Credit Rating Agency of Bangladesh Ltd. (CRAB) was established in 2003 at the initiative of some leading personalities in private sector and institution of the country with the commitment to contribute to the development pg the capital Market by providing quality ratings and comprehensive research services.
The Credit Rating Process of Credit Rating Agency of Bangladesh Ltd (CRAB)
Part 1.4 Abstract
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redit Rating Agency of Bangladesh Ltd. (CRAB) was established in 2003 at the initiative of some leading personalities in private sector and institution of the country with the commitment to contribute to the development pg the capital Market by providing quality ratings and comprehensive research services. CRAB was incorporated as a private limited company in 2003 and receives its certificate of commencement of business in the same year. In 2004 CRAB was granted license by the Securities and Exchange Commission (SEC) of Bangladesh (under the credit rating company’s rules 1996) for operating as a credit rating Company. Within short span of time, CRAB has established its reputation as a reliable source of independent opinion on risks based on systematic and standardized analysis done by professionals.
Part 1.4 Methodologies
For the preparation of the report I have used basically the secondary data that are obtained mainly from CRAB’s distinctive website, BASEL II (a new capital adequacy) formulated by Bangladesh Bank, requirement for credit ratings approved by Securities & Exchange Commission (SEC), Major portion of data is collected from the official publication of Annual Reports of different years by the company. Analyses tools and techniques required few assumptions to be made which were considered based on utmost sincerity by the analysts and experts’ suggestions & business development teams’ view as well. Again I have used CRAB’s corporate brochure, various rating report of the companies including (Bank, manufacturing co, trading co, insurance, telecom & so on), CRAB’s client lists, ICRA & ACRAA website, company’s annual report, and finally my individual judgments have been used to develop the overall framework of this report.
Part 1.5 Limitations of the study
For exclusive report it requires highest effort which asks for a huge time, money and manpower. Moreover, no corporate house likes to disclose their strategic plans or other key points to outsiders for their business interest.
Another challenge was to conduct the financial analysis as we concentrate to Marketing, there is lot more knowledge and expertise required to do it. In spite of these the guys were so busy that they were not capable to give me enough time to expand their helping hand to develop an exclusive report.
Moreover some latest data could not be collected due to confidentiality, which was essential for my study. The other limitations of the study are as follows:
· Limitation due to dependence on secondary data.
· Lack sufficient previous years’ information in an organized way.
· CRA’s policies do not permit of disclosing some sensitive information and data for obvious reason that poses as an obstacle to evaluate my report.
· There are four Credit Rating Agency in Bangladesh, for this it was difficult for me to collect the data and evaluate them.
Part 1.7 Executive Summary
Credit rating agencies (subsequently denoted CRAs) specialize in analyzing and evaluating the creditworthiness of corporate and sovereign issuers of debt securities. In the new financial architecture, CRAs are expected to become more important in the management of both corporate and sovereign credit risk. The logic underlying the existence of CRAs is to solve the problem of the informative asymmetry between lenders and borrowers regarding the creditworthiness of the latter. Issuers with lower credit ratings pay higher interest rates embodying larger risk premiums than higher rated issuers. Moreover, ratings determine the eligibility of debt and other financial instruments for the portfolios of certain institutional investors due to national regulations that restrict investment in speculative-grade bonds.
The banking sector in Bangladesh passed through significant changes in terms of structure and policies. Starting with six nationalized commercial and a few specialized banks after independence, the total number of banks has reached 48 at present including private and foreign commercial banks. The Bangladesh financial sector is under going through a phase of transaction, transformation and convergence. The regulators are more active then ever before to bring the sector up to an international standard. The competitive environment created with the presence of too many banks in a small economy has also been forcing the banks to increase risk in both sides of the balance sheet. In the asset side, banks are shifting from traditional financing from sector corporations to private sector group business, housing, automobile commercial vehicles 5SMEs. On the liabilities side the transformation is from passive retail strategy to a very active retail trust to attract and retain customers and increase in deposit base.
Keeping pace with the global changes, the banking sector of the country has been undergoing a remarkable change during the last couple of years. In order to bring the sector in line with the international norms, the central bank has taken a number of steps under the Financial Sector Reform Program. During the last couple of years, Bangladesh Bank has taken a number of steps through prudential circulars and best practices guidelines to improve the governance practice of the sector. Some of the worth mentioning steps were: limiting the percentage of family shareholding and directorship from the same family, limiting the number of directors in the board, obtaining prior permission of the central bank in appointment and termination of the services of CEO, issuance of best practice guidelines for core risk management, mandatory requirement of Risk grading system in order to minimize risk of credit etc. Most recently, the central bank introduced the mandatory annual credit rating requirement for all schedule banks. The Bank for International Settlement (BIS) has finalized the Basel-II Accord after issuing several consultative papers and impact studies and published the same under the title “International Convergence of Capital Measurements and Capital Standards” in June 2004 to be effective from 2006. Most of the developed and developing countries have drawn up the implementation plan of Basel-II in their respective countries. The neighboring countries are now implementing Basel –II Accord. The Bangladesh Bank has also decided to go for adoption of Basel-II with effect from January 2009 with parallel run BASEL I and II with effect from January, 2009.
