Chapter 9
Credit Rating, Securitization and
Financial Councillors
Learning Outcomes:
After studying this chapter, you should be able to understand:
• Basic knowledge about credit rating and agencies that provide credit ratings
• Concepts of Factoring and Forfaiting
• Concepts and role of a financial counsellor
9.1 Credit Rating
9.1.1 Concept and Significance:
• A credit rating assesses a potential debtor's credit risk (individual, business,
government).
• It estimates the ability to repay loans and implies the probability of default.
• It includes qualitative and quantitative analysis based on data from the
debtor and credit agency’s evaluation.
• A credit bureau or credit reporting organization provides credit scores,
which are numerical values indicating individual creditworthiness.
9.1.2 Evaluates Credit Ratings
• A credit agency analyzes both qualitative and quantitative aspects of a
company to assess its ability to repay debt.
• Information comes from audited data, media, analyst reports, etc.
• Major agencies: Moody’s, Standard and Poor’s (S&P), and Fitch Group.
• Their job is to give an unbiased credit risk rating, often used when
companies issue bonds or loans.
9.1.3 Users of Credit Ratings
• Used by:
o Investors, borrowers, intermediaries like investment banks
o Corporations and institutions
• Helps in:
1. Assessing investment quality.
2. Understanding a borrower’s repayment capacity.
3. Supporting risk management and pricing.
4. Making decisions in M&A, joint ventures, and structured finance
deals.
🇮🇳 9.1.4 Types of Credit Ratings in India
1. Corporate Ratings – Rate companies based on ability to repay debt (bonds,
commercial papers).
2. Sovereign Ratings – Evaluate countries’ financial strength and debt
repayment ability.
3. Municipal Bond Ratings – For municipal/local govt. bonds used in public
projects.
4. Structured Finance Ratings – For complex instruments like ABS (Asset-
Backed Securities) and MBS (Mortgage-Backed Securities).
5. Bank Loan Ratings – Judge creditworthiness of bank loans, including risk
of default.
Example (Explained in Book)
• If a company issues a bond, the rating agency checks its financials and
assigns a rating (e.g., AAA = safest).
• This helps investors judge whether the borrower is trustworthy.
9.1.5 Understanding the Significance of Credit Ratings
• Credit ratings show:
o Willingness and ability to repay
o Past repayment record
o Creditworthiness
• Credit bureaus also assess past defaults, repayment behavior, and assign
credit scores.
9.1.6 Importance of Credit Ratings
For Investors:
• Safety Assurance – Confidence that investment will be returned.
• Informed Decisions – Helps choose reliable borrowers or companies.
For Borrowers:
• Low Interest Rates – Better scores = lower interest.
• Faster Loan Approvals – Easier and quicker loan processing with good
ratings.
9.1.7 Different Credit Rating Scales
Credit ratings are symbolized by grades like:
Symbol Meaning
AAA Highest degree of safety
AA High degree of safety
A Adequate degree of safety
BBB Moderate degree of safety
BB Moderate risk of default
B High risk of default
C Very high risk of default
D In default or expected to default soon
SEBI Guideline: Rating symbols must begin with the credit rating agency’s
name.
9.1.8 Major Credit Rating Agencies in India
Key agencies include:
1. CRISIL – Credit Rating Information Services of India Ltd.
2. ICRA – Investment Information and Credit Rating Agency
3. India Ratings and Research
4. CARE – Credit Analysis and Research Ltd.
5. Brickwork Ratings
6. Fitch India
7. Acuite Ratings & Research Ltd.
9.2 Factoring and Forfaiting
Both are financing tools, especially for exporters, but differ in terms of usage, risk,
and structure.
9.2.1 Meaning of Forfaiting with Example
• A company sells goods on credit to a foreign client but needs money
immediately.
• It sells the receivables (invoices) to a forfaiter (bank or financial
institution).
• The forfaiter gives money right away at a discount and takes the risk of
collection.
• Used for long-term receivables (more than 90 days).
9.2.2 Meaning of Factoring with Example
• Businesses sell short-term invoices to a factoring company for quick cash.
• Factoring helps manage working capital and maintain liquidity.
