As an investor, what are the ways in which one can attempt to minimize the market volatilities to their best efforts? Our best bet is to trust our investments with companies and banks that come with a verified legacy of creditworthiness and history of minimum defaults and timely payments. This not only ensures a steady rate of growth but also keeps your investments safe from turning into losses. So how does one determine the creditworthiness of the borrower? Be it an individual borrower, or a company - everybody comes with a credit rating or credit score. Awarded to them by authorised Credit Rating Agencies globally, and within the country - these help money lenders determine if their loans will be repaid on time.
The credit rating is instrumental in deciding the rates of interests, based on the risks the borrower poses. It is an important aspect to consider for all investors.
The concept of credit ratings and credit rating agencies are relatively new in India, dating back to just a couple of decades only. That being said, this medium of evaluation is most influential in our current environment as investors trust the independent assessments of such agencies - relying on them for their insights and findings before making an investment decision.
In this article, we endeavour to understand what Credit Ratings mean, the role they play and the agencies that help carry this out. Just as important it is to understand which investments make for a good one, it is also imperative for an investor to understand what impacts their investment choices.
DEMYSTIFYING CREDIT RATING
Right off the bat, let’s begin with understanding what credits ratings really are. Essentially, credit ratings are certifications issued to every company by credible assessment agencies, based on their financial health, determining the creditworthiness of the securities that are being issued into the public sphere. These could be securities issued by government bodies, banks, corporations or any other entity.
The same concept is also extended to individual borrowers, in the form of credit scores - an instrument to measure a borrower’s credit history. This is determined by credit bureaus after taking into account an individual’s ability to repay bills and debts on time, the frequency at which they apply for loans and how often their credit cards are maxed out, amongst other things. This helps determine whether or not an individual is eligible for a loan, and at what interest rate.
While every credit rating agency has its own set of ratings, they are usually represented as AAA, AA, A, BBB, and so on - the highest rating being AAA and the lowest being D - indicating that the security borders on defaulting. Typically, credit ratings are dynamic, reviewed every month by agencies - keeping in mind the constant market movements impacting the securities and finances held by a company.
Credit ratings rightfully influence investor sentiments, guiding them away from securities with downgrading ratings that are not posed to perform well in the near future. A hearty recommendation from credit rating agencies indicates that the firm is doing well, and has the ability to service its debt methodically while meeting all investor expectations. In a nutshell, accurate and objective credit ratings help investors in these ways :
- Guides investor into better assessing securities before investing
- Helps filter out risky investments from investor consideration
- Impacts a nation’s economic policy
WHO ACCESSES THE CREDIT RATINGS?
With very little left to the imagination, credit ratings are issued and awarded by credit rating agencies and establishments - who are solely dedicated to monitoring the movements and the health of various securities and their performance. These agencies carry out their assessments independently, going through all their paperwork to gauge how the securities are faring. Their findings are objective, unbiased and driven by rationale - evolving every month based on their continuous evaluations. On a side note, it is important to note that the Securities and Exchange Board of India (SEBI) reserves the right to authorise and regulate credit rating agencies according to SEBI Regulations, 1999 of the SEBI Act, 1992.
The core functions of the credit rating agencies include :
- Compiling and accessing financial data that is relevant to loan disbursals and insurance
- Statistical analysis of data that is pertinent to issuing a rating
- Providing investors with an analysis of the organization’s ability to service their debt, on time.
VARIABLES THAT ARE FACTORED INTO A CREDIT RATING
The process of evaluating a company’s securities performance is a complex process that runs on a cycle of 3-4 weeks, updating its credit rating nearly every month. This process engages with a lot of internal workings of the company that is under scrutiny, in order to issue a credit rating corresponding to the company’s performance. Here are the two prominent determinants of the process.
- The Company’s History: The credit rating agency dwells deep into the company’s history, examining old patterns of credit and debt servicing. A history of bad loans can severely deter a company’s chance at a high credit rating.
- The economic potential of the company: Any credit rating agency also takes into account the future economic potential of the company they are auditing in order to gauge its ability to repay loans in the future. If their growth looks promising, backed by a statistical study of their own books then ratings would be kinder towards the company.
Other factors (including but not limited to) influencing a company’s credit ratings:
- Repayment history
- Credit Utilization
- Credit History Length
- Credit Mix
CREDIT RATING AGENCIES IN INDIA
India has seven active and authorized credit rating agencies, approved by SEBI that issue credit ratings and scores to companies and individuals alike. In global circles, establishments like Moody’s Investors Services and Standard and Poor’s assess global firms and companies, and the same is done on a domestic level by these 7 agencies.
Credit Rating Information Services of India Limited (CRISIL) is one of the oldest credit rating agencies, set up in 1987. The agency stepped on to infrastructure rating in 2016. CRISIL has been operational in countries such as USA, UK, Poland, Hong Kong, China, and Argentina in addition to India. The company’s portfolio includes mutual funds ranking, Unit Linked Insurance Plans (ULIP) rankings, CRISIL coalition index and so on.
The Investment Information and Credit Rating Agency (ICRA), a joint venture of Moody’s and Indian Financial and Banking Service Organisation was established in 1991. The organisation is known for assigning corporate governance rating, performance rating, mutual funds ranking, and more. ICRA’s product portfolio includes a rating for - corporate debt, financial rating, structured finance, infrastructure, insurance, mutual funds, project and public finance, SME, market-linked debentures and so on.
3. India Ratings and Research Pvt Ltd
India Ratings and Research, a wholly-owned subsidiary of Fitch Group, provides accurate and timely credit opinions on the country’s credit market. The firm covers corporate issuers, financial institutions, managed funds, urban local bodies, project finance companies, and structured finance companies.
4. Credit Analysis and Research Limited (CARE)
Credit Analysis and Research Limited (CARE) is a credit rating agency that is operational since April 1993. The agency provides credit rating that helps corporates to raise funds for their investment requirements. Investors can make decisions based on credit risk and risk-return expectations. CARE Ratings has also ventured into valuation services and offers a valuation of equity, debt instruments, and market-linked debentures.
5. Brickwork Ratings India Pvt Ltd
Brickwork Rating was established in 2007 and is promoted by Canara Bank. It offers ratings for bank loans, SMEs, corporate governance rating, municipal corporation, a capital market instrument, and financial institutions. It also grades NGOs, tourism, IPOs, real estate investments, hospitals, IREDA, educational institutions, MFI, and MNRE.
6. Acuité Ratings & Research (earlier SMERA Ratings Ltd.)
Originally, known as Small Medium Enterprises Rating Agency Of India Limited, this credit rating agency is now known as Acuité Ratings & Research. This agency has two divisions – SME Ratings and Bond Ratings. It was established in 2011.
7. Infomerics Valuation and Rating Pvt Ltd
This is a SEBI-registered, and RBI-accredited credit rating agency that was founded by former bankers, finance professionals and administrative services personnel. It assesses and calculates credit ratings for banks, NBFCs, large corporates and SMUs (small and medium scale units). It aims to play a key role in serving the financial markets by minimizing the information asymmetry among different lenders and investors and facilitating borrowers to several fundraising opportunities.