credit rating, in simple terms, indicates the probability of
a borrower repaying the debt or defaulting on debt payments. Debt
include both the interest and the principal. A poor rating indicates a
probability of default on debt payments.
credit rating is assigned to either a debt security or a
borrower by a credit rating agency. Globally there are three major
agencies: Standards & Poor’s, Fitch and
Moody’s. In India, there are four
ratings agencies: CRISIL, ICRA, Fitch and CARE. Except for CARE, all
rating agencies in India are subsidiaries of the major global rating
Every rating agency has its own scale of credit ratings to indicate the
probability of default.
securities (or GILTS) have a sovereign rating (SOV),
indicating absolutely no risk of default for the citizens of that
Need for Credit
it is not mandatory for a debt security to have a
credit rating, most debt securities do get a credit rating from one of
agencies as this provides a standard that investors can use to compare
from different borrowers more easily, without spending too much time on
the credit-worthiness of the borrower. A debt security that has a
is more easily bought or sold than a debt security that does not have a
ratings also determine the rate at which the borrower
can borrow from the market. A debt security with AAA can borrow at the
rate in the markets, which will be slightly above the Government
rate of the same maturity period. As one moves down the rating scale,
borrower needs to pay a higher interest rate to compensate for the
Credit Ratings for Debt
Mutual Fund Investors
mutual fund investors must also understand the significance
of the credit ratings before they invest their money into a debt fund.
mutual fund invests in many debt securities with different credit
should make sure they are comfortable with the credit ratings of debt
securities that the fund invests in, otherwise they would be taking
risk which may later lead to losses.
and short term debt securities have different ratings.
Long-term debt refers to the debt wherein the maturity of the security
greater than one year. Short-term debt refers to debt whose date of
less than one year. Different ratings are needed for long and short
because long-term debt tends to be more sensitive to changes in
interest rate than
short term debt.
long-term credit rating scale ranges from AAA to D. AAA
indicates a low probability of default and D indicates that the
borrower is in
default, or will most likely default. An
additional ‘+’ or ’–‘
sign is affixed to the ratings (except for AAA and D) to
indicate higher or lower quality among the debts of the same rating.
instance, a debt security rated AA+ has better quality than AA. A debt
rating of AA- is of lower quality than a rating of AA.
scale is pretty similar across all four rating agencies. AAA
is the best credit rating possible for a non-government
debt security. This rating indicates that the borrower will repay the
and the interest on time and has adequate reserves to fulfill debt
Ratings from AAA to BBB- are considered investment-grade ratings. Debt
rated from AAA to BBB- are mostly purchased by mutual funds and
investors, as they are safer than speculative debt securities.
rating below BBB- (i.e., BB+ and below) is considered speculative
grade. These debt securities are for people who can take high risk as
of default is considerably higher in comparison to investment-grade
The returns are also considerably higher than investment-grade debt
Such speculative securities are more commonly known as high-yield
Globally, there are special mutual funds called high-yield funds that
into these speculative-grade securities. As of now, there are no
mutual funds in India.
security with a ‘D’ credit rating will default or
already defaulted. These securities are for investors who are
very high risk. Most issuers of D-rated debt instruments are sick
the process of financial reconstruction. If
the issuer is able to recover financially, then the D-rated debt
holder gets returns of high magnitudes.
long-term credit ratings for all four rating agencies
are shown in Table 1
1: Long Term Ratings scale from four rating agencies in India
iFAST Financial Compilations.
long-term debt ratings are similar
across the four
ratings agencies, short-term debt ratings vary far more.
length of the scale is different for
agencies. The rating scale ranges from 1 (highest quality) to 5 (lowest
quality). The rating agency can use ‘+’ or
to indicate better or lower
quality. The use of the signs is more common in the long-term debt
in short-term debt ratings.
into average-to-low quality (a
rating of 3 and
above) short-term bond funds are at a disadvantage to long-term bond
investors. Suppose a long-term debt security is given a rating of D,
there is some
hope, given the longer maturity, that the company might be turned
restructured, thereby providing a good return. With short-term bonds,
maturity period means there is less time for such a turnaround.
investors are advised to invest in
short-term bond funds
with most debt securities with ratings of 1 and 2. Investors with
appetites may invest in bond funds with debt securities with ratings of
2: Short Term debt ratings
from four rating agencies in India
iFAST Financial Compilations