new companies to collect funds from the market. This is because, a new company may not be in a position to prove its financial soundness. Therefore, it may receive lower credit ratings. This will make it difficult to collect funds from the market. Downgrading by Rating Agency : The credit-rating agencies periodically review the ratings given to a particular instrument. If the performance of a company is not as expected, then the rating agency will downgrade the instrument. This will affect the image of the company.
  • Transcript of "Intro to Credit Rating Agencies"

    1. 1. Financial Services Industry Training Introduction to Credit Rating Agencies Saunders Learning Group, LLC Saunders Learning Group, LLC, Andover, KS
    2. 2. Training from Saunders Learning Group Saunders Learning Group provides a variety of training programs, workshops and seminars targeted to the financial services industry. Programs are available in a wide range of topics, and we are specialists in developing custom programs that are targeted to your needs. Contact the founder, Floyd Saunders at 316-680-6482 or at floyd@floydsaunders.com for more information. Saunders Learning Group, LLC, Andover, KS1
    3. 3. Topics 1. Meaning and Definition 2. Role and Function of Credit Rating Agencies 3. Moodys, Standard & Poors, Fitch Ratings 4. Rating Methodology 5. Advantages of Credit Rating 6. Disadvantages of Credit Rating Saunders Learning Group, LLC, Andover, KS Slide 2
    4. 4. Basic TermsSaunders Learning Group, LLCSaunders Learning Group, LLC, Andover, KS
    5. 5. Credit Rating A credit rating estimates the credit worthiness of an a financial security, a corporation, local government or even a country. It is an evaluation made by credit reporting agency of a risk of buying into a specific security offering and based on a number of factors. Credit ratings are calculated from financial history and current assets and liabilities. Typically, a credit rating tells a lender or investor the probability of the subject being able to meet payment requirements for interest and principal repayment. Saunders Learning Group, LLC, Andover, KS
    6. 6. What is A Credit RatingAn opinion on the issuer‟s capacity to meet its financial obligations on aparticular issue in a timely manner, for example long-term bonds: Saunders Learning Group, LLC, Andover, KS
    7. 7. Distinction Between Credit Rating and Reporting A Credit Rating Agency (CRA) is a company that is responsible for assessing the financial strength of a company or government entity. This includes domestic and foreign companies. The main area that a credit rating agency focuses on is the ability of the company or government entity to meet the interest and principle payments on their debts and bonds.  A credit rating agency is different from a credit reporting agency.  A credit reporting agency is responsible for compiling financial data that is necessary for loan decisions.  A credit rating agency does all the statistical assessments that are involved in placing a rating on a company or organization’s credit history..  A credit rating agency is responsible for providing investors with information about an organization’s creditworthiness. Saunders Learning Group, LLC, Andover, KSSlide 3
    8. 8. Meaning and Definition  A Credit Rating issued by a credit rating agency is an assessment of the credit worthiness of individual financial securities (For example, a bond) and debt issued by corporations, government issued securities or even a country’s ability to repay debt.  Credit Ratings are assigned by rating agencies to companies and debt instruments, are designed to gauge the likelihood that a company will default on its obligations to creditors. Thus, they give investors a rough idea of the risk associated with loaning money to the entity being rated.  Credit ratings are forward-looking opinions about credit risk. It express the agency’s opinion about the ability and willingness of an issuer, such as a corporation or state or city government, to meet its financial obligations in full and on time. Saunders Learning Group, LLC, Andover, KSSlide 4
    9. 9. Uses of credit ratings Building Pricing Portfolios Credit Ratings Contracts Trading Regulatory RequirementsCredit ratings are critical to the activities of securities markets, as they are depended on to create andmanage investment portfolios, the pricing of new securities, trading of securities, financial contracts (andloans) and for some financial institutions to meet regulatory requirements. Saunders Learning Group, LLC, Andover, KS 8
    10. 10. Module 1 Role and Function of Credit Rating AgenciesSaunders Learning Group, LLCSaunders Learning Group, LLC, Andover, KS Slide 9
