Fee based

Financial
Services
MOD U L E 2 : EVA LUATE T H E
C RED IT WORTHINESS O F CO RPO RATES
U S ING C RED IT RAT ING T EC H NIQUE
Module III : Investment Banking and Merchant Banking: Meaning, nature and functions of
merchant banking – pre and post issue management services – loan syndication- Merchant
banking services in India –SEBI merchant bank regulations.
What are we going to learn
❖Merchant Banking-functions and role of merchant bankers- SEBI guidelines on merchant bankers-
Merchant Banking in India

❖Credit Rating- Concept- process of Credit rating- Credit rating agencies in India
Fee-Based?
❖Fee Based Services Fee based financial services are those services wherein financial institutions
operate in specialized fields to earn a substantial income in the form of fees or dividends or
brokerage on operations.

❖A fee-based investment is a product where the financial professional is compensated through fees
and commissions.

❖There is no transfer of a bulk amount of fund from the providers to customers

1.
Merchant
Banking

Merchant bankers
1. Merchant Banking
❖Merchant Banker is a person who is engaged in business of issue management either:
❖By making arrangements regarding selling, buying or subscribing securities
❖Or acting as manager/ consultant/ advisor
❖Or rendering corporate advisory services related to issue management

❖Merchant banking is a professional service provided by the merchant banks to their customers considering
their financial needs, for adequate consideration in the form of fee.

❖Merchant banks are banks that conduct:

❖ fundraising
❖financial advising
❖loan services to large corporations.

❖Issue – Offer for sale/ Purchases of securities/ from public / any body through merchant banker
 Difference between Merchant
Bank and Commercial Bank
1. Commercial banks basically deal in debt and debt related finance. Their activities are clustered
around credit proposals, credit appraisal and loan sanctions. On the other hand, the area of activity of
merchant bankers is equity and equity related finance. They deal with mainly funds raised through
money market and capital market.
2. Commercial banks’ lending decisions are based on detailed credit analysis of loan proposals and the
value of security offered. They generally avoid risks. They are asset oriented. But merchant bankers are
management oriented. They are willing to accept risks of business.
3. Commercial banks are merely financiers. They do not undertake project counselling, corporate
counselling, managing public issues, underwriting public issues, advising on portfolio management etc.
The main activity of merchant bankers is to render financial services for their clients. They undertake
project counselling, corporate counselling in areas of capital restructuring, mergers, takeovers etc.,
discounting and rediscounting of short-term paper in money markets, managing and underwriting public
issues in new issue market and acting as brokers and advisors on portfolio management.
Objectives of Merchant Banking
1. To help for capital formation.
2. To create a secondary market in order to boost the industrial activities in the
country.
3. To assist and promote economic endeavour.
4. To prepare project reports, conduct market research and pre-investment surveys.
5. To provide financial assistance to venture capital.
6. To build a data bank as human resources.
7. To provide housing finance.
Objectives of Merchant Banking
8. To provide seed capital to new enterprises.
9. To involve in issue management.
10. To act as underwriters.
11. To identify new projects and render services for getting
clearance from government.
12. To provide financial clearance.
13. To help in mobilizing funds from public.
Objectives of Merchant Banking
14. To divert the savings of the country towards productive
channel.
15. To conduct investors conferences.
16. To obtain consent of stock exchange for listing.
17. To obtain the daily report of application money collected at
various branches of banks.
18. To appoint bankers, brokers, underwrites etc.
19. To supervise the process on behalf of NRIs for their ventures.
Objectives of Merchant Banking
18. To appoint bankers, brokers, underwrites etc.
19. To supervise the process on behalf of NRIs for their ventures.
20. To provide service on fund based activities.
21. To assist in arrangement of loan syndication.
22. To act as an acceptance house.
23. To assist in and arrange mergers and acquisitions.
1. Merchant Banking
Role OF MERCHANT BANKING
•Project management - Merchant bankers offer help to clients in several ways in the process of project
management. They offer advice regarding the location of the project, preparation of project report, in
carrying out feasibility studies
•Raising Finance - Merchant Bankers help their clients in raising finance by way of issue of a
debenture, shares, bank loans, etc. They tap both the domestic as well as the international markets.
Finance raised by this method may be used for commencing a new project or business or it may even
be used for expansion and modernization of an existing business.
•Promotional activities - In India, merchant bankers play the role of promoter of industrial
enterprises. They help entrepreneurs in conceiving ideas, identifying projects, preparation of
feasibility reports, getting Government approvals as well as incentives, etc.
 1. Merchant Banking
Role OF MERCHANT BANKING
•Brokers in stock exchanges - Merchant bankers buy and sell shares in the stock exchange on behalf of the
clients. They additionally conduct researches on equity shares, advise the clients on the share to be
purchased, the time of purchase, quantity of such purchase and the time for selling these shares.
•Managing public issue - They provide the following services in the above-mentioned process:
• the timing of the public issue
• the size of the issue
• the price of the issue
• acting in the capacity of manager to the issue