• Used for domestic or short-term international trade.
Comparison: Factoring vs. Forfaiting
Feature Factoring Forfaiting
Definition Sale of receivables for cash Sale of receivables to a forfaiter for
immediate cash
Trade Domestic and international Mostly international
Type
Protection Not protected from Forfaiter absorbs currency risk
currency changes
Goods Consumer goods and Capital goods (e.g., machinery)
services
Recourse Sometimes with recourse Always without recourse
Risk Seller bears risk Forfaiter bears risk
Time Short-term (< 3 months) Medium to long-term receivables
Period
9.2.3 Key Differences Between Factoring and
Forfaiting
Point Factoring Forfaiting
1. Goal Meant for short-term trade Handles long-term
receivables receivables
2. Nature of May not involve negotiable Often uses promissory
Receivables instruments notes, bills, etc.
3. Assumption of Risk may remain with seller Forfaiter assumes full risk
Risk (recourse) (non-recourse)
4. Cost Cost borne by seller Cost borne by buyer
5. Confidentiality Usually not confidential Transactions are
confidential
6. Recourse May be with or without Always without recourse
recourse
7. Type of Goods Consumer goods and Capital goods, machinery
services
8. Participants More common in companies Often used by exporters
& intermediaries and govts.
9. Focus Local/domestic trade International trade
10. Market No secondary market Receivables can be sold in
secondary markets
9.3 Securitization
9.3.1 Concept
• Securitization is converting financial assets (like loans) into securities to
sell to investors.
• Common in mortgages, auto loans, and credit card debts.
• Used to raise funds by pooling loans into a single product and selling that
pool.
9.3.2 History
• Originated in USA in the late 18th century.
• HUD (Housing & Urban Development) and Government National
Mortgage Association were early promoters.
• Became popular post-1970 with mortgage-backed securities.
• Enabled low-income buyers to get loans, promoting financial inclusion.
9.3.3 Concept of CBOs/CLOs
• CBOs (Collateralized Bond Obligations) and CLOs (Collateralized Loan
Obligations) are bonds issued against loan/bond portfolios.
• Banks bundle loans, convert them into securities, and sell them to investors.
• Used to transfer risk and raise funds.
9.3.4 Why is Securitization Preferred?
1. Better capital returns – Increases return on capital by reducing capital
locked in loans.
2. Alternative to bank funding – Especially useful when banks are unwilling
to lend.
3. Cost-effective – Cheaper source of capital compared to other funding
options.
9.3.5 Advantages of Securitization
1. Liquidity Creation – Converts illiquid assets (like loans) into liquid
marketable securities.
2. Investment Avenue – Provides investors with options for predictable
returns.
3. Foreign Funds – Helps raise global funds via depositories listing bonds.
4. Portfolio Diversification – Reduces over-dependence on bank loans.
5. Lower Risk – Transfers credit exposure from balance sheet to investors.
6. Asset Management – Helps match maturity of assets with long-term
funding needs.
7. Regulatory Benefits – Eliminates risks that attract regulation, thus boosting
funding access.
9.3.6 Impact of the Financial Crisis on
Securitization
• Pre-crisis: Banks originated loans and securitized them (high-quality loan
distribution model).
• Crisis Effect:
o Banks didn’t bear risk → Led to careless loan approvals.
o Credit quality dropped → Resulted in defaults.
o Mortgage-based securities became risky due to poor screening and
mismatched interest rates.
o Investor trust declined → Demand for mortgage-backed securities fell
sharply.
9.3.7 Structuring a Securitized Deal
• Involves pooling loans, setting terms (e.g., interest rate, maturity), and
selling to investors.
• The originator (e.g., bank) passes cash flow rights to investors.
• Tranches are created based on risk → safer tranches get lower interest,
riskier ones get higher.
• Underwriters and credit rating agencies evaluate and certify structure for
transparency.
9.3.8 Securitization Use and Benefits
• Purpose: Reduce funding costs and offload debt from balance sheet.
• Example:
o Ford used securitization to raise $1.6 billion at a lower interest rate
(5%) vs 6.8% for unsecured loans.
