Credit rating helps investors by providing an easily recognizable, simple tool that couples a possible unknown issuer with an informative and meaningful symbol of credit quality.
Credit rating provide unbiased assessment of the creditworthiness of the companies issuing debt instruments. And they also provide information about the creditworthiness of corporate to the investors at a low cost.
Credit Rating Process of Financial Instruments
The steps involved in credit rating process are explained below:
1. Receipt of the Request
The credit rating process begins, with the receipt of a formal request for rating from a company desirous of having its issue obligations under proposed instrument rated by credit rating agencies.
An agreement is entered into between the rating agency and the issuer company.
The agreement spells out the terms of the rating assignment and covers the following aspects:
- It requires the CRA (credit rating agency) to keep the information confidential.
- It gives the right to the issuer company to accept or not to accept the rating.
- It requires the issuer company to provide all material information to the CRA for rating and subsequent surveillance.
2. Assignment to Analytical Team
On receipt of the above request, the CRA assigns the job to an analytical team.
The team usually comprises of two members/analysts who have expertise in the relevant business area and are responsible for carrying out the rating assignments.
3. Obtaining Information
The analytical team obtains the requisite information from the client company. Issuers are usually provided a list of information requirements and a broad framework for discussions.
The requirements are derived from the experience of the issuers business and broadly confirm to all the aspects which have a bearing on the rating.
The analytical team analyses the information relating to its financial statements, cash flow projections, and other relevant information.
4. Plant Visits and Meeting with Management
The obtain classification and a better understanding of the client’s operations, the team visits, and interests with the company’s executives.
Plants visits facilitate understanding of the production process, assess the state of equipment and main facilities, evaluate the quality of technical personnel and form an opinion on the key variables that influence level, quality, and cost of production.
Direct dialogue is maintained with the issuer company as this enables the CRA’s to incorporate non-public information in a rating decision and also enables the rating to be forward-looking.
The topics discussed during the management meeting are wide-ranging including competitive position, strategies, financial policies, historical performance, risk profile, and strategies in addition to reviewing financial data.
5. Presentation of Findings
After completing the analysis, the findings are discussed at length in the internal committee, comprising senior analysts of the credit rating agencies.
All the issues having a bearing on the rating are identified.
An opinion on the rating is also formed.
The findings of the team are finally presented to the rating committee.
6. Rating Committee Meeting
This is the final authority for assigning ratings.
The rating committee meeting is the only aspect of the process in which the issuer does not participate directly.
The rating is arrived at after composite assessment of all the factors concerning the issuer, with the key issues fetting greater attention.
7. Communication of Decision
The assigned rating grade is communicated finally to the issuer along with reasons or rationale supporting the credit rating.
The credit ratings which are not accepted are either rejected or reviewed in the light of additional facts provided by the issuer.
The rejected credit ratings are not disclosed and complete confidentiality is maintained.
8. Dissemination of the Public
Once the issuer accepts the rating, the credit rating agencies disseminate it through printed reports to the public.
9. Monitoring for Possible Change
Once the company has decided to use the rating, CRAs are obliged to monitor the accepted ratings over the life of the instrument.
The CRA constantly monitors all ratings with reference to new political, economic, and financial developments and industry trends.
All this information is reviewed regularly to find companies for, major changes. Any changes in the rating are made public through published reports by CRAs.
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