•Credit syndication - A merchant banker provides specialized services in the stages of preparation of a
project, the loan applications required for the raising of short-term and long- term credit from various banks
and financials institutions, etc.
 1. Merchant Banking
FUNCTIONS OF MERCHANT BANKING (Related to primary issue of shares)

1. Corporate counseling:
(a) Providing guidance in areas of diversification based on the Government’s economic and licensing policies.
(b) Undertaking appraisal of product lines, analyzing their growth and profitability and forecasting future trends.
(c) Rejuvenating old-line companies and ailing sick units by appraising their technology and process, assessing
their requirements and restructuring their capital base.
(d) Assessment of the revival prospects and planning for rehabilitation through modernization and
diversification and revamping of the financial and organizational structure.
(e) Arranging for the approval of the financial institutions/banks for schemes of rehabilitation involving financial
relief, etc.
(f) Monitoring of rehabilitation schemes.
(g) Exploring possibilities for takeover of sick units and providing assistance in making consequential
arrangements and negotiations with financial institutions/banks and other interests/authorities involved.
 1. Merchant Banking
FUNCTIONS OF MERCHANT BANKING (Related to primary issue of shares)

2. Project counselling:
(a) Undertaking the general review of the project ideas/project profile.
(b) Providing advice on procedural aspects of project implementation.
(c) Conducting review of technical feasibility of the project on the basis of the report prepared by own experts or by outside consultants.
(d) Assisting in the preparation of project report from a financial angle, and advising and acting on various procedural steps including
obtaining government consents for implementation of the project.
(e) Assisting in obtaining approvals/licenses/permissions/grants, etc from government agencies in the form of letter of intent, industrial
license, DGTD registration, and government approval for foreign collaboration.
(f) Identification of potential investment avenues.
(g) Arranging and negotiating foreign collaborations, amalgamations, mergers, and takeovers.
(h) Undertaking financial study of the project and preparation of viability reports to advise on the framework of institutional guidelines and
laws governing corporate finance.
(i) Providing assistance in the preparation of project profiles and feasibility studies based on preliminary project ideas, covering the
technical, financial and economic aspects of the project from the point of view of their acceptance by financial institutions and banks.
(j) Advising and assisting clients in preparing applications for financial assistance to various national financial institutions, state level
institutions, banks, etc.
 1. Merchant Banking
FUNCTIONS OF MERCHANT BANKING (Related to primary issue of shares)

3. Pre-investment studies:
(a) Carrying out an in-depth investigation of environment and regulatory factors, location of raw
material supplies, demand projections and financial requirements in order to assess the
financial and economic viability of a given project.
(b) Helping the client in identifying and short-listing those projects which are built upon the
client’s inherent strength with a view to promote corporate profitability and growth in the
long run.
(c) Offering a package of services, including advice on the extent of participation, government
regulatory factors and an environmental scan of certain industries in India.
1. Merchant Banking
FUNCTIONS OF MERCHANT BANKING (Related to primary issue of shares)

4. Loan syndication:
(a) Estimating the total cost of the project to be undertaken.
(b) Drawing up a financing plan for the total project cost which conforms to the requirements of the
promoters and their collaborators, financial institutions and banks, government agencies and
underwriters.
(c) Preparing loan application for financial assistance from term lenders/financial institutions/banks, and
monitoring their progress, including pre-sanction negotiations.
(d) Selecting institutions and banks for participation in financing.
(e) Follow-up of term loan application with the financial institutions and banks, and obtaining the approval
for their respective share of participation.
(f) Arranging bridge finance.
(g) Assisting in completion of formalities for drawing of term finance sanctioned by institutions by
expediting legal documentation formalities, drawing up agreements etc. as prescribed by the participating
financial institutions and banks.
(h) Assessing working capital requirements
1. Merchant Banking

