Credit rating is an assessment of the creditworthiness of individuals and corporations. It is based upon the history of borrowing and repayment as well as the availability of assets and extent of liabilities. A credit rating tells a lender or investor the probability of the subject being able to pay back a loan.
However, in recent years, credit ratings have also been used to adjust insurance premiums, determine employment eligibility, and establish the amount of a utility or leasing deposit.
A poor credit rating indicates a high risk of defaulting on a loan and thus, leads to high-interest rates or the refusal of a loan by the creditor.
Characteristics of Credit Ratings
Following are the main characteristics of credit rating:
1. Rating is Based on Information
Any rating based entirely on published information has serious limitations and the success of a rating agency will depend, to a great extent, on its ability to access privileged information.
Co-operation from the issues as well as their willingness to share even confidential information is important pre-requisites.
The rating agency must keep information of confidential nature possessed during the rating process, a secret.
2. Many Factors Affect Rating
The rating does not come out of a predetermined mathematical formula.
To ensure consistency and reliability a number of qualified professionals are involved in the rating process.
3. Rating by More than One Agency
In the well-developed capital markets, debts issues are more often than not, rated by more than one agency.
And it is only natural that ratings given by two or more agencies differ from each other like a debt issue, maybe rated AA+ by one agency and AA or AA- by another.
It will indeed be unusual if one agency assigns a rating of AA while another gives a BBB.
4. Monitoring the Already Rated ISsues
A rating is an opinion given on the basis of information available at a particular point in time.
Many factors may affect the debt servicing capabilities of the issuer.
It is, therefore, essential that rating agencies should put issues under close credit watch and upgrade or downgrade the ratings as per the circumstances after intensive interaction with the issuers.
5. Publication of Ratings
In India, ratings are undertaken only at the request of the issuers, and only those ratings which re-accepted by the issuers are published.
Thus, 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.
6. Right of Appeal Against Assigned Rating
Where an issuer is not satisfied with the rating assigned, he may request for a review, furnishing additional information, if any, considered relevant.
The rating agency will undertake a review and thereafter give its final decision.
Unless the rating agency had overlooked critical information at the first stage chances of the rating being changed on appeal are rare.
7. Rating of Rating Agencies
Informed public opinion will be the touchstone on which the rating companies have to be assessed and the success of a rating agency is measured by the quality of the services offered, consistency, and integrity.
8. Rating is for Instrument and not for the Issuer Company
The important thing to note is that rating is done always 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, particularly if maturities are substantially different or one of the instruments is backed by additional credit reinforcements like guarantees.
9. Credit Rating not Applicable to Equity Shares
By definition, credit rating is an option 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 ratings do not apply to equity shares.
10. Credit Versus Financial Analysis
Credit rating is a much broader concept than financial analysis.
One important factor which needs consideration is that the ratings are normally done at the request of and with the active cooperation 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.
11. Time Taken in Credit Rating Process
The rating process is a fairly detailed exercise.
It involves, among other things analysis of published financial information, visit the issuer’s offices and works, intensive discussion with the senior executives of issuers, discussions with auditors, bankers, creditors, etc.
It also involves an in-depth study of the industry itself and a degree of environment scanning.
All this takes time, a rating agency may take 6 to 8 weeks or more to arrive at a decision.
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