Banks and Financial Institution (FI) rating are the OPINION of CRA on the ABILITY and WILLINGNESS of a Bank/FI to discharge its obligations including depositors’ money in timely manner that is as per contract. These opinions are arrived at after a through analysis of both quantitative and qualitative areas of the Bank. In Bangladesh CRA offers two types of ratings- Long Term and Short Term. Long-term ratings are valid for maximum one year while short-term rating carries a validity of maximum six months.
Part 2.1 Introduction
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he term “Credit Rating” can be analyzed by dividing it in two parts – credit and rating. Credit is taking money or some benefits from a lender for generating some benefits with a promise to pay back the principle and the interest after a specific time period. Rating usually denotes to a symbol or on a relative judgment of something on a scale. So the entire term ‘credit rating’ can defined as a judgment or an opinion on the quality of a credit, whether the creditor or the borrower is financially capable to meet the obligations i.e., principle and interest.
A credit rating assesses the credit worthiness of an individual, corporation, or even a country. It is an evaluation made by credit bureaus of a borrower’s overall credit history. 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 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.
Credit ratings are used by investors, issuers, investment banks, broker-dealers, and governments. For investors, credit rating agencies increase the range of investment alternatives and provide independent, easy-to-use measurements of relative credit risk; this generally increases the efficiency of the market, lowering costs for both borrowers and lenders. This in turn increases the total supply of risk capital in the economy, leading to stronger growth. It also opens the capital markets to categories of borrower who might otherwise be shut out altogether: small governments, startup companies, hospitals, and universities.
Part 2.3 Literature Review
In terms of the BRPD Circular Letter No. 05 dated May 29, 2004 it was made mandatory for the banks to have themselves credit rated to raise capital from capital market through IPO. The issue has been reviewed further and with a view to safeguard the interest of the prospective investors, depositors and creditors and also the bank management as a whole for their overall performances in each relevant areas including core risks of the bank, it has now been decided to make it mandatory from January 2007 for all banks to have themselves credit rated by a Credit Rating agency.
Banks are, therefore, advised to take necessary measures from now on so that they can have their credit ratings in all relevant areas as well as the bank management. Banks will be required to complete their credit rating by June 30, 2007. The credit rating will be an ongoing process i.e. credit rating should be updated on a continuous basis from year to year, within six months from the date of close of each financial year. The rating report completed in all respects be submitted to Bangladesh Bank and made public within a period of one month of the notification of rating by the credit rating agency.
Banks will disclose their credit rating prominently in their published annual & half yearly financial statements.
Part 2.4 Objectives of the Report
Primary Objective
To correlate theoretical learning acquired through classroom study with the real life business situation faced as an internee during the Internship period.
SECONDARY Objectives
The secondary objectives regarding this study are as follows:
1. Depicting the credit rating process of CRAB.
2. To analyze and identify the quantitative factors of rating methodology of bank.
3. To analyze and identify the qualitative factors which are considered at the time of credit rating of the bank.
4. Find out those key ratios significantly contributing differences in credit rating.
5. Predicting the potential impacts of CRAs on our financial market.
6. Finally making some recommendations to improve the activities of the bank and credit rating practices of the country to better coup with the international practices.
Part 2.5 Scope of the Study
Since I have selected my topic “Credit Rating Process of Credit Rating Agency of Bangladesh Ltd. (CRAB)”, I have opportunity to collect different documents relating to the credit rating and banking sector. Most of the financial analyst of CRAB helped me to prepare a constructive report by providing relevant paper and files for which I was highly encouraged. Besides this I have faced very difficulty to prepare a report on this topic. To prepare this area requires time, much contract, careful attention and study.
Part 2.6 Sources of the Study
I have prepared the report by conducting three months internship program by analyzing qualitative and quantitative information collected through primary and secondary sources. To analyze the regulatory environment of the rating agencies in both national and international level, internet provides the most of the information. Sites of SEC of India, Malaysia, US and Bangladesh were visited and necessary documents were retrieved. Sites of many major rating agencies around the world were visited to get a clear understanding on rating industry.
Ø Primary Source: The primary data was collected by convincing the financial analysts of the Credit Rating Agencies.
Ø Secondary Sources:
· Credit Rating reports of CRAB and CRISL of the banks and others corporations.
· Annual Report of Selected Banks-Top 10Banks Based from 2003-07.
· Circulation and announcement of Bangladesh Bank.
· Circulations of Stock Exchange Commission and BRPD.
· Other related published documents, books and journals etc.
Part 2.7 Definition of Credit Rating
A credit rating is an opinion of the credit agency on the future ability and willingness of the borrowing entity/ Issuer of debt instruments/ obligations to make payment of principal and interest as per the terms of the underlying contract. It measures the relative probability of borrowing defaulting on its obligations over its life and also an assessment of the severity of monetary loss of the lender should such default occur.
