Large Corporate Credit Risk Rating Model Presented by:Dhiraj ShrikhandeDeepak Kumar DohreYogesh Kumar Thakker

Credit Risk: Definition & Need of Credit Risk RatingThe risk of default by borrower due to inability and/or unwillingness to repay his debts in accordance with the agreed terms and conditionsHelps in taking prudent credit decisionsWhether to lend or notRisk mitigantsFrequency of renewal and MonitoringSetting Terms and Conditions:PriceMaturityForm of CreditCompetitive Advantage

Credit risk ratings eventually help a bank to assign a probability of default for borrower according to its risk category

Sources for Capturing Signals of Credit RiskFinancials Business PerformanceIndustry OutlookQuality of Management Conduct of account

Financial Risk Evaluation : Past Financials

CategoryParameterPAST FINANCIALS - INDUSTRY COMPARISONGrowth Rate (3 yr)Gross Sales growth rate (%)ProfitabilityOPBDIT/Sales (%)EfficiencyShort term bank borrowings/ Net sales (%)Cash FlowsOperating cash flow/ Total debt (%)Net operating cash flow/ Total debt (%)PAST FINANCIALS - ABSOLUTE COMPARISONSolvencyDebt equity ratioTOL/TNWLiquidityCurrent RatioDebt CoverageInterest coverageDSCRProfitabilityReturn on capital employed (%)

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Financial Risk Evaluation: Future Risk

The expectation of future financial risk is an important input to the credit rating process. This is used to evaluate the cash flows of a company as well as any major risks, which the company might be facing in future that may adversely impact its financial performance.

FUTURE RISK Subjective1. Impact of contingent liability2. Foreign Transaction risk3. Impact of merger/de-merger/expansion on key financials4. Cash flow adequacy5. Impact of diversion on future financials

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Financial Risk Evaluation : Discounting Factors

SUBJECTIVE ASSESSMENT OF FINANCIALS1. Transparency in accounting2. Quality of inventory3. Realisability of debtors4. Quality of investment/ advances made to group/ other companies

TREND ADJUSTMENT1. Net sales2. PBDT less Non recurring income/expenditure3. Operating cash flow/ Total debt4. Tangible net-worth

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Business Evaluation : Operating Efficiency

OPERATING EFFICIENCY PARAMETERS (Industry Comparison)5 most relevant factors to be selectedMANUFACTURING SECTOR SERVICE SECTOR 1Operating leverage*1Operating leverage*2Inventory Turnover2Operating income/Op. Assets3Net Sales/Current Assets3Wages/Operating income4Net Sales/ Operating Assets4Other Operating cost/ Operating income5Raw Material/Cost of Production5Administrative & selling expenses /Operating income6Wages/Cost of Production6Credit period allowed7Power Cost/Cost of Production7Credit period availed8Administrative and Selling Expenses/Net Sales9Cost of Goods Sold/Net Sales10Credit Period Allowed11Credit Period Availed* - COMPULSORY

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Business Evaluation : Subjective evaluation MANUFACTURING SECTOR

Sub-GroupParameters1. Competitive PositionExpected sales growthMarket dominanceTrend in market share

2. Input Related RiskAvailability of raw material and other critical inputsSuppliers power Availability of alternate raw material/fuelManagement of price volatilityReliable vendor base for componentsDependence on importsProximity to raw material sourcesStatus of backward integration

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Business Evaluation : Subjective evaluation MANUFACTURING SECTOR contd

Sub-GroupParameters

3. Production Related RiskCapacity UtilizationState of technology used Flexibility in product manufacturingPatents and proprietary technologyR&D Expenses Dependence on single manufacturing plant

4. Product Related RiskProduct rangeProduct qualityHighly customized productThreat of substitution/ obsolescence

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Business Evaluation : Subjective evaluation MANUFACTURING SECTOR contd.

Sub-GroupParameters

5. Price CompetitivenessEconomies of scaleBrand EquityPricing FlexibilityFinancing edge over competitors Buyers power

6. MarketingSelling & distribution networkAfter sales & service networkGeographical diversity of marketProximity to marketLong term contracts / assured off takeAdvertising / other promotional strategies

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Business Evaluation : Subjective evaluation MANUFACTURING SECTOR contd.

Sub-GroupParameters7. OthersThreat from environmental factorsVulnerability to event riskRegional rating of states

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Business Evaluation : Subjective evaluation SERVICE SECTOR

Sub-GroupParameters

1. Service Related FactorsOccupancy/ Utilization rateQuality of services offeredRange of ServicesCustomer's Perceived valueLevel of customer satisfactionService features & Packaging of allied benefitsLevel of standardization & homogeneity of services

2. Market Related FactorsAmbience of service outlet & accessibility to desired serviceDistribution Channels/ Supply ChainEffectiveness of distribution channels on target customersExtent of customer base/ customer's loyaltyTie up arrangements/ Joint venture/ FranchiseAdvertising/ other promotional strategies

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SERVICE SECTOR contd

Sub-GroupParameters

3. Price competitivenessEconomies of operationsBrand Equity/ Image of companyPricing flexibilityAbility to extend credit

4. Competitive Position Expected Market growthCore competencyMarket segment/ Niche areaLocational advantage/ delivery of servicesMarket dominance

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Business Evaluation : Subjective evaluation SERVICE SECTOR contd

Sub-GroupParameters

5. Infrastructure availableQuality of basic infrastructureAttitude & skills of employeesAgency/ back up arrangementsInternal Systems & ProceduresTechnology adopted in the processes

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Business EvaluationIndustry Scores: The Industry Scores are an indicator of the future outlook of that industry.The Risk Management Division (RMD), Head Office is providing the Industry Score for all major industries. They are used to augment/discount the Business scores. Unrated industries are awarded neutral scores.

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Management Evaluation

ParameterMANAGEMENT OBJECTIVE1Gross sales achievement vis--vis target2PBT achievement vis--vis targetMANAGEMENT SUBJECTIVE1Management Set-up and Corporate Governance2Commitment and sincerity3Track record in execution of projects4Track record in debt repayment5Track record in Industrial relations6Financial strength/ flexibility /Group support7Capital market perception

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Conduct of Account

The conduct of account provides useful indications about the ability and willingness of the borrower to meet his obligations. The manner in which a borrower has been conducting his accounts in the past is a good indicator of how the account is likely to behave in future as well.

CONDUCT OF ACCOUNT EVALUATION1Preventive Monitoring System ratingOR1Status of account2Operations in account3Submission of financial data/ statements

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Rating Categories & Grades

Rating CategoryRisk Profile (Description)Score ObtainedGrade within the rating categoryPNB AAAMinimum RiskAbove 80.00PNB- AAAPNB-AAMarginal RiskAbove 77.50 up to 80.00PNB- AA +Above 72.50 up to 77.50PNB- AAAbove 70.00 up to 72.50PNB- AA -PNB-AModest RiskAbove 67.50 up to 70.00PNB- A +Above 62.50 up to 67.50PNB- AAbove 60.00 up to 62.50PNB- A -PNB-BBAverage RiskAbove 57.50 up to 60.00PNB- BB +Above 52.50 up to 57.50PNB- BBAbove 50.00 up to 52.50PNB- BB -PNB-BMarginally Acceptable RiskAbove 47.50 up to 50.00PNB- B +Above 42.50 up to 47.50PNB- BAbove 40.00 up to 42.50PNB- B -PNB-CHigh RiskAbove 30.00 up to 40.00PNB- CPNB-DCaution Risk30.00 and belowPNB D

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