NCD Credit Rating

NCD Rating Meaning

The NCD rating indicates whether the NCD is safe for investment or not. The NCD rating is a value that assesses the ability of the issuer to make its payments at the time of maturity/repayment. If the company issuing the NCD has a positive cash flow and strong financials, the NCD will receive a higher rating.

It is mandatory for a company to obtain a credit rating for the issuance of NCD. The issuing company can obtain credit rating from one or more than one credit rating agency, A credit rating for a non-convertible debenture (NCD) reflects the issuer's ability to meet its financial obligations. These obligations include payment of interest when due and paying maturity proceeds on time. There are seven SEBI-registered credit rating agencies in India. Of all, ICRA, CRISIL Rating, India Ratings and Research and CARE Ratings are more popular and regularly rate the NCD bonds.

The rating agencies assign the NCD ratings. The NCD rating indicates the level of risk and helps investors decide whether or not to invest in an NCD.

The NCD Rating shows mainly 3 indications:

1. Safety degree
2. Risk degree
3. Outlook

1. NCD Safety Degree Explained

   This explains how safe it is to invest in an NCD. The Higher the rating, the safer it is to invest in an NCD. For example, an NCD with a rating of AAA will be considered the safest to invest as this indicates the highest safety in terms of debt repayment. Similarly, an NCD with CCC or C ratings will fall under the category of most unsafe investment.

2. NCD Risk Degree Explained

   A risk degree explains how risky it is to invest in a particular NCD. The higher the credit rating, the lower the credit risk and the lower the credit rating, the higher the credit risk.

3. NCD Outlook Explained

   A rating outlook provides insight to investors about expected rating changes during medium-term period of one to two years.

   A rating outlook can be "Stable", "Positive", or "Negative":

   • Stable: The rating is likely to remain unchanged
   • Positive: The rating may be upgraded
   • Negative: The rating may be lowered

Let’s understand the safety degree, risk degree and outlook with an example:

Muthoot Finance NCD Tranche III is rated [ICRA] AA+/Stable by ICRA Limited.

1. This rating is considered to have a high degree of safety.
2. Very low credit risk.
3. Stable Outlook.

This NCD has a very low credit risk and indicates that investing in that NCD is safe. Although the ratings are not a recommendation to buy, sell or hold securities investors should make their own decisions.

Credit rating agencies rate non-convertible debentures (NCDs) to indicate the issuer's ability to pay their debts. These ratings are based on several factors, such as the issuer's financial strength, loan repayment history, and cash flow.

NCDs with a higher credit rating are considered less risky and offer a lower return. NCDs with lower credit ratings are considered riskier and offer a higher yield.

Some say that AAA-rated issues are the safest and that retail investors should avoid issues rated below AA/AA+.

NCDs are not backed by collateral, so the ratings assigned by rating agencies are important. Let's understand the importance of Credit ratings in detail.

1.1 Importance of NCD Credit Rating

NCD Credit Ratings are important as it helps:

1. Assess the issuer’s ability to repay its financial obligations.
2. The rating agency evaluates the financial information based on the financials.
3. Assess the risk and return of the credit instrument.
4. Creates financial discipline within the company to maintain the rating of the financial instrument.
5. Expressed in symbols that are easier for an individual investor to understand.
6. Assigned by accredited institutions or experts.
7. Gives investors an indication of whether an investment in an instrument is worthwhile or not.
8. A good credit rating enhances the visibility and reputation of the issuing company.
9. A good credit rating makes it easy for companies to raise funds through loans.

1.2 Users of Credit Ratings

Credit ratings of companies are considered by various bodies or users and organizations, including:

1. Investment Banks

   Investment banks use credit ratings to determine the risk of debt instruments or shares before offering them on the market.

2. Lenders

   Lenders evaluate ratings to assess the ability of a borrowing company to repay loans. A favourable rating reduces the risk of default and increases the likelihood of loan approval.

3. Retail/institutional investors

   Retail and institutional investors use credit ratings to assess the risk and potential return of investing in a company's securities, such as stocks or bonds. These ratings influence investment decisions and help investors determine the reliability of their investments.

4. Issuers of debt securities

   Companies monitor their credit ratings to evaluate their creditworthiness and borrowing costs, manage financial strategies and make informed decisions.

5. Other companies/corporations

   When conducting business transactions or partnerships, companies often check the credit ratings of other organizations involved. This helps them assess the potential partner's financial stability and creditworthiness.

1.3 Importance/Advantages of NCD Credit Ratings (For Investors)

1. Better Investment Decision

   It helps investors decide whether the company is worth investing in.

2. Indication of Safety assurance

   A higher credit rating assures the customers that the amount will be paid back on time with interest.

3. Help to select Securities

   Customers invest in high-rated instruments for repayment assurance and minimal risk.

1.4 Drawbacks/disadvantages of NCD Credit Ratings

1. Lack of Real time

   Credit ratings may not accurately reflect a company's current situation since they are based on historical financial data that does not reflect the current economic crisis.

2. No Attention on Future Information

   Credit ratings are based on past performance and may not reflect future growth, resulting in inaccurate ratings for companies that have grown significantly since their inception.

3. NCD Ratings are not Static

   Credit ratings get revised based on the company’s performance. A downgrade from previous ratings can impact the pricing of NCD in the secondary market. It is typical for the credit rating of a non-convertible debenture not to be revised by credit rating agencies despite unexpected events in the company, which can negatively impact investors.

4. Credit rating only acts as assurance

   The rating only serves as security and does not guarantee the investor a risk-free investment.

2. NCD Credit Rating Agency

Credit rating agencies (CRAs) rate companies and assign credit ratings to help investors and lenders understand the risk of lending to these companies.

Below is the list of credit rating agencies that rate the NCDs in India:

1. Credit Rating Information Services of India Limited (CRISIL)
2. Investment Information and Credit Rating Agency of India (ICRA) Ltd.
3. Credit Analysis and Research (CARE) Ltd.
4. Acuite Ratings & Research Ltd.
5. Brickwork Ratings India Private Ltd.
6. India Ratings and Research Pvt. Ltd.
7. INFOMERICS Valuation and Rating Private Ltd.

Note: CRISIL Ratings may use modifiers {“+” (plus) / "-" (minus)} with the rating symbols for the categories 'CRISIL AA' to 'CRISIL C'. The modifiers reflect the comparative position within the category.

For example: The rating with + and - takes place in this order AA+, AA, AA- and A+

• AA+ has the highest degree of safety compared to AA and AA-.
• NCDs rated AA are safer than AA-.
• AA- is safer than A+

Key Takeaways

It is mandatory for all NCD issuers to obtain a rating for the NCDs from rating agencies. The credit rating provides information about a company's ability to meet its liabilities. NCDs with a higher credit rating are considered less risky and offer a lower return. NCDs with a lower credit rating are considered riskier and offer a higher return. NCDs with a AAA rating have the highest degree of safety, while NCDs with a C rating or below are considered risky.