The primary objective of Credit Rating is to provide guidance to the investors in determining credit risk associated with a debt instrument/ credit obligation. The Credit Rating is neither a general-purpose evaluation of the issuer/ entity nor an opinion on all the debt contracted/ to be contracted by such an entity. Credit Rating is not a recommendation to buy or sell or hold securities / debt obligations. It is only an opinion of the Credit Rating Agency on the relative capacity of the issuer to service its debt obligation as per terms of the contract with particular reference to the instrument being rated.
Part 2.8 Definition of Credit Rating Agencies
A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. In some cases, the servicers of the underlying debt are also given ratings. In most cases, the issuers of securities are companies, special purpose entities, state and local governments, non-profit organizations, or national governments issuing debt-like securities (i.e., bonds) that can be traded on a secondary market. A credit rating for an issuer takes into consideration the issuer’s credit worthiness (i.e., its ability to pay back a loan), and affects the interest rate applied to the particular security being issued.
The Rating Agency does not guarantee the completeness or accuracy of the information on which the rating is based. A credit rating agency has to rely extensively on the information, clarifications and opinion provided by the Issuers as well as those obtained from other professional agencies like auditors, bankers, solicitors, investors, customers and suppliers, etc. The Rating, usually expressed by way if an alphabetical or alphanumeric symbol, is an easily understood tool enabling the investors to differentiate between credit instruments on the bases of underlying credit quality. A Rating dose not gives any direct or indirect assurance or guarantee against the probability of default. The Rating Agency , in fact, endeavours to arrive at a relative rankings in terms of the probability of default in a debt offering based on its predictive tools and techniques, rigorous process of Due Diligence, internal and external research that constitute its analytical framework. It enables lenders/ investors to take an informed decision based on their individual risk return preferences. It also enables the lender to assess the risk underlying a debt offering and factor the same in his lending/ pricing decision. A Rating tries to establish a linkage between risk and return. The Rating being an opinion, subjective and judgemental in nature, there can not be a precise correct or incorrect Rating, the endeavour always at a “fair” Rating.
When there is a chance of default in repayment, the borrower is assigned a low grade and when the borrower has the sound financial health to meet its obligations it is awarded a high grade. The grades or rates assigned to the borrower are called rating symbols or rating notch. Rating notches range from “AAA” to “D”. “AAA” is the highest safety grade in the rating scale for an entity that indicates a safe and timely repayment of borrowed money whereas “D” signals a current or future default in repayment of the borrower. The table in the next page summarizes the rating scales used by premier rating agencies:
Generally, international rating agencies assign short-term and long-term credit ratings.
- Short-term rating gives the benchmark of the likelihood of borrower’s default within one year.
- Long-term rating evaluates the likelihood of default over longer time (up to the lifetime of the securities issued).
| Rating Grade | Rating Symbol / Rating Notch | Definitions |
| Investment Grade | AAA | Highest Safety |
| AA+, AA, AA- | High Safety | |
| A+, A, A- | Adequate Safety | |
| BBB+, BBB, BBB- | Moderate Safety | |
| Speculative Grade | BB+, BB, BB- | Inadequate Safety |
| B+, B, B- | Risky | |
| C | Vulnerable | |
| Default Grade | D | Default |
It is important to note that ratings are not equal to or the same as buy sell or hold recommendations, it is an opinion on the creditworthiness of a person or an entity or even of a country. Ratings are rather a measure of the borrower’s ability and willingness to repay borrowed money.
The rating agencies fall into two categories: (i) recognized; and (ii) non-recognized. The former are recognized by supervisors in each country for regulatory purposes. In the United States, only five CRAs of which the best known are Moody’s and Standard and Poor’s (S&P) are recognized by the Security and Exchange Commission (SEC). The majority of CRAs such as the Economist Intelligence Unit (EIU). Institutional Investor (II) and Euro money are “non recognized”.
There is a wide disparity among CRAs. They may differ in size and scope (geographical and sectoral) of coverage. There are also wide differences in their methodologies and definitions of the default risk, which renders comparison between them difficult.
Part 2.9 Origin of Credit Rating
The credit rating system emerged as a private sector institution in the middle of the 19th century. The precursors of bond rating agencies were the mercantile credit agencies, which rated merchants’ ability to pay their financial obligations. In 1841, in the wake of the financial crisis of 1837, Louis Tappan established the first mercantile credit agency in New York. Robert Dun subsequently acquired the agency and published its first ratings guide in 1859. A similar mercantile rating agency was formed in 1849 by John Bradstreet, who published a ratings book in 1857.
In 1941 Poor Publishing merged with Standard Statistics to form the S&P. In 1960 S&P acquired a stake in Fitch Investors Service rating agency operations. The ratings symbols that are today used worldwide that were developed by Fitch were incorporated into the S&P ratings. In 1966 McGraw Hill an American publishing house bought out S&P and still today they own the company.