FUNCTIONS OF MERCHANT BANKING (Related to primary issue of shares)

5. Issue management:
The pre-issue management involves the following functions:
(a) Public issue through prospectus.
(b) Marketing and underwriting.
(c) Pricing of issues.
1. Merchant Banking
FUNCTIONS OF MERCHANT BANKING
5. Issue management:
6. Portfolio management:
7. Merger and acquisition:
8. Foreign currency financing:
9. Working capital finance:
10. Acceptance credit and bill discounting:
11. Venture financing:
12. Lease financing:
13. Relief to sick industries:
14. Project appraisal:
1. Merchant Banking
FUNCTIONS OF MERCHANT BANKING (Related to primary issue of shares)
• Determining the composition of Capital structure: Related to the combination of equity, preference,
debentures or long term loans. What should be the authorized capital, paid up capital etc.
• Draft of prospectus: Preparation of the same during public issue. Talks everything including inherent risk
• Application form filling: With relation to public issue. SEBI requirements will be fulfilled
• Compliance with procedural formalities: According to SEBI and companies Act.
• Appointment of registrar to deal with share application: Carrying on the activities in relation to an issue
including collecting application forms from investors, keeping a record of applications and money received from
investors
• Listing of securities: After close of bid, merchant bankers assist in listing it in NSE or BSE
• Selection of Brokers & Bankers
• Publicity and advertising, agent selection etc.
1. Merchant Banking
SEBI Regulations on Merchant Banking –

❖Registration
❖Compulsory registration required with SEBI
❖Four Categories

All in one, Legal too

Managing funds

Ensure full subscription

Capital / What?
❖Only in category I, merchant bankers can act as lead managers
 Category I – Merchant bankers
❖Minimum networth Rs. 5 crores

❖What can they offer?

❖Issue Manager / Lead manager
❖Portfolio Manager
Category 2 ❖Underwriter
❖Advisor & Consultant Category 3 Category 4
What are all these?
Issue Manager /Lead Manager
❖Pre issue: In the pre-issue process, the Lead Manager (LM) takes up the due diligence of company’s
operations/ management/ business plans/ legal aspects.

❖Mandatory document preparation: Design of Offer documents, Prospectus, statutory

advertisements and memorandum containing salient features of the Prospectus

❖Documentation: Completion of prescribed formalities with the Stock Exchanges, RoC and SEBI
including finalisation of Prospectus and RoC filing.

❖Post issue: Management of escrow accounts, coordinate non-institutional allocation, intimation of

allocation and dispatch of refunds to bidders etc. Trading and dealing of instruments and dispatch of
certificates and demat of delivery of shares
Portfolio Manager
❖Merchant banks provide portfolio management services to institutional investors and other
investors.

❖They help in the management of securities to enhance the value of the underlying investment.

❖Merchant banks may assist their clients in purchasing and selling securities to help them attain their
investment objectives.
Underwriting
❖Middlemen function: The underwriter in a new stock offering serves as the intermediary between
the company seeking to issue shares in an initial public offering (IPO) and investors.

❖Firm commitment: Underwriter agrees to assume the risk of buying the entire inventory of stock
issued in the IPO and sell to the public at the IPO price
Advisor & Consultant
❖Project counselling: The main consultation aspect of a merchant bank. They provide more insight
about the project

❖Market survey and forecasting: Market research and analytical services are rendered by them to
provide idea about the viability of the product / service

❖Business feasibility: Preparation of feasibility studies and aids to prepare business plans

❖Estimating funds required: Type of fund and requirement of capital are estimated. It includes size
of IPO, price of IPO etc.

