Bank Loan Rating

Bank loan rating (BLR) is an opinion on the relative degree of risk associated with timely repayment of principal and interest or fulfilling commitments on a specific bank facility, exposure or commitments. It thus reflects an opinion on the likelihood of financial obligations being serviced on time and in full, as specified in the terms of the facility.

The primary focus of BLR rating is to assess future cash generation capability and their adequacy to meet debt obligations as per the repayment terms. The analysis therefore attempts to determine the fundamentals of the business and the industry and the probabilities of change in these fundamentals, which could affect the creditworthiness of the borrower.

BLR is an offshoot of banks’ capital adequacy requirement under Basel II framework. Basel Capital Accord II in respect of capital measurement and capital standards aligns capital of a bank more closely with the underlying risk a bank undertakes through providing funded and non-funded facilities in favour of client or counterparty.

Rigorous analysis is made of several qualitative and quantitative factors prevailing in the borrowing entity’s business. Qualitative factors are converted into quantitative terms to avoid biases. Broad factors evaluated include industry risk, business risk, governance risk, management risk, financial risk, environmental risk. Quantitative factors include appraisal of historic and projected financials, profitability, capacity utilization, capital expenditure need, cash flow adequacy, debt servicing capacity, and free cash flow. These factors will essentially depend on the sectors in which the entity belong.

Industry characteristics, industry financials, global perspective, industry prospects (growing, stable, declining). Other industry factors include:

• Industry structure: Number of participants, nature of competition, supply chain management
• Entry and exit barriers: Start-up capital requirement, infrastructure requirement, regulatory environment, labour-intensive or capital-intensive nature of production
• Level of cyclicality: Source of cyclicality such as demand, price, input prices
• Technological change: Traditional, Modern
• Capital expenditure requirements: Recurring, investment plans

• Market position: Competitive position, brand value, market share, nature and extent of diversification, product quality, quality control, marketing and networks
• Operating efficiency: Labour relations, location of production facility, access to markets, access to supply sources, manufacturing efficiency compared to competitors
• Plant, machinery and infrastructure: Plant layout, capital expenditure requirement, economies of scale, capacity utilization, product design
• Position in business cycle: Product profile, nature of product such as commodity, luxury, normal, product life cycle, strategic importance, elasticity of demand

• Composition of board
• Board meetings
• Committee effective functioning
• Directors’ independence
• Delegation of power to management and committees

• Management track record: Previous history, corporate strategy, corporate plans, execution status of past plans and prospective plans.
• Management style: Delegation of authority and responsibility
• Personnel policies: Quality of professional staff, human resource plan, staff compensation package, promotion policies, incentive schemes

• Operating environment
• Government economic policy relating to the industry
• National economic outlook
• Special significance to economy
• Pending litigation
• Tax status
• Import/ export policy