The ratings developed by Moody in early 1900s, were later applied to industrial companies and in the 1970s they began rating commercial paper and euro bonds. Since 1962 Moody’s has been a subsidiary of the Dun and Bradstreet Corporation (D&B). The most significant new entry in the United States since that time has been the Chicago-based Duff and Phelps, which began to provide bond ratings for a wide range of companies in 1982. Another major ratings provider–McCarthy, Crisanti, and Maffei–was founded in 1975 and acquired by Xerox Financial Services before its fixed income rating and research service was merged into Duff and Phelps in 1991.
In the beginning the CRAs sold their information to investors, rather than charging issuers as is the case today. Some issuers were skeptical in the beginning and regarded the CRAs as intruding, but in the end they were forced to provide the agencies with information because absence of information would affect their rating. In these initial stages the ratings provided by CRAs were financed through the sale of publications. Following the invention of the photocopier however and ease at which these publications were copied, CRAs started to charge the issuers. Since the beginning of the 1980s, the role and importance of rating agencies has increased. As it stands today they hold a central role in the international system of capital allocation.
Part 2.10 Role of Credit Rating Agencies
Rating merely provides a relative ranking of issuers with regard to the risk of default. CRAs publish historical data on the default rates associated with rating. These data provide important information and give an idea of how the agencies’ rating have performed in past. The rating agencies are an integral component of the financial market. Done properly, their evaluations of credit risk are essential to many market participants who lack the resources or skill to make an independent evaluation. In recent years credit rating agencies (CRA) have become increasingly important in the management of financial market risk. CRA are commercial firms that receive payment for publishing an evaluation of the creditworthiness of their clients. This information is especially useful when borrowing takes place through the issue of securities, rather than by bank loans, since buyers of securities do not know the issuers as well as banks usually know their customers. CRA originated in the USA at the turn of the century and concentrated on rating corporate bonds. Their activities subsequently increased in scope and scale. At present no major type of security, issuer or geographic area is excluded. CRA now define a truly global benchmark for credit risk. Published ratings are not only closely observed in the market place. They are significant for regulation as well. Since CRA judgments define a globally uniform benchmark, they are attractive as a reference for international regulatory standards as well. A good case in point is the recent proposition by the Bank for International Settlements to use ratings to calculate capital adequacy ratios for banks.
The major roles played by Credit Rating Agencies are given below:
· Investor protection via independent, 3rdparty opinion on the credit risk or default risk of issuers/issues
· Distill complex financial structures into user-friendly symbols
· Provide a common yardstick to evaluate default risk for investment decision making
· Monitor and disseminate credit opinions on rated issuers/issues in a timely and efficient manner
· Bridge the information gap between issuers and investors and a source of credit surveillance for investors
· Assist regulatory authorities in developing and facilitate implementation of prudential guidelines requirements e.g. BASLE II
· Provide a performance benchmark -3rdparty evaluation of company’s business and financial performance within and across industries
· Tracks and monitor performance of economy/industries, as well as default statistics
Part 2.11 Background of Credit Rating Agencies in Bangladesh
Although the concept of credit rating emerged in early twentieth century in the financial market of USA, it is still new in the developing countries like Bangladesh. Long after a century of its emergence, Securities and Exchange Commission (SEC) of Bangladesh promulgated rules regarding the operation of rating agencies in 1996. No rating agency was licensed in the country till 2002, hence no rating was published. It was the South-east Bank Limited to be rated for the first time in Bangladesh by premier credit rating agency CRISL, in November 2002. After that delayed initiation, hundreds of institutions and few bonds are rated each year. CRISL and CRAB are the two licensed credit rating agency of the country permitted to rate the entity and debt instruments under the Credit Rating Companies Rules 1996. CRISL and CRAB earned their certificate of registration in August 2002 and February 2004 respectively. Here is an overview of both the CRAs:
Part 2.12 About CRAB
Credit Rating Agency of Bangladesh Ltd. (CRAB) was established in 2003 at the initiative of some leading personalities in private sector and institution of the country with the commitment to contribute to the development pg the capital Market by providing quality ratings and comprehensive research services. CRAB was incorporated as a private limited company in 2003 and receives its certificate of commencement of business in the same year. In 2004 CRAB was granted license by the Securities and Exchange Commission (SEC) of Bangladesh (under the credit rating company’s rules 1996) for operating as a credit rating Company. Within short span of time, CRAB has established its reputation as a reliable source of independent opinion on risks based on systematic and standardized analysis done by professionals.
Part 2.13 Mission & Objectives
Mission:
Effect significant contribution towards qualitative development of the money and capital markets and enhancement of transparency of financial information and credibility of the corporate sector in Bangladesh.
Objectives:
The objectives of Credit Rating Agencies are:
To perform the credit rating of various debt instruments as Commercial papers, Bonds and Debentures, Islamic bonds, Preference shares, Equity instruments, Rights issue, Mutual fund units etc.
To perform grading of various institutions as banks, non banking financial institutions, insurance companies, corporations, non-corporations, societies, trusts or individuals or their clients for purposes requested clients or required by authorities.
To accumulate, process and offer information services in broad areas for the use of organization and clients at different levels.
