Bank Loan Rating Methodology

1.0    OVERVIEW AND SCOPE

This article represents National Credit Ratings’ (NCR) Bank Loan Rating (BLR) Methodology for the rating of funded and non-funded credit facilities provided to an entity by Financial Institutions i.e., Banks and NBFIs. The BLR is an underlying credit rating of the corresponding entity rating. The entity rating provides an overall assessment of an entity’s credit quality while BLR indicates the degree of risk regarding timely servicing of a specific debt obligation (principal including interest) being rated. This methodology should therefore be read in conjunction with the Corporate Rating Methodology of NCR.

2.0    FRAMEWORK

Framework for notching of bank loan rating in terms of entity rating is as follows:

Entity Ratings are opinions of the ability of entities to repay the debt and debt like obligations. Generally, Bank Loan Rating (BLR) would be the same as the Entity Rating. However, the following special factors may influence the BLR to be different from the ICR.

• Security Coverage
• Collateral Coverage
• Charge on the Collateral
• Performance Behavior of the Borrowings
• Status of Loans

2.1 RATING CRITERIA FOR UNCLASSIFIED LOANS:

Unclassified loans are categorized into four groups: Standard-0 (STD-0), Standard-1 (STD-1), Standard-2 (STD-2), and Special Mention Account (SMA). Generally, the Bank Loan Rating (BLR) is assigned at the same notch as the entity rating when the loan classification status is Standard. Nevertheless, in cases of weak security and collateral coverage, subordinate claims on collateral, or subpar borrowing performance, the BLR may be rated one notch lower than the entity rating.

If the classification status shifts to SMA, the BLR will also be rated one notch below the entity rating. The same factors that contribute to a lower rating under the Standard classification will similarly apply in the case of SMA.

2.2 RATING CRITERIA FOR CLASSIFIED LOANS:

Classified loans are categorized into three groups: Sub-Standard (SS), Doubtful (DF) and Band/Loss (B/L). If any bank loan is classified under any of these categories, the BLR will be designated as “Default”, indicating a failure to meet financial commitments on time or when due.

3.0    SECURITY RISK

Security risk analysis involves the assessment of securities provided against each particular credit facilities. Quality of security is an important factor in determining security risk. Following parameters are considered during the analysis of security risk: 

• Security Coverage
• Collateral Coverage
• Location
• Support/Guarantee
• Forced Sale Value to Market Value
• Seniority Ranking (Priority claims on the assets during liquidation)
• Types of Collateral (FDR, Marketable Securities, Tangible Assets, Intangible Assets)

4.0    RELATIONSHIP RISK

To assess the willingness of the entity to repay the debt obligation, NCRL assesses the banking relationship with entity. The company fundamental analysis performed in the entity rating (corporate/trading) serves as the foundation of evaluation of the entity’s ability, whereas the historical record of the banking performance, transaction behavior and relationship with the banks and NBFIs are used to evaluate the willingness of the entity to service the debt obligation. Relationship risk is assessed considering the following factors: 

• Payment Behavior
• Tenure of Relationship
• Utilization of Limit
• Compliance of Covenants and Conditions
• Depository Relationship with the Bank
• Rescheduling History

5.0    LIMITATION

The BLR methodology bases on the assumptions for which NCRL puts best efforts to match each case or situation. While considering parameters for evaluation of each credit facilities and securities and collaterals, the BLR methodology is not exhaustive at the time of declaration; and in reality, their qualities (entity, security and collateral) may be different from those at the time of declaration. Further, NCRL only rates credit facilities in local currency, so no consideration is given to exchange rate risk and sovereign risk etc. NCRL also does not consider the impact of interest rate risk. In addition to that NCRL is to depend highly on client provided credit information where there is likelihood of concealing irregular as well as regular facilities with other financial institutions availed beyond the exposed credit facilities.

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