❖Revival of sick units: To improve financial and operational performance

❖Advise on modernization and expansion: For existing companies

1. Merchant Banking
SEBI Regulations on Merchant Banking –
❖Grant of Certificate – Other conditions to be met:
❖A body corporate other than a non-banking financial company
❖Necessary infrastructure including office space, equipment & manpower
❖At least two persons with experience to carry out merchant banking business
❖Capital adequacy ratio with minimum paid up capital of Rs. 5 crores (Category I)
❖Partners/ directors or principal officers should not have litigation with securities market
❖Application is fit & proper person

❖Renewal of registration –
❖Once in three years – 3 months before expiry – Renewal application shall be submitted
❖Application fee – Rs. 25,000, Registration fee – Rs. 10,00,000 – Re-registration fee – Rs. 5,00,000
1. Merchant Banking
Code of Conduct for Merchant Bankers
• Protect the interest of the investors to the best of his capabilities
• Conduct business with a high level of dignity, integrity, and fairness
• Professionally and ethically fulfill all obligations
• Refrain from discriminating against clients
• Make sure that all necessary documents like letter of offer, prospectus, etc. are available at the
time of issue to all investors
• Advise clients in the most efficient way possible
• Inform clients about any penal action taken against them by the Securities Exchange Board of
India.
• Inform SEBI regarding any legal proceedings that have been initiated against him or her.
• Develop an internal code of conduct to govern internal operations
 Merchant Banking V/S Commercial
Bank
1.TO WHOM: Merchant banks work primarily for corporate firms, whereas commercial banks cater to the needs of
individual customers.

2.IPO: Merchant banks can be book runners / lead managers but commercial banks cannot be issue managers

3.RISK: Merchant Banks are always open to take risks, but commercial banks usually avert taking any kind of
risk.

4.ORIENTATION: Merchant banks are management-oriented, but commercial banks are asset-oriented.

5.PRODUCTS: Merchant banks usually do business with equities, but commercial banks usually buy and sell debt-
related finance such as loan approvals, credit proposals, etc.

6.ACTIVITIES: The major activities done by merchant bankers are underwriting, portfolio management,
consultant, and advisor, whereas commercial banks mostly play the role of financers only.

7.MARKET: Merchant banks are more related to the primary market and the commercial banks to the secondary
market.
Small task – Find the following:
1.Who provides merchant banking functions in India?

2.First merchant bank in India?

3.Top 5 merchant banks in India?

4.Top 3 merchant banks in the World?

5.Incorporation of JP Morgan

6.Job opportunities in Merchant banking field

7.NISM IX
History
Merchant banking started in Italy in late medieval times (from the fifth to the fifteenth century)

Reached in France during the seventeenth century

Italian merchant bankers introduces merchant banking into England in eighteenth century

European bankers developed Merchant banking in USA

In 1972, merchant banking started in South Africa.

Merchant Banking in India
1.Merchant banking in India began in 1967 by National Grindlays; later, Citi Bank started it in 1970.

2.In the year 1972, SBI became the first commercial bank to set up a distinct division for merchant
banking.

3.Then it was followed by ICICI in 1973, and then various banks started these services such as PNB,
Bank of India, UCO Bank, etc.

4.It was in 1973 when FERA came into existence that helped increase merchant banking activities in
India. After that, various banks such as IDBI and IFCI entered the market.

5.The Securities and Exchange Board of India (SEBI) regulates and governs merchant banking
activities in India.
SBI Capital Markets Limited

HDFC Bank.

Punjab National Bank offers Merchant Acquiring Services

Kotak Mahindra Capital

Credit Rating
Who
Who should
What: Why? will How?
do?
do?

Govt. Bonds,
Corporate
All NBFC Using
Measuring To get fund bonds, CRA (Credit
products need to quantitative and
creditworthiness (NCD/PD etc.) Certificate of rating agency)
have qualitative data
deposits, Mutual
funds, Insurance
 Credit Rating
i. “Credit rating is the symbolic indicator of the current opinion of the rating agency regarding the
relative ability of the issuer of the financial (debt) instrument to meet the service obligations as
and when they arise”.

ii. In simple terms, credit rating evaluates the credit worthiness of the debtor or essentially a
business company or government firm and estimate the likelihood of the default in payment.

iii. A credit agency evaluates the credit rating of a debtor by analyzing the qualitative and
quantitative attributes of the entity in question.

iv. The information may be sourced from internal information provided by the entity, such as
audited financial statements, annual reports, as well as external information such as analyst
reports, published news articles, overall industry analysis, and projections.
 Credit Rating - Users
1. Both institutional and individual investors use credit ratings to assess the risk related to investing in a
specific issuance, ideally in the context of their entire portfolio.