To provide consultancy and advisory services in broad areas to clients at different levels.
To act as trustees of any debentures, bonds, securities, commercial papers or any other obligations and to exercise the powers of executor, administrator, receiver, treasurer, custodian in respect of such debts and securities
Part 2.14 CRAB Corporate Profile:
Board of Directors:
| Chairman | |
| Mr. M Syeduzzaman
Former Finance Minister, Govt. of Bangladesh |
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| Vice Chairman | |
| Mr. Md. Matiul Islam, FCA
Chairman, Industrial and Infrastructure Development Finance Company Ltd. Former Secretary of Finance, Govt. of Bangladesh |
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| Directors | |
| Mr. Samson H. Chowdhury
Chairman, Astras Ltd.Chairman, Square Group |
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| Mr. Syed Manzur Elahi
Chairman, Apex Footwear Ltd. & Apex Tannery Ltd.& Former Advisor to the Caretaker Govt. of Bangladesh. |
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| Mr. M. Anis Ud Dowla
Chairman, ACI Ltd. |
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| Md. Fayekuzzaman
Managing Director, Investment Corporation of Bangladesh |
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| Mr. M. Haider Chowdhury
Chairman National Life Insurance company Ltd. |
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| Mr. A K M Rafiqul Islam, FCA
Managing Director, Pragati Insurance Ltd. |
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| Mr. Mir Mustafizur Rahman
Former Secretary of Finance, Govt. of Bangladesh |
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| Mr. A. S. M. Quasem
Chairman, New Age Group |
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| Mr. Sohail Humayun
Managing Director, Unicorn Equities Ltd |
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| Mr. M Faizur Rahman
Chairman, Asian Surveyors Ltd. |
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| Selim RF Hussain
CEO & Managing Director,IDLC Finanace Ltd. |
Managing Director:
Hamidul Huq
| Hamidul Huq, Managing Director of Credit Rating Agency of Bangladesh Limited is an MBA From IBA, Dhaka University. He Joined CRAB in June, 2008. Prior to joining the CRAB, Mr. Huq was the Managing Director of United Commercial Bank Ltd.
Mr. Huq brings with him vast experience in commercial as well as development banking having held senior positions in various institutions in these areas. |
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| Part 2.15 Rating Committee Members are:
The credit rating process has at its apex a high powered Rating Committee composed of personalities with impeccable integrity, judgment and standing. The Committee is entrusted with the responsibility for finalization of the Rating Report and Fixation of the “Rating Award” to client entities and/or instruments. Currently the members of the Committee are:
* The Committee composition may change from time to time. |
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Part 2.16 A Snap Shot of The Company
Part 2.17 Rating Service Provided by CRAB
CRAB is a full service credit rating agency offering ratings of all kinds of financial instruments and entities including those required by regulatory authorities. Our services cover ratings of securities issued by manufacturing companies, corporate bodies, commercial banks, non-bank financial institutions, investment banks and mutual funds, among others. The obligations include long term instruments such as bonds and debentures, medium term instruments such as fixed deposit programmes, and short term instruments such as commercial papers.
CRAB also offers ratings of structured obligations and sector specific debt obligations such as instruments issued by Power, telecom and Infrastructure companies. The other services offered include Credit Assessment of large, medium and small scale units for obtaining specific lines of credit from commercial banks, financial institutions and financial services companies.
CRAB offers the following Rating Services:
· Entity Ratings:
Entity ratings are a measure of a company’s intrinsic ability and overall capacity for timely repayment of its financial obligations. They are mandatory ratings required for any regulatory compliance or voluntary ratings that may be sought by companies to enhance corporate governance and transparency. These ratings are useful for benchmarking a company against its peers, enhancing investors’ confidence, market profiling, reducing time for future debt ratings, enhancing a company’s standing for counterparty risk purposes and facilitating credit evaluation for bank borrowings and bank lines
· Financial Institution Ratings:
These ratings will assess the creditworthiness of financial institutions, i.e. commercial and merchant banks, non-banking finance companies, housing finance companies etc. While each of these entities has the same function, i.e. leverage on own funds and lend to others on a cost plus basis, there are significant differences in terms of scale of operations, and their internal control systems. Ratings of financial institutions focus on the risks that can possibly affect the operations of a finance company – operating risks, financial risks and management risks.
· Corporate Debt Ratings:
Such ratings specifically assess the likelihood of timely repayment of principal and payment of interest over the term to maturity of such debts as per terms of the contract with specific reference to the instrument being rated. A missed or delayed payment by an issuer in breach of the agreed terms of the issue is considered as default.
· Equity Ratings (Initial public Offerings and Right Offerings):
Equity rating makes assessment of the relative inherent quality of equity reflected by the earnings prospects, risk and financial strength associated with the specific company. The rating is not intended to predict the future market price of the stock of a company, but to evaluate the fundamentals of a company, which ultimately act as important inputs in the price behavior of the stock of such a company over the medium term and long term. In the short term, the rating helps in reconciling the market sentiment with respect to the stock of a company to the long term fundamentals as reflected by the equity grade.