    11. 11. Credit Reporting AgenciesFunction Provides investors with unbiased reviews and opinion as the credit risk of various securities.  Performs credit and risk analysis to produce ratings.  Maintains databases of credit and risk information on companies and financial securities.  Provides unbiased opinion. An independent credit rating agency provides anExample unbiased opinion as to relative capability of a company to service debt obligations.  Provides quality and dependable information on investment and credit risk which isActivities more authenticate and reliable.  Provides information at low cost or no cost to investors.  Investors rely on the ratings assigned by the ratings agencies while taking investment decisions.  Ratings are published in the form of reports and are available easily on the payment of negligible price or free of charge depending on the arrangements in specific countries.  A.M. Best; Credit Analysis & Research (CARE), India; Dominion Bond Rating Example Service, Canada; Fitch Ratings, U.S. & UK; Investment Information and CreditCompanies Rating Agency (ICRA), India, Moody‟s, S&P. Complete list @: http://www.defaultrisk.com/rating_agencies.htm Saunders Learning Group, LLC, Andover, KS Slide 10
    12. 12. Functions of a Credit Rating Agency Provide easy to understand information: Rating agencies gather information, then analyze information to interpret and summarize complex information in a simple and readily understood manner. Provide basis for investment: An investment rated by a credit rating enjoys higher confidence from investors. Investors can make an estimate of the risk and return associated with a particular rated issue while investing money in them. Healthy discipline on corporate borrowers: Higher credit rating to any credit investment makes the financial instrument (bond, mortgage security) more attractive to investors. Corporations can borrow money more cheaply if they maintain high credit ratings on their debt. Formation of public policy: Once the debt securities are rated professionally, it would be easier to formulate public policy guidelines as to the eligibility of securities to be included in different kinds of institutional portfolios. Saunders Learning Group, LLC, Andover, KS 11
    13. 13. How Credit Ratings Are Established AnalysisAdjusted FinancialStatement Data Rating CommitteeOther Company Package andSpecific Data RecommendationIndustry / MacroEconomic Data A credit rating agency collects a variety of data, analyses it and produces a recommended credit rating, once reviewed, it distributed to potential investors. Saunders Learning Group, LLC, Andover, KS 12
    14. 14. Industry methodologies…Analysis Key metrics Benchmark and rate Weigh Indicative Rating Other qualitative factors Final ratingThe typical methods used by credit rating agencies to compare a individual rating analysis to keymetrics about that company, and benchmark data to weighted values and produce an indicativerating. This is then reviewed internally to produce a final rating. Saunders Learning Group, LLC, Andover, KS 13
    15. 15. Importance of Credit Ratings Credit ratings establish a link between risk and return. They thus provide a yardstick against which to measure the risk inherent in any instrument. An investor uses the ratings to assess the risk level and compares the offered rate of return with his expected rate of return (for the particular level of risk) to optimize his risk-return trade-off. The risk perception of a common investor, in the absence of a credit rating system, largely depends on his familiarity with the names of company and what they might know about the company. It is not feasible for the corporate issuer of a debt instrument to offer every prospective investor the opportunity to undertake a detailed risk evaluation. For the typical investor, it would difficult to assess all of the financial information available to assign their own risk ratings. Thus the need for credit rating in today’s world cannot be over emphasized. Saunders Learning Group, LLC, Andover, KS
    16. 16. Module 2 Moodys, Standard & Poors, Fitch RatingsSaunders Learning Group, LLCSaunders Learning Group, LLC, Andover, KS 15
    17. 17. Nationally Recognized Statistical RatingOrganization In 1975, the U.S. Securities Exchange Commission established the „Nationally Recognized Statistical Rating Organization‟ (NRSRO) designation Three of best known rating agencies in the U.S. were named: • Moody‟s Investor Services • Standard and Poor‟s • Fitch Rating In 2003, the SEC approved a fourth NRSRO, Dominion Bond Rating Services (DBRS) from Canada. Saunders Learning Group, LLC, Andover, KS
