everything you need to know about credit rating

1.     What is a credit rating?

2.     How does a credit rating agency differ from a credit bureau?

3.     Is a credit rating a recommendation to invest in a debt instrument?

4.     What is the difference between credit rating and equity research?

5.     How does a credit rating differ from an audit?

6.     How does a rating agency operate when issuers’ disclosure levels are low?

7.     Does a credit rating assure repayment?

8.     Who pays for a credit rating?

9.     If the issuer pays for the rating, how does a credit rating agency maintain its independence?

10.   Who regulates a rating agency?

11.   Is competition desirable in the credit rating industry?

12.   How do investors benefit from a credit rating?

13.   What do the various credit rating symbols mean?

14.   Does the minus sign in a rating symbol have negative connotations relating to the issuer’s performance or its debt-servicing capability?

15.   What are Structured Obligation (so) ratings? Are they different from other credit ratings?

16.   What is the validity period of a credit rating?

17.   How are credit rating changes communicated?

18.   Why do credit ratings change?

19.   If a credit rating is downgraded, does it mean that a default is imminent? 

20.   Does the size of the rated debt obligation affect its credit rating? 

21.   What are ‘Provisional’ ratings?

1. What is a credit rating? 
A credit rating represents the rating agency’s opinion on the likelihood of a rated debt obligation being repaid in full and on time. A simple alphanumeric symbol is normally used to convey a credit rating.
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2. How does a credit rating agency differ from a credit bureau? 
A credit rating agency provides an opinion relating to future debt repayments by borrowers. A credit bureau provides information on past debt repayments by borrowers.
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3. Is a credit rating a recommendation to invest in a debt instrument? 
A credit rating is not a recommendation to buy, hold, or sell a debt instrument. A credit rating is one of the inputs used by investors to make an investment decision.
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4. What is the difference between credit rating and equity research? 
Credit ratings are assigned to debt instruments, while equity research relates to equity shares. A credit rating is focused on the risk of non-payment, the primary variable in debt instruments. Equity research is focused on growth possibilities, for that is what drives equity valuations.
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5. How does a credit rating differ from an audit? 
A credit rating agency relies on a variety of information sources, including published annual reports. An audit process is designed to detect fraud or misrepresentation of information, whereas the credit rating process is not.
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6. How does a rating agency operate when issuers’ disclosure levels are low? 
During a credit rating exercise, issuers provide rating agencies with confidential information and insights into business strategy that are not normally available in the public domain. As a policy, CRISIL does not assign credit ratings without issuer interaction, except when a previously rated instrument is outstanding or when a specific investor asks for a private exercise. In cases where CRISIL believes that the information is inadequate to assign a rating, it may not do so. Also, for rated clients, if subsequent information is not adequate, CRISIL may suspend the rating and inform the investors.
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7. Does a credit rating assure repayment? 
A credit rating is not an assurance of repayment of the rated instrument. Rather, it is an opinion on the relative degree of risk associated with such repayment. This opinion represents a probabilistic estimate of the likelihood of default.
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8. Who pays for a credit rating? 
Most credit rating agencies across the world use a revenue model where the issuer pays for the credit rating. Alternative revenue models (such as the one based on investor fees) pose numerous challenges in terms of ease and practicality of implementation that have not yet been overcome.
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9. If the issuer pays for the rating, how does a credit rating agency maintain its independence? 
Although the issuer pays for the rating, the investor uses it. Like any other product or service, the ‘value’ of the rating depends entirely on the perceptions of the investor. Investor perceptions are based on the credibility of the past ratings assigned by each rating agency. (Please also refer to section – How CRISIL manages Conflict)
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10. Who regulates a rating agency? 
The capital market regulator regulates rating agencies in most regions. In India, the capital markets regulator, the Securities and Exchange Board of India (SEBI), regulates the rating agencies in the country.
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11. Is competition desirable in the credit rating industry? 
Competition in the credit rating industry is desirable to meet the ‘better service at a cheaper price’ objective on an ongoing basis. However, it is essential to guard against some undesirable effects of competition, such as lax ratings or sub-optimal quality of research and analysis.
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12. How do investors benefit from a credit rating? 
Credit ratings help investors facilitate comparative assessment of investment options, complement the investors’ own credit analysis, and allow asset monitoring.
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13. What do the various credit rating symbols mean? 
CRISIL uses simple alphanumeric symbols to convey credit ratings. CRISIL assigns credit ratings to debt obligations on three basic scales: the long-term scale, the short-term scale, and the fixed deposit scale. To illustrate, CRISIL’s long-term credit rating scale and the description associated with each category on the rating scale is given below:
Symbol
(Rating category).
Description (with regard to the likelihood of meeting the debt obligations on time)
AAA Highest Safety
AA High Safety
A Adequate Safety
BBB Moderate Safety
BB Inadequate Safety
B High Risk
C Substantial Risk
D Default
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14. Does the minus sign in a rating symbol have negative connotations relating to the issuer’s performance or its debt-servicing capability? 
Plus and minus symbols are used to indicate finer distinctions within a rating category. The minus symbol associated with ratings has no negative connotations whatsoever.
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15. What are Structured Obligation (so) ratings? Are they different from other credit ratings? 
Structured Obligation (so) ratings are ratings that are based on a ‘credit enhancement’ mechanism and/or a structured payment mechanism. A suffix in the form of ‘(so)’ indicates the presence of non-credit risk in the form of risks associated with the instrument structure.
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16. What is the validity period of a credit rating? 
Credit ratings are assigned either to specific instruments or to the general debt obligations of issuers. CRISIL assigns credit ratings to debt obligations. A rating is valid until the rated debt obligation is fully paid.
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17. How are credit rating changes communicated? 
Once a credit rating is assigned and published, CRISIL keeps the credit rating under surveillance until the instrument is fully repaid. The surveillance process may result in credit rating changes from time to time. All changes in CRISIL’s credit ratings are communicated publicly through CRISIL’s website (www.crisil.com) and media releases.
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18. Why do credit ratings change? 
Credit ratings are assigned based on certain expectations and assumptions about variables that impact the issuer’s performance. However, these variables can change, causing the rated entities’ performance to deviate materially from expectations. This is reflected in their changed credit ratings.
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19. If a credit rating is downgraded, does it mean that a default is imminent? 
Not necessarily. In most cases, a downgrade does not mean that a default is anticipated. All it indicates is that the risk associated with the debt obligation is relatively higher than what it was before the downgrade.
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20. Does the size of the rated debt obligation affect its credit rating? 
No. What matters is the size of the total debt in the company, and not the amount that is sought to be rated.
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21. What are ‘Provisional’ ratings? 
In case completion of certain critical steps/documentation is pending at the time of rating assignment, CRISIL will assign provisional ratings to such instruments which will be characterised by a prefix ‘Provisional’ to the rating symbol. To elaborate, a prefix of ‘Provisional’ to a CRISIL-assigned rating indicates that the rating centrally factors in the completion of certain critical steps/documentation by the issuer for the instrument; without this, the rating would either have been different or not assigned. The provisional nature of such ratings will be disclosed by CRISIL in its communications, including rating letter and rating rationale. Once the relevant steps/documents (as per expectations when the provisional ratings were assigned) are in place, the provisional ratings will be converted into final ratings.
Please refer to CRISIL’s release – “Revision in CRISIL policy for assigning ‘provisional’ ratings” for more
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