· Structured Finance Ratings:
Structured Finance Ratings are opinion on the likelihood of the rated structured instrument servicing its debt obligations in accordance with the terms. An SFR is generally different from the corporate Credit Rating of the originator and is based on the risk assessment of the individual components of the structured instrument. These components include legal risk, credit quality of the underlying asset, and the various features of the structure.
· Insurance Companies Rating/Claims Paying Ability Rating:
Such ratings assess the ability of the insurers concerned to honor policy-holder claims and obligations on time. Rating provides an opinion on the financial strength of the insurer, from a policyholder’s perspective, which may act as an important input influencing the consumer’s choice of insurance companies and products. The rating process involves analysis of business fundamentals, competitive position, franchise value, management, organizational structure/ownership, and underwriting and investment strategies. The analysis also includes an assessment of company’s profitability, liquidity, operational and financial leverage, capital adequacy, and asset/liability management method.
· Mutual Funds Schemes Rating:
Mutual Funds Schemes rating is designed to provide Investors, Intermediaries and Fund Sponsors/Asset Management Companies with an independent opinion on the performance and risks associated with various Mutual Fund Schemes. Funds ratings incorporate various qualitative and quantitative factors affecting a fund’s portfolio. Such analyses focus on the resilience to economic changes, assessing asset quality, portfolio diversification and performance, and liquidity management.
· Clientele Rating for Banks/Financial Institutions:
Clientele Rating service has been designed to assist the management of the loan portfolios of banks/financial institutions by bringing in the present and prospective clients under continuous evaluation and monitoring of CRAB’s rating unit. Clientele rating provides banks/financial institutions on a continuous basis with opinions on the relative credit risks (or default risks) associated with the existing and/or proposed loans of the clients.
Part 2.18 Other Rating Services
CRAB performs other rating assignments as requested by clients or required by regulatory authorities. The other service provided by CRAB is-
1. Grading Service
2. Advisory & Consulting Service
3. Information Service
1) Grading Service
CRAB is equipped to offer specialized evaluation methodologies addressing exclusive and area specific requirements under the umbrella of Grading services. The services are meant for evaluation of different activities and entities belonging to multi-faceted industries. CRAB’s grading service is designed to provide an objective, credible and independent opinion on the quality of entities being examined with specific reference to parameters and issues unique to the sector/sub-sector. Construction and real-estate development activities, hospitals and diagnostic services, are examples of such sector/sub-sectors.
2) Advisory & Consulting Service
The Advisory & Consultancy Services will offer wide ranging management advisory services which include strategic counseling, restructuring solutions, financial feasibility, financial structuring/modeling, client specific need-based studies in the banking and financial services, corporate and other core sectors. CRAB is prepared to extend sophisticated Credit Risk Management services for banks and other lenders. CRAB advisory services are also available for project preparation, evaluation and execution.
CRAB is also ready to offer advisory/consulting services to clients who are seeking to be more competitive in their operating spheres. Such advisory services will be useful for a variety of clients – corporate entities, regulatory authorities, banks/financial service organizations, industry associations, local governments, government organizations, and multi-lateral agencies, through selective tie-ups with reputed organizations having expertise in specific sectors.
3) Information Service
CRAB provides information service in the form of database, financial analysis, market analysis, market survey etc. The service is customized to specific need of the clients. For further information please contact through email or telephone.
Part 2.19 Necessity of Credit Rating
The motives act behind the entities’ paying fees to secure a credit rating depends on the surrounding regulatory environment and form of financial market. There are several reasons of getting a rating. The reasons are different in different markets and economies. The motives of getting a rating in Bangladesh are not identical as USA or UK. As same, the motives of American entities are not same as those of European or Australian entities. However, there are some common reasons for which the entities all over the world are spending money to get rating from the rating agencies. The identical reasons are enumerated here with in the context of Bangladesh:
Market access:
Any company that wishes to enter capital markets and issue debt in capital market is obliged to obtain a credit rating. Rating conveys the entity’s ability and willingness to the market participants regarding repayment of its borrowed money or equity capital. In Bangladesh, as per Credit Rating Companies Rules 1996, all the companies are required to be rated before issuing its debt or floating its equity share at premium in the market.
Build up market reputation:
New companies that seek to build a reputation in the international financial markets demand credit ratings to increase the exposure of their brand name. This brand exposure is important when companies for example initiate foreign direct investments. An entity with a higher rating is considered as a reputable organization. Recently, Delta Brac Housing – DBH has been awarded as an “AAA” rated company of the country that excels the company’s reputation that was reflected through the share price the company at DSE and CSE.
Lower cost of funding:
A less known company can lower their cost of borrowing if they obtain a higher investment grade rating. Banks or financial institutions consider rating as an indication of an entity’s performance measurement yardstick. Entities with a higher rating are sanctioned loan at a lower interest rate whereas a lower graded entity is charged at a higher interest rate. So, it is going to be a common practice of the country to require an entity to be rated itself before applying for a loan to the banks or financial institutions.