    18. 18. Major Credit Rating Agencies The major agencies were either independent or owned by nonfinancial companies. Moodys, a subsidiary of Dun and Bradstreet, dominated the market for commercial credit ratings. Standard and Poors was a subsidiary of McGraw-Hill, a major publishing company with a strong business information focus. Fitch, initially a publishing company, was bought by an independent investor group in 1989. Credit-rating agencies are often regarded as the gatekeepers of the capital markets because of the impact of their opinions on the structuring and pricing of financial products. Saunders Learning Group, LLC, Andover, KS
    19. 19. Rating Scales used by Major Credit RatersThe three largest credit rating agencies each use different scales for their ratings asshown here: Saunders Learning Group, LLC, Andover, KS
    20. 20. Value of Credit Ratings Credit ratings can also speak to the credit quality of an individual debt issue, such as a corporate note, a municipal bond or a mortgage-backed security, and the relative likelihood that the issue may default. The credit rating represents the credit rating agencys evaluation of qualitative and quantitative information for a company or government; including non-public information obtained by the credit rating agencies analysts. Each agency applies its own methodology in measuring creditworthiness and uses a specific rating scale to publish its ratings opinions. A poor credit rating indicates a credit rating agencys opinion that the company or government has a high risk of defaulting, based on the agencys analysis of the entitys history and analysis of long term economic prospects Saunders Learning Group, LLC, Andover, KS
    21. 21. Factors Involved in Credit Rating  Credit rating depends on several factors, some of which are tangible/numerical and some of which are judgmental and intangible. These factors include:  Overall fundamentals and earnings capacity of the company and volatility of the same.  Overall macro economic and business/ industry environment.  Liquidity position of the company (as distinguished from profits).  Requirement of funds to meet irrevocable commitments.  Financial flexibility of the company to raise funds from outside sources to meet temporary financial needs.  Guarantee/support from financially strong external bodies.  Level of existing leverage (borrowings) and financial risk. Saunders Learning Group, LLC, Andover, KSSlide 18
    22. 22. S&P Credit Rating ProcessThis is an example of a ratingprocess: 1. The issuer of a financial product requests a rating 2. The rating agency does an initial evaluation 3. This may include meetings with an issuer’s management team 4. The financial product is reviewed 5. The analysis is reviewed by a rating committee 6. Once a rating is assigned the issuer is notified 7. Ratings are then distributed to the public 8. Rating agencies then monitor the issuers and reports adjustments. Saunders Learning Group, LLC, Andover, KS 21
    23. 23. Rating data flow…Company Reports Adjusted Financial XYZ Company DATABASE Statement DataRating Methodologies Adjustment Worksheets Saunders Learning Group, LLC, Andover, KS 22
    24. 24. Nature of Credit Rating Rating is based on information: A rating is not based entirely on published information and the success of a rating agency depends, on its ability to access privileged information.  Cooperation from the issuers as well as their willingness to share even confidential information are important pre-requisites.  The rating agency must keep information of confidential nature possessed during the rating process, a secret. Many factors affect rating: A rating is given by taking into account the 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.  The Rating Committee, which assigns the final rating, consists of specialized financial and credit analysts.  Rating agencies also ensure that the rating process is free from any possible clash of interest. Rating by more than one agency: In a well developed capital market, debt issues are often rated by more than one agency.  And it is only natural that ratings given by two or more agencies differ from each other e.g., a debt issue, may be rated ‘AA+’ by one agency and ‘AA’ or ‘AA-’ by another.  It would be unusual if one agency assigns a rating of AA while another gives a ‘BBB’. Saunders Learning Group, LLC, Andover, KS
    25. 25. Module 3 Rating MethodologySaunders Learning Group, LLCSaunders Learning Group, LLC, Andover, KS Slide 24
