Executive Summary  

The rating of the credit facilities/debt instruments issued by any issuer (i.e. obligor) primarily revolves around a holistic assessment of its industry, business, financial and management profile. The rating is based on the obligor’s standalone credit profile as evaluated under the aforementioned parameters, i.e. wherever the obligor entity is not associated with any larger group or company, i.e. the standalone credit profile is the driver of the rating.

There are certain cases where the obligor is a subsidiary of another company with a strong credit profile or an associate of an established corporate group with a demonstrated track record of performance and established credibility. In such cases, the final rating factors in not only the standalone credit profile of the obligor entity but also the benefits it derives from being associated with a larger group or parent. The benefits are in the form of a notch up over the standalone rating, which reflects the expectation of support from the group both on a going basis and also in distress. The rating exercise in such cases will broadly entail the following three steps:

• Assessing the standalone credit Rating of the obligor
• Assessing the credit quality (i.e. Rating) of the parent or group (if not already rated by Acuité)
• Arriving at the extent of notch up over the standalone credit profile

The credit quality of the parent company is arrived at after considering the assessment under business, financial and management parameters. In case of a direct parent-subsidiary relationship or a stepdown relationship (i.e. parent holds the majority stake in one company, which in turn holds majority stake in our obligor company), it is the ultimate parent company which will be considered for the rating notch up. The key aspects to be examined are the ability and management’s willingness to extend timely support to the obligor, i.e. firstly, the parent or group itself has to be rated higher than the standalone obligor and in the investment-grade category. Secondly, a majority holding does not necessarily qualify for parent notch up unless there is an implicit or explicit understanding based on management discussions, past track record, documentation through guarantee or letter of comfort, etc. that the parent will continue to extend necessary support (financial and non-financial) to the obligor in future.

In case of a Group Notch up (i.e. cases wherein the majority shareholding in the obligor is held by multiple entities controlled by the same promoter), the flagship operating entity of the group may be considered as a surrogate for the Group. Acuité observes that in certain situations, the support could also flow from other group entities besides the flagship entity, based on their free cash flow generation. Hence, under group assessment, Acuité also examines the various entities in the group to understand their financial strength and their debt burden. This is important since some of the entities may not be consolidated in the flagship entity but still may be pivotal to the group in terms of their cash flow generation and overall debt position.

 

The extent of notch up is essentially based on broadly two parameters: (a) Economic importance of the obligor to the parent or group & (b) Moral obligation to support the entity. Under each of these parameters, there are sub-parameters for which objective scores are assigned. Based on the scores arrived at under these two factors, an aggregate notch-up score is computed. The gap between the parent and standalone rating is compared with the percentage notch-up score to decide the extent of notch-up. Acuité will mention in its analytical approach section of the Rating Rationale that the rating factors in support from the parent or group. It may be noted that the mere presence of a Corporate Guarantee or Letter of Comfort (particularly in case of non-sovereign corporate entities) does not necessarily qualify for the equation of the rating with the guarantor’s credit rating unless there is an associated payment structure which can ensure timeliness of the support.

The following section dwells on the specific sub-parameters which are considered for determining the notch up:

1. Business Rationale

Strategic importance to Parent / Group

The criticality of the rated entity to the parent/ group is one of the most important factors in the parent notch-up framework. The importance of any entity will

emanate from factors like significant operational and/ or financial linkages with the parent/ group. An entity supplying a significant proportion of the raw material requirements of its parent company or providing critical job work services to its parent is an example of such operational linkage. Similarly, if the major part of distribution of the products/ allied services of the parent is handled in a separate entity, such an entity will be critical to the parent/group. A related example is a captive BPO unit of a large bank handling its back-office functions. Such a unit will be critical to the bank’s operations, and ongoing managerial and financial support to the entity can be expected from the bank. A typical example is of an Indian subsidiary of a multinational group. The scale of operations of the subsidiary could be modest relative to the group. However, if the management has significant expansion growth plans for India, the lenders/ investors can expect significant ongoing support from the overseas parent.

In a nutshell, the scoring under this parameter will be based on the extent of operational and/or financial linkages, both present and expected, with the parent /group and the way the business of the entity is correlated with the growth strategies of the group.

Magnitude of parent’s investment in company

The investment of the parent in the subsidiary/ associate entity also has a bearing on the likelihood of support which can be expected by the investee entity. A significant investment by the parent in its subsidiary indicates a high level of commitment to the subsidiary and its operations. The significance of the investment has to be evaluated both in terms of the absolute amount of fund infusion and in relation to the net worth of the investing entity. A subsidiary/ associate entity which contributes significantly to the overall consolidated performance will continue to get ongoing as well as distress support from its parent. It has to be understood in this context that besides equity