Distinguish oneself from the competition:
In sectors that are characterized by a limited number of competing companies such as the banking or insurance industry, a credit rating is a tool to distinguish them from the competition. Our banking sector is an example of this practice. In 2006, only Standard Chartered Bank was rated “AAA” by CRISL that makes the bank unique. But in 2007, both Standard Chartered Band and HSBC operation of Bangladesh has been awarded the highest rating “AAA” by CRISL and CRAB respectively that creates some competitive advantage for both the banks.
Regulatory Requirement:
All over the world entities are rated for the regulatory bindings by the securities commissions and other authorities. In Bangladesh, SEC, Bangladesh Bank and Department of Insurance are the three regulators who issued regulations, circulars and notifications for the entities for rating. Our banks and insurances are now rated once in a year for these requirements of the regulatory authorities.
| Benefits to the Issuers/Companies Credit Rating of an issue would ensure due compliance with the relevant legal regulatory provisions of the Securities & Exchange Commission and Bangladesh Bank. |
CRAB opinion would help the issuer company to broaden the market for their instruments. As ‘name recognition’ is replaced by objective opinions, the issuer company may access the securities market more comfortably.
Credit rating may help in stabilizing issuers’ access to the market even when the market price of listed equities is relatively unfavorable in the prevailing market conditions.
Credit ratings of Entities would confer upon the companies a greater confidence of the market and enhance a greater access to the financing sources.
Values to the Investors & Creditors :
Credit rating gives market participants timely access to unbiased, objective, independent, expert, professional opinion on the quality of securities in a user friendly manner that may be relied upon for investment decisions
Rating opinion would facilitate the investors to decide their portfolios by choosing investment options in the market according to their profiles and preferences.
Credit rating would effect significant contribution towards developing the stock market investor confidence and enhancing the quality and perfection of the securities market, through provision of credible information for guidance of institutional and individual investors.
Values to the Economy & the Capital Market :
Assists in qualitative development of the money and capital markets and enhancement of transparency of financial information and governance of the corporate sector in Bangladesh.
Credit rating assists the regulators in promotion and enhancement of the precision of the financial markets.
Part 2.20 Project Part:
Part 2.21 Rating Process
CRAB’s rating process initiated on receipt of a formal request (or mandate) from the prospective issuer. A rating term, which usually consists of two analysts with the expertise and skills required to evaluate the business of the issuer, is involved with the Rating assignment. An issuer is provided a list of information requirements and the broad framework for discussions. These requirements are derived from CRAB’s experience of the issuer’s business and broadly cover all aspects that may have a bearing on the rating.
CRAB also draws on secondary sources of information, including its own research division. The Rating involves assessment of a number of qualitative factors with a view to estimating the future earnings of the issuer. This requires extensive interactions with the issuer’s management specifically relating to plans, outlook, and competitive position and funding policies. Plant visits are made to gain a better understanding of the issuer’s production process, make an assessment of the state of equipment and main facilities, evaluate the quality of technical personnel and form an opinion on the key variables that influence the level, quality and cost of production. These visits also help in assessing the progress of projects under implementation. After completing the analysis, a Rating Report is prepared, which is presented to the CRAB Rating Committee. The Rating Team also makes a presentation on the issuer’s business and management. The Rating Committee is the final authority for assigning Ratings.
Part 2.22 Requirements for Rating
The Credit Rating Companies Rules 1996 issued by the Securities & Exchange Commission of Bangladesh requires that the following instruments be rated prior to making issuance, and that the information on rating be incorporated in the prospectus of offer documents :
· Public Offer of all Debt Instruments: Bond, Debenture, Commercial Paper, Structured Finance (Asset/Mortgage Backed Securities), and Preference Shares.
· Public Issue of shares at a premium
· Issue of Right Shares of a public company at a premium
B. SEC (Asset Backed Security Issue) Rules, 2004 requires that the Credit Rating Report for the asset pools to be securitized be compiled along with the application for consent of the commission for issuance of Asset Backed Securities
C. Bangladesh Bank through its circulars requires mandatory credit rating for the followings:
· Initial Public Offerings of all Commercial Banks
· Initial Public Offerings of all Non Banking Financial Institutions
· Rating of all Commercial Banks on an annual basis with arrangement for continuous surveillance
D. Office of the Chief Controller of Insurance through its circular requires mandatory rating for the followings:
· General Insurance Companies on an annual basis
· Life Insurance Companies on biennial (once in every two years) basis
The basic objective of rating is to provide an opinion on the relative credit risk (or default risk) associated with the instrument being rated. This in a nutshell includes, estimating the cash generation capacity of the issuer through operations (primary cash flows) vis-à-vis its requirements for servicing obligations over the tenure of the instrument. Additionally, an assessment is also made of the available marketable securities (secondary cash flows), which can be liquidated if required, to supplement the primary cash flows. It may be noted that secondary cash flows have a greater bearing in the short-term ratings, while the long-term ratings are generally entirely based on the adequacy of primary cash flows. All the factors, which have a bearing on future cash generation and claims that require servicing, are considered to assign ratings. These factors can be conceptually classified into business risk and financial risk drivers.