    26. 26. Rating Methodology The methodology for creating a rating involves an analysis of all the factors affecting the creditworthiness of an issuer company: business, financial and industry characteristics, operational efficiency, management quality, competitive position of the issuer and commitment to new projects etc. • A detailed analysis of the past financial statements is made to assess the performance and to estimate the future earnings. • The company’s ability to service the debt obligations over the tenure of the instrument being rated is also evaluated. • In fact, it is the relative comfort level of the issuer to service obligations that determine the rating. A rating analysis includes the following factors: 1. Business Risk Analysis 2. Financial Analysis 3. Management Evaluation 4. Geographical Analysis 5. Regulatory and Competitive Environment 6. Fundamental Analysis Saunders Learning Group, LLC, Andover, KS
    27. 27. Business Risk AnalysisBusiness risk analysis aims at analyzing the industry risk, market position of the company,operating efficiency and legal position of the company.  Industry risk: The rating agencies evaluates the industry risk by taking into consideration various factors like strength of the industry prospect, nature and basis of competition, demand and supply position, structure of industry, pattern of business cycle etc.  Industries compete with each other on the basis of price, product quality, distribution capabilities etc.  Industries with stable growth in demand and flexibility in the timing of capital outlays are in a stronger position and therefore enjoy better credit rating.  Market position of the company: Rating agencies evaluate the market standing of a company taking into account: i. Percentage of market share ii. Marketing infrastructure iii. Competitive advantages iv. Selling and distribution channel v. Diversity of products vi. Customers base vii. Research and development projects viii. Quality Improvement programs undertaken to identify obsolete products Saunders Learning Group, LLC, Andover, KS
    28. 28. Business Risk Analysis - continued Operating efficiency: Favorable locational advantages, management and labor relationships, cost structure, availability of raw-material, labor, compliance to pollution control programs, level of capital employed and technological advantages etc. affect the operating efficiency of every issuer company and hence the credit rating. Legal position: Legal position of a debt instrument is assessed by letter of offer containing terms of issue, trustees and their responsibilities, mode of payment of interest and principal in time, provision for protection against fraud etc. Size of business: The size of business of a company is a relevant factor in the rating decision.  Smaller companies are more prone to risk due to business cycle changes as compared to larger companies.  Smaller companies operations are limited in terms of product, geographical area and number of customers.  Whereas large companies enjoy the benefits of diversification owing to wide range of products, customers spread over larger geographical area. Business analysis covers all the important factors related to the business operations over an issuer company under credit assessment. Saunders Learning Group, LLC, Andover, KS
    29. 29. Rating Methodology Financial Analysis: Financial analysis is used to determine the financial strength of the issuer company through quantitative means such as:  ratio analysis  cash flow analysis  study of the existing capital structure. Both past and current performance is evaluated to comment the future performance of a company This includes an analysis of four important factors namely:  Accounting quality: As credit rating agencies rely on the audited financial statements, the analysis of statements begins with the study of accounting quality.  This includes: qualification of auditors, overstatement/understatement of profits, methods adopted for recognizing income, valuation of stock and charging depreciation on fixed assets are studied.  Earnings potential/profitability: Profits indicate company’s ability to meet its fixed interest obligation in time.  A business with stable earnings can withstand any adverse conditions and also generate capital resources internally.  Profitability ratios like operating profit and net profit ratios to sales are calculated and compared with last 5 years figures or compared with the similar other companies carrying on same business. As a rating is a forward-looking exercise, more emphasis is laid on the future rather than the past earning capacity of the issuer. Saunders Learning Group, LLC, Andover, KS