2. Intermediaries such as investment bankers utilize credit ratings to evaluate credit risk and further
derive pricing of debt issues.

3. Debt issuers such as corporations, governments, municipalities, etc., use credit ratings as an independent
evaluation of their creditworthiness and credit risk associated with their debt issuance. The ratings can,
to some extent, provide prospective investors with an idea of the quality of the instrument and what kind
of interest rate they should be expecting from it.

4. Businesses and corporations that are looking to evaluate the risk involved with a certain counterparty
transaction also use credit ratings. They can help entities that are looking to participate in partnerships or
ventures with other businesses evaluate the viability of the proposition.
Credit rating - types
•Investment grade ratings mean the investment is considered solid by the rating agency, and the
issuer is likely to honor the terms of repayment. Such investments are typically less competitively
priced in comparison to speculative grade investments. In the Indian context, debt instruments rated
'BBB-' and above are classified as investment grade ratings.

•Speculative grade investments are high risk and, therefore, offer higher interest rates to reflect the
quality of the investments. Instruments that are rated ‘BB‘ and below are classified as speculative
grade category ratings in which case the ability to meet the payment obligations is considered to be
“speculative”.
 Top 3 CRA in the world
I. S&P

II. Moody's

III. Fitch
 Credit rating agencies in India
I. There are a total of seven credit agencies in India:
I. CRISIL - Credit Rating Information Services of India Limited - 1987
II. CARE - Credit Analysis and Research - 1993
III. ICRA - Investment Information and Credit Rating Agency of India Limited - 1991
IV. SMREA - SME Rating Agency of India Limited - 2005
V. Brickwork Rating
VI. India Rating and Research Pvt. Ltd
VII. Infomerics Valuation and Rating Private Limited.
Credit rating Process
Credit rating – Methodologies
This is the analysis which assesses the risk involved related to the client’s industry risk,
business risk and financial risks.

Rating process flow chart for new issue ratings:

◦ Initial contact by issuer
◦ Introductory meeting of CRA and issuer
◦ Supply of data by issuer or presentation
◦ Rating exercised by analysts
◦ Analysis of new facts and enlisting new unresolved questions
General factors affecting credit rating
• Financial history – Profitability, turnover etc.
• Current assets – Cash, inventory, short-term investments etc.
• Liabilities – Wages, taxes, purchases, loans, mortgages etc.
• Auditor’s information – Any adverse comments mentioned.
• Payment history – Outstanding debts, punctuality to make a payment.
• Age of company – An older company will have more history to assist with calculation than a
newer company.
• Size of company – Larger companies are calculated differently to smaller companies.
• CCJ information (County Court Judgements) – How many? How frequently? What value? The
higher the number the bigger the affect on the ratings.
• Punctuality of filing accounts – Filing late lowers the ratings.
Credit rating – Methodologies – For
Mfg. companies
I. Business Risk Analysis – It includes the following:
◦ Industry risk – Nature of competition, key success factors, demand and supply positions etc.
◦ Market position of the issuing entity – Market share, Competitive advantage, selling and distribution
arrangements etc.
◦ Operating efficiency of borrowing entity – Locational advantage labour relationship, cost structure etc.
◦ Legal position – Terms of issue documents, systems for timely payment etc.

II. Financial Risk Analysis – It includes:

◦ Accounting Quality – Overstatement / Understatement of profit, Auditors’ report, inventory valuation and
depreciation policies etc.
◦ Earning Prospects – Sources of future earnings growth, profitability ratios, earnings related to fixed income
charges etc.
◦ Adequacy of cash flows – Stability of cash flows, capital spending flexibility etc.
◦ Interest & Tax Sensitivity – Exposure to interest rate changes, tax law changes, Hedging positions etc.
Credit rating – Methodologies – For
Mfg. companies
III. Management Risk Analysis – It includes the following:
◦ Track record of management, planning & control systems
◦ Evaluation of capacity to overcome adverse situations
◦ Goals, philosophies & Strategies
A small example task – Its process
1. Read the question
2. Prepare a table for positive and negative points
3. Add them
4. Rate accordingly
Contents
1. Introduction
2. Rating analysis
3. Conclusion
Parameters

