You must have heard the phrase “The Zero Moment of Truth.” Zero moment of truth is all about the research we do on the product before we purchase it. Whether we are buying a villa or vase, we go through reviews and ratings. The same happens in the bond market as well. Here the rating is a systematic process executed by independent organizations, and they are called Credit Rating agencies. Credit rating agencies are well-regulated entities. Let’s discuss more about Credit Rating Agencies (CRA).
The credit rating is an evaluation of prospective debtors. The debtor could be a country or organization that owes money. Credit Rating Agencies study the debtor’s credit history and predict the ability to pay back the bonds or other debt instruments and a forecast on anticipated debtor defaulting. Credit ratings help both institutional and individual investors to invest appropriately.
A credit rating agency is a company that assigns credit ratings.
Credit Rating Agencies consider the following factors to understand and predict the creditworthiness of the borrower.
- Financials: Financials include the income statement, balance sheet, and cash flow.
- Performance: The performance of a company is determined based on production, sales, sales growth, and market coverage.
- Management Quality: An organization with a value-based leadership team that is compliant with regulations performs better in the long run and sounds promising to the investors.
- Prospect of usage of the fund: Understanding the business development strategies and purpose of fundraising.
- Payment History: Payment history includes repaying debts, dividends, taxes, and compensation to the employees.
The CRA and issuer make a contract. Credit rating agencies periodically collect credit history, credit type, duration, credit utilization, credit exposure, etc. They collect other financial details from banks and Financial Institutions that are related to the issuers. Considering all these collated data, agencies generate a report. These ratings guide investors and banks to make investment decisions. The CRAs disclose the report even if the issuer doesn’t accept the report and ratings. But the issuer can appeal to CRA to review the rating.
Credit Rating Agencies provide a later-based rating. In India, “AAA” to “BBB” rated bonds are considered relatively safer instruments, and bonds rated below “BBB” are considered relatively riskier instruments.
Benefits of Credit Rating
For Investors :
It helps the investors to make better decisions. A high credit rating means an assurance about the safety of the money and that it will be paid back with interest on time and principal amount on maturity.
For borrowing companies (issuers), credit rating works as a tool to convince investors. It facilitates the capital raising and saves time.
Top Credit Rating Agencies
Moody’s was founded in the year1909 by John Moody is headquartered in Newyork. Later in 1962, it was acquired by Dun and Bradstreet.Moody’s assigns ratings to companies and countries. Moodys rate the commercial and public debt securities that include corporate bonds, money market funds, fixed-income funds, and hedge funds. Their rating ranges from Aaa to C. Aaa to Baa3 ratings are given to investment-grade bonds and Ba1 to C ratings are given to junk bonds.
John Knowles Fitch founded Fitch rating in 1914.It is headquartered in Newyork. Fitch rate countries by evaluating their financial and political conditions. Ratings from Fitch range from AAA to D. AAA to BBB ratings are given to investment-grade bonds and BB to D ratings are given to riskier bonds. FIMALAC acquired it in 1997. The fact to be noted here is Fitch delivered risk management software to IBM.
Standard and Poor’s:
Standard and Poor’s is one of the three largest CRAs in the world. Its a subsidiary of S&P Global. S&P Global was founded in 1860 headquartered in Newyork. Its ratings range between AAA and D. AAA to BBB ratings indicate safety and BB+ to D ratings are given to riskier bonds.
CRISIL was incorporated in 1987. CRISIL happens to be the first credit rating agency in the country. It is a subsidiary of S & P Global. Crisil has two categories of securities: Long term and short-term. Long-term securities ratings range from AAA to D and short-term securities ratings range from A1 to D. It offers eight types of credit rating, which are as follows:
AAA, AA, and A ratings indicate a higher level of safety.
BBB and BB ratings indicate medium safety.
B, C, and D ratings indicate a lower level of safety.
ICRA was established in 1991. ICRA is headquartered in Mumbai.ICRA is owned by Moody’s. ICRA’s rating scale starts from AAA and ends with D. Ratings AAA to A ratings indicate higher safety, BBB to B indicate moderate safety, and C and D ratings are given to riskier securities. . The rating services of ICRA are:
- Bank Loan Rating
- Public Finance Rating
- Corporate Governance Rating
- Infrastructure Sector Rating
- Insurance Sector Rating
Credit Analysis and Research Limited (CARE) has been functioning since 1993. Its rating scale includes two categories – long term debt instruments and short term debt ratings. AAA to A rated instruments are safe, BBB and BB rated instruments are moderately safe and B to D rated instruments are riskier.
CRAs study the overall economic condition of different countries. They consider political stability, capital market transparency, foreign currency reserves, and investments. CRAs prepare reports on the government’s general creditworthiness and give credit ratings called a sovereign credit rating.
The credit rating agencies are well-regulated by SEBI Credit Rating Agencies Regulations, 1999 of the Securities and Exchange Board of India Act, 1992. SEBI has a detailed framework of guidelines to control the operations of CRAs to protect investors’ interests. Hence investors can rely on credit ratings and make investment decisions.
You, as a bond investor, are trying to know what Bond Rating is?
Credit rating is the rating given to the issuer, and whereas Bond-rating is the rating assigned to the Bond, i.e., the issue. Rating the issuer and rating the issue are like two faces of the same coin. In either case, the process and purpose remain the same. The same issuer may offer multiple issues; hence having a different rating system for the issuer, and each of the issues helps the issuer to make informed decisions.