    30. 30. Cash Flow and Financial Analysis Cash flow analysis: Cash flow analysis is undertaken in relation to debt and fixed and working capital requirements of the company.  Indicates the usage of cash for different purposes and the extent of cash available for meeting fixed interest obligations.  Cash flows analysis facilitates credit rating of a company as it better indicates the issuer’s debt servicing capability compared to reported earnings. Financial flexibility: Existing Capital structure of a company is studied to find:  The debt/equity ratio, alternative means of financing used to raise funds, ability to raise funds, asset deployment potential etc.  The future debt claims on the issuer’s as well as the issuer’s ability to raise capital is determined in order to find issuer’s financial flexibility. Management Evaluation: Any company’s performance is significantly affected by:  Management goals, plans and strategies  Capacity to overcome unfavorable conditions  staff’s own experience and skills, planning and control system etc. Rating of a debt instrument requires evaluation of the management strengths and weaknesses. Saunders Learning Group, LLC, Andover, KS
    31. 31. Additional Analysis Geographical Analysis: Geographical analysis is undertaken to determine the locational advantages enjoyed by the issuer company.  An issuer company having its business spread over large geographical area enjoys the benefits of diversification and hence gets better credit rating.  A company located in backward area may enjoy subsidies from government thus enjoying the benefit of lower cost of operation.  Thus geographical analysis is undertaken to determine the locational advantages enjoyed by the issuer company. Regulatory and Competitive Environment: Credit rating agencies evaluate structure and regulatory framework of the financial system in which it works.  While assigning the rating symbols, CRAs evaluate the impact of regulation/deregulation on the issuer company. Fundamental Analysis: Fundamental analysis includes an analysis of liquidity management, profitability and financial position, interest and tax rates sensitivity of the company. Saunders Learning Group, LLC, Andover, KS
    32. 32. Rating scaleInvestment Aaa Minimal credit risk Grade Aa(1-3) A(1–3) Watch list = Baa(1-3) under review Ba(1-3) B(1-3) Caa(1-3) Outlook = likely direction High Ca Yield C In default, little prospect of recovery Saunders Learning Group, LLC, Andover, KS 31
    33. 33. Rating Categories Ratings are constructed to represent the risk of default; that is, a high (low) rating implies a low (high) probability of default.  Default refers to any event that results in the issuer‟s breaching its financial contract.  Large companies with strong and stable cash flows are likely to be rated higher than small companies with more volatile cash flows. Investment grade refers to the safest levels of financial securities.  Investment-grade securities have historically exhibited relatively low rates of default. Speculative grade, or noninvestment grade, refers to the riskier securities.  Debt rated BB (Ba for Moody‟s) or below is noninvestment grade, and is sometimes referred to as “high yield” or “junk.”  Default rates among these classes of securities are comparatively high. Within the major rating categories (AA, A, etc.), credit ratings are often modified to show relative standing within a category. Moody‟s uses numbers 1, 2, and 3, while S&P and Fitch use plus (+) and minus (−) signs. Saunders Learning Group, LLC, Andover, KS
    34. 34. Nature of Credit Rating Monitoring the already rated issues: Rating agencies monitor all outstanding debt issues rated by them as part of their investor service. Rating agencies may put issues under a credit watch and upgrade or downgrade the ratings as per the circumstances after intensive interaction with the issuers. Publication of ratings: Once a rating is accepted it is published and subsequent changes emerging out of the monitoring by the agency will be published even if such changes are not found acceptable by the issuers. Right of Appeal: Where an issuer is not satisfied with the rating assigned, a review may be requested. Unless the rating agency had over looked critical information at the first stage chances of the rating being changed on appeal are rare. Rating is for instrument and not the issuer company: A rating is done for a particular issue and not for a company or the Issuer.  It is quite possible that two instruments issued by the same company carry different ratings, if maturities are substantially different or one of the instruments is backed by additional credit reinforcements like guarantees.  In many cases, short-term obligations, like commercial paper (CP) carry the highest rating even as the risk profile changes for longer maturities. Saunders Learning Group, LLC, Andover, KS