Parameters Judgement
Age of the company Higher the better
Size of the company Higher the better
Accounting Based on ratio analysis.
Qualitative data Positive / Negative with
reasoning
Give a try !
Two companies approached CRISIL to rate their NCDs. From the following information you have to rate
them(Which company is AA which company is BB) based on the facts and figures.
Company A Company B

Industry: Automobile Industry: FMCG

Number of employees: 15,000 Number of employees: 1,50,000
Age of the company: 22 years Age of the company: 75 years

Parameter Company A Company B

Debt-Equity ratio 4:1 7:1
Gross profit ratio 55 % 71 %
Net profit ratio 22 % 18 %
GST 18 % (Ht) 12 %
Cash flow stability Increased over the past Consistent
Some more information
Answer

Parameter Company A Company B

Employees & Age 0 2
Debt-Equity ratio 1 0
Gross profit ratio 0 1
Net profit ratio 1 0
GST 0 1
Cash flow stability 1 0
Statements 1+1+1+0+1+1 0+0+1+1+0
Total 8 6
Rating AA BB
Credit rating – Methodologies – For
Financial service sector
I. Fundamental Analysis – It includes the following:
◦ Capital adequacy: Assessment of true net worth of issuer, adequacy of capital in relation to
volume of business and risk profile of assets
◦ Resources: Funding sources, Funding profile, Cost & tenor of sources of funds
◦ Asset Quality: Issuer’s credit risk management, system for monitoring credit, sector risk,
financing commitments etc.
◦ Liquidity management: Capital structure, Policy on liquid assets, commitments of maturing
deposits etc.
◦ Profitability & Financial positions: Historic profits, spread on fund deployment, reserves and
surplus etc.
◦ Interest & Tax sensitivity: Exposure to interest rate change, foreign exchange fluctuations etc.
How to address the case

Step 3: Rating Step 4: Rating

Step 2: analysis. One table
Introduction: sentence each (Parameter Step 5: Add
Step 1: Read About the about: and points) them and rate
the question company, A • Earnings • Positive outlook
according to
carefully quick • Loan/Asset = +1 CRISI (Hyp.)
snapshot of its quality • Negative outlook parameter
earnings • Management = -1
profile
Step 4 – Rating Table (How to?)
❖Step 1 – Earnings – Take Profit After Tax only (Based on analysis)
❖Step 2 – Ratio – Take ratios individually (Based on analysis)
❖Step 3 – Loan / Asset Quality – Do not take individually
❖Step 4 – Qualitative information – Take individually
❖Step 5 – Add + 1 & -1 = Then provide final rating based on parameter
Activity
I. Go to the official website of CRISIL, CARE & ICRA and find out the
following:
❖ Incorporated year
❖ Share price
❖ Major services rendered by those companies
❖ Who are the major clients for each rating agency
Activity
There are two firms A & B approaching to CRISIL and you are appointed as the analyst to rate the firm.
Abstract details about the company are provided to you by those companies. The two symbols you can
use for rating are AAA & AA. Based on the data, analyze them and rate those two companies and
elucidate the reason for such ratings. Both companies are going to issue debentures.

Company Gross Net Asset- Age of the Total paid

profit Profit Turnover company up capital
Ratio Ratio ratio (In years)
A 18% 8.5% 3 times 24 300 Cr.
B 15% 8% 2 times 17 270 Cr.
Activity
❖Company A had a serious litigation before two years related to window dressing and auditors’ report

❖Company B has already issued NCDs worth Rs. 100 crores which had BB rating by Crisil

❖Company B had two times paid penalty due to late filing of accounts

❖Company B has punctuality in terms of repayment of loans and interest

❖Company A has defaulted twice in terms of repayment of interest during the year 2020 & 2021

❖Company A is going to issue debentures for the first time to raise capital of 250 crores
Rating !
Company Positive Negative Initial Rating
points Points
A
B
Total
Thank You ☺ Module 2 – The End