-Shantnu Bansal
What is a Credit Rating?
A lender before lending or advancing money would be willing to conduct a background check on the borrower’s repayment capacity, ability and willingness to repay it, i.e., to test the creditworthiness of the borrower which can be assessed by a credit rating assigned by a credit rating agency using various parameters.
Any form of debt or loan has to be repaid along with the interest and that is the reward for the lender.
Standard & Poor’s (S&P), Moody’s and Fitch have globally recognized credit rating agencies. ICRA (Investment Information and Credit Rating Agency of India Limited), CRISIL (Credit Rating Information Services of India Limited) and CARE (Credit Analysis & Research Limited) are some of the credit rating agencies in India.
How is credit rating determined?
To arrive at a credit rating, an agency not only evaluates current and past data but also assesses the potential influence of anticipated future events on the borrower’s capacity to repay.
While assigning a credit rating to a country, the focus is on political and monetary stability, the impact of world events on the country’s economy, and overall debt burden.
For a company, deciding parameters are its historical and current performance, industry profile, company’s position in the industry and how it is performing in comparison with its competitors, revenue model and cash flow, accounting methods, current debt burden, projected earnings capacity and corporate governance.
Implication
The AAA rating is the topmost rating that can be given to a borrower and its major benefit is that it helps to borrow at low-interest rates, simply because lenders know that lending to such a borrower comes with negligible risk as it would almost not default.
Credit ratings reflect relative judgements about the creditworthiness of a borrower, from the strongest (AAA) to the weakest (D).
Like, a borrower that is rated ‘A’ is only less likely to default on repayment than one with a ‘BBB’ rating. It is not that it will not default, but only that the probability of non-repayment is less likely than those rated below it and different agencies may assign different ratings depending on its analysis of the borrowers’ situation.
The table will help one to understand grades in a credit rating:
INVESTMENT-GRADE | AAA | Immensely strong position to meet financial obligations. Highest rating |
| AA | Very strong position to meet financial obligations | |
| A | Strong capacity to meet financial obligations, but prone to unfortunate economic challenges or alteration in situations | |
| BBB | Sufficient capacity to meet financial obligations, but more subject to adverse economic situations | |
| BBB- | Deemed to be least investment grade by market contenders | |
| SPECULATIVE GRADE | BB+ | Deemed topmost speculative grade by market contenders |
| BB | Less vulnerable in immediate future, but faces current uncertainties to critical economic, financial, industry and business conditions | |
| B | More vulnerable to economic, financial, industry and business conditions, but can meet financial obligations currently | |
| CCC | Presently vulnerable and depends upon favourable conditions to meet financial obligations | |
| CC | Highly vulnerable at the moment | |
| C | A bankruptcy petition or similar action has been submitted, but payments of debt are continued | |
| D | Payment default on financial houses | |
| Ratings from ‘AA’ to ‘CCC’ may be modified by using the (+) or (-) sign to show comparable standing within the key rating categories. |
Where does India stand?
In July 2020, Fitch Ratings retained India’s sovereign rating at the least investment grade of ‘BBB-minus’ with an anchored stance, holding that a feeble fiscal position continues to coerce India’s sovereign ratings. Standard and Poor’s had similar ratings for India.
Moody’s is the only renowned rating agency that has a higher sovereign rating for India at ‘BAA 2’- one nick above ‘BBB-minus’ – with a firm viewpoint.
Fitch, in a conference, said, “India’s rating position a sturdy medium-term development outlook and conducive external balances relative to countries with weak fiscal finances, a brittle financial sector and some lingering structural factors.”
In Moody’s ‘Global Emerging Market Outlook’ report released in October 2020, it is mentioned that India faces a probable sharp downturn in credit availability as NBFCs (Non-Banking Financial Companies) face a possible credit crunch, even though forex reserves buffer and meagre external debt extent help provide greater resilience to economic blows. “In India, the asset quality cycle is sustaining following identification of problematic loans and their solution and provisioning. But the recent default of IL&FS (Infrastructure Leasing and Finance Services), a massive infrastructure company and the ensuing liquidity stress in the capital market, has created a potential risk for banks,” it affixed.
The Bottom Line
Investors use data from multiple rating agencies as they expect them to provide information based on apt analytical methods and accurate statistical computations. Investors expect CRAs to adhere to reporting standards developed by governing bodies.
The analyses and evaluation provide investors with the knowledge that helps them to make informed and safe choices as to the countries, industries and classes of securities in which they choose to invest.
Reference – https://www.wallstreetmojo.com/bond-rating/
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