    35. 35. Nature of Credit Rating Rating not applicable to equity shares: A credit rating is an opinion on the issuers capacity to service debt. For equity shares there is no debt servicing obligation, so credit rating does not apply to equity shares. Credit vs. financial analysis: Credit rating is much broader concept than financial analysis. One important factor which needs consideration is that the rating is normally done at the request of and with the active co-operation of the issuer.  The rating agency has access to unpublished information and the discussions with the senior management of issuers give meaningful insights into corporate plans and strategies.  Necessary adjustments are made to the published accounts for the purpose of analysis. Rating is carried out by specialized professionals who are highly qualified and experienced. The final rating is assigned keeping in view the number of factors. Time taken in rating process: The rating process is a fairly detailed exercise.  It involves analysis of published financial information, visits to the issuers offices and works, intensive discussion with the senior executives of issuers, auditors, bankers, and creditors etc.  All this takes time, a rating agency may take 6 to 8 weeks or more to arrive at a decision. Saunders Learning Group, LLC, Andover, KS
    36. 36. Module 4Advantages and Disadvantages of RatingsSaunders Learning Group, LLCSaunders Learning Group, LLC, Andover, KS Slide 35
    37. 37. Benefits of Ratings For Companies For Investors Market access (gate keeping)  Due diligence efficiency Expands breadth of market  Multiple independent perspectives Widens distribution  Facilitates comparisons Improves liquidity  Tool in portfolio management Improves pricing  Enhances secondary market liquidity Helps management with  Relatively stable over time independent, outside perspective on  Basis for performance benchmarks company Helps management monitor counterparty risk Saunders Learning Group, LLC, Andover, KS 36
    38. 38. Advantages of Credit Rating Benefits to Investors Benefits the Company  Safety of investments.  Easier to raise funding  Recognition of risk and  Reduced cost of borrowing returns.  Reduce cost of public issues  Freedom of investment  Ratings can build up image decisions.  Ratings facilitates growth  Wider choice of investments  Recognition to unknown  Dependable credibility of companies issuer  Easy understanding of investment proposalsBenefits to Intermediaries For brokers ratings make it easier to persuade clients to select an investment proposal of investment in highly rated instruments. Saunders Learning Group, LLC, Andover, KS Slide 37
    39. 39. Disadvantages of Credit RatingCredit rating suffers from the following limitations: Non-disclosure of significant information Static study Rating is no certificate of soundness Rating may be biased Rating under unfavorable conditions Difference in rating grades Improper Disclosure May Happen Impact of Changing Environment Problems for New Companies Downgrading by Rating Agency Saunders Learning Group, LLC, Andover, KS
    40. 40. Questions Saunders Learning Group, LLC, Andover, KS
    41. 41. Thank You !Saunders Learning Group, LLCSaunders Learning Group, LLC, Andover, KS
    42. 42. About the Author/Presenter  Floyd Saunders has worked on Wall Street with both Bank of America and JPMorgan, where is was a vice president in global financial systems. He has worked across the industry in retail, commercial, and investment banking.  He has taught courses in Money and Banking and extensively for the American Institute of Banking and various colleges.  As a consultant, he developed and taught a wide range of banking and investing courses.  He authored three programs for the American Bankers Association: Banking on Mutual Funds and Annuities, Introduction to Securities Markets and Investing in Securities.  He is the author of “Figuring Out Wall Street” and his next book is “Family Financial Freedom” a book on personal money management. Saunders Learning Group, LLC, Andover, KS
    43. 43. Reference Material Figuring Out Wall Street Consumer‟s Guide To Financial Markets By Floyd Saunders Publisher: Saunders Learning Group ISBN: 978-0-9824019-0-3 Available from Amazon: http://www.amazon.com/Figuring-Out-Wall-Street- Consumers/dp/0982401906 and many other online book stores. Book summary: Figuring Out Wall Street, is the concise guide to help everyone understand how what to do now to restore our financial systems. Written in an easy to understand manner, even the most complex financial concepts are easy to digest. This book provides help to monitor investments with a review of investment products, financial regulators and economic indicators. Learn how the stock market exchanges work and the world of investment banking, hedge funds, venture capital and private equity. Every chapter includes action plans for investing. Saunders Learning Group, LLC, Andover, KS
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