• Result: More efficient borrowing, cost savings, and better investor appeal.
9.3.9 Financial Counselling
• Helps people manage debt, budgeting, saving, and other financial goals.
• Especially useful during personal or economic crises.
• Services are free or low-cost when done by certified professionals.
9.3.10 What can a Financial Counsellor Do?
They can:
• Analyze finances and spending habits.
• Help you set goals and budget.
• Recommend debt reduction plans.
• Suggest ways to save and invest wisely.
• Assist with overcoming financial challenges.
9.3.11 Financial Counsellor vs. Financial Advisor
vs. Financial Planner
Point Financial Counsellor Financial Advisor/Planner
Focus Budgeting, debt help Investment & wealth planning
Certification AFC (by AFCPE) CFA, CFP, or other advisor certs
Fees Free or nominal $1000–$5000 per plan or 1% of assets
managed
Services Financial literacy, credit Insurance, estate, retirement planning
repair
9.4 Portfolio Management Services
9.4.1 Portfolio Manager
• A professional who manages investment portfolios for
individuals/institutions.
• Handles daily trading, asset allocation, and performance monitoring.
9.4 Portfolio Management Services (PMS)
9.4.1 Portfolio Manager
A professional who manages investment decisions and day-to-day trading for
individuals or institutions. They are responsible for choosing, monitoring, and
adjusting portfolios.
9.4.2 Key Takeaways
• A portfolio manager selects and manages investments using a specific
strategy.
• They can follow either active or passive management.
• Their success depends on:
o Skill in research and analysis
o Ability to act on investment insights
9.4.3 Benefits
1. Individual Investment Plans – Custom plans as per goals and risk.
2. Diversification – Reduces portfolio risk.
3. Higher Returns – PMS can be aggressive and yield higher profits.
4. Leverage – Uses themes like market timing, sector rotation.
5. Fund Manager’s Expertise – You benefit from their accountability.
9.4.4 Duties & Responsibilities
• Select investments (mutual funds, closed-end funds, ETFs, etc.).
• Apply strategies (e.g., small-cap, value, growth, index, contra).
• Monitor and rebalance portfolios.
• Reduce losses and boost returns via regular research and communication.
9.4.5 Types of Portfolio Managers
1. Active Managers – Try to beat the market using research and timing.
2. Passive Managers – Match index returns, e.g., Sensex or Nifty.
3. Discretionary Managers – Make all decisions on behalf of investors.
4. Non-Discretionary Managers – Advise; final decisions made by clients.
9.4.6 Objectives of Portfolio Management
• Capital Growth – Through asset appreciation.
• Risk Management – Via diversification.
• Income Generation – Steady returns via dividends, interest.
• Liquidity – Mix of liquid and illiquid assets.
• Tax Efficiency – Optimize for minimum tax impact.
• Investment Goals Alignment – Retirement, education, etc.
9.4.7 Key Elements of Portfolio Management
1. Asset Allocation – Spread across asset classes to balance risk.
2. Diversification – Invest in varied instruments to avoid losses.
3. Rebalancing – Adjust portfolio to maintain original strategy.
4. Active vs Passive Management – Depends on goals and market views.
Review Questions
Multiple Choice Sample Answers:
1. Main purpose of credit rating:
B. Evaluate a debtor’s risk of default
2. Key benefit of securitization:
B. Improves asset liquidity
3. Forfaiting’s special feature:
B. Forfaiting involves negotiable instruments
4. Portfolio Management’s key objective:
D. Diversifying investments to minimize risk
5. Highest degree of credit safety:
A. AAA
Short Answer Questions:
1. Define credit rating; its importance for borrowers & investors.
2. Differentiate corporate vs sovereign ratings.
3. Main advantages of securitization.
4. Forfaiting explained with an example.
5. Roles of financial counselors.
6. Two types of portfolio management.
7. Benefits of diversification.
8. How factoring improves business cash flow.
Essay Questions:
1. Discuss the significance of credit ratings with agency examples.
2. Compare factoring and forfaiting.
3. Evaluate securitization’s impact on liquidity & risk.
4. Examine objectives/principles of portfolio management with risk focus.