| A. Business Risk Drivers |
B. Financial Risk Drivers |
| Industry characteristics | Funding policies |
| Market position | Financial flexibility |
| Operational efficiency | |
| New projects | |
| Management quality |
A. Business Risk Drivers
1. Industry Characteristics: This is the most important factor in the credit risk assessment. It is a key determinant of the level and volatility in earnings of any business. Other factors remaining the same, industry risk determines the cap for ratings.
| Demand factors | State of competition |
| Drivers & potential | Existing & expected capacities |
| Nature of product | Intensity of competition |
| Nature of demand – seasonal, cyclical | Entry barriers for new entrants |
| Bargaining position of customers | Exit barriers |
| Threat of substitutes |
2. Market position:
All the factors influencing the relative competitive position of the issuer are examined in detail. Some of these factors include positioning of the products, perceived quality of products or brand equity, proximity to the markets, distribution network and relationship with the customers. In markets where competitiveness is largely determined by costs, the market position is determined by the unit’s operational efficiency. The result of these factors is reflected in the ability of the issuer to maintain /improve its market share and command differential in pricing. It may be mentioned that the issuers, whose market share is declining, generally do not get favorable long-term ratings.
3. Operational efficiency:
In a competitive market, it is critical for any business unit to control its costs at all levels. This assumes greater importance in commodity or “me too ” businesses, where low cost producers almost always have an edge. Cost of production to a large extent is influenced by:
· Location of the production unit(s)
· Access to raw materials
· Scale of operations
· Quality of technology
· Level of integration
· Experience
· And last but not the least the ability of the unit to efficiently use its resources.
A comparison with the peers is done to determine the relative efficiency of the unit. Some of the indicators for measuring production efficiency are: resource productivity (both assets and manpower), material usage (or input-output ratios) and energy consumption. Collection efficiency and inventory levels are important indicators of both the market position and operational efficiency.
4. New project risks:
The scale and nature of new projects can significantly influence the risk profile of any issuer. Unrelated diversifications into new products are invariably assessed in greater detail. The main risks from the new projects are:
Time and cost overruns, even non-completion in an extreme case, during construction phase; financing tie-up; operational risks; and market risk. Besides clearly establishing the rationale of new projects, the protective factors that are assessed include: track record of the management in project implementation, experience and quality of the project implementation team, experience and track record of technology supplier, implementation schedule, status of the project, project cost comparisons, financing arrangements, tie-up of raw material sources, composition of operations team and market outlook and plans.
5. Management quality:
The importance of this factor cannot be overemphasized. When the business conditions are adverse, it is the strength of management that provides resilience. A detailed discussion is held with the management to understand its objectives, plans & strategies, competitive position and views about the last performance and future outlook of the business.
B. Financial Risk Drivers
Labor relations, track record of meeting promises specifically relating to returns and project implementation, performance of “group” companies, transactions with the “group” companies etc.
1. Funding policies:
This determines the level of financial risk. Management’s views on its funding policies are discussed in detail. These discussions are generally focused on the following issues:
· Future funding requirements
· Level of leveraging
· Views on retaining shareholding control
· Target returns for shareholders
· Views on interest rates
· Currency exposures including policies to control the currency risk
· Asset-liability tenure matching.
These sources include:
Availability of liquid investments, unutilized lines of credit, financial strength of group companies, market reputation, relationship with financial institutions and banks, investor’s perceptions and experience of tapping funds from different sources. Generally financial flexibility factor facilitates determination of the relative strength within a rating category (i.e., + or – prefix with the rating) and has a greater bearing on the short-term ratings.
Past financial performance:
The impact of the various risk drivers is reflected in the actual performance of the issuer. Thus while the focus of rating exercise is to be determined the future cash flow adequacy for servicing debt obligations, a detailed review of the past financial statements is critical for better understanding of the influence of all the business and financial risk factors.
Accounting Quality:
Consistent and fair accounting policies are a pre-requisite for financial evaluation and peer group comparisons. It may be mentioned that accounting quality is also an important indicator of the management quality. Rating analysts review the accounting policies, notes to the accounts and auditors comments in detail. Where necessary, rating analysts adjust the financial statements to reflect the correct position.
Profitability:
A traditional indicator of success or failure of any business endeavor has been its ability to add value to its wealth or generate profits. A few important indicators are, trends in:
· Return on capital employed
· Return on net worth
· Gross operating margins
Higher profitability implies greater cushion to debt holders. Profitability also determines the market perception, which has a bearing on the support of shareholders and other lenders. This support can be an important factor during stress.
Liquidity position:
The indicators of liquidity position are, the levels of:
· Inventory
· Receivables
· Payables
The state of competition, issuer’s market position & policies, relationship with customers and suppliers are the important factors that impact the above levels. Comparison with peers on these indicators help to determine the relative position of the issuer in the industry. The funding profile with respect to matching of assets -liability tenures also has an important bearing on the liquidity position.
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