Bond or NCD: Why looking at credit rating is not sufficient Debt market is currently flooded with some attractive offers in India. One such offer is from real estate developer D.S. Kulkarni. Rate of interest offered by the investor is as high as 13% in the monthly interest plan. The issue looks attractive as far as rate of return is concerned. Even post tax, returns look good. But going by the conventional wisdom of finance any investment option offering high rate of return, may potentially pose high level of risks. Also the rate of return offered is directly related to the credit worthiness of a borrower. So how will an investor decide if there are risks in investing in this offer before deciding to make investment? One of the tools to assess risks for investors is to look at the credit rating assigned to the issue. Credit rating for this issue has been done by CARE, one of the leading credit rating agencies in India. CARE has assigned a rating of BBB+ to this issue. So what does BBB+ mean and what can an investor do with this rating? Rating symbol BBB as per CARE denotes, “Instruments with this rating are considered to have moderate degree of safety regarding timely servicing of financial obligations. Such instruments carry moderate credit risk”. Additionally a modifier of + or – is used to reflect the standing within that category which makes rating as BBB+. The rating BBB+ in this case does not convey much except the fact that there is moderate level of credit risk which is not quantifiable just going by the rating. Looking at credit rating at the time of investment has certain limitations. First of all, rating is subject to change and can fall over the life span of an instrument. So an investor needs to be watchful to ensure that any fall in rating in future acts an alarm bell for the investor. These rating changes are announced by the rating agency through press release and their respective websites. Beyond credit rating, an investor himself needs to look at certain factors to ascertain the risks in investments like debt instruments. While this might have been considered at the time of rating by credit rating agency, investors still need to check these details. Some of the basic checks include checking interest coverage ratio of a company coming out with a bond issue. This ratio is used to verify whether the company’s operations generate enough earnings to sustain its interest payments. If interest coverage ratio is high, it means the company is in a good position to make your interest payments. While investing in any company, go through the company’s profit and loss statement and by calculating its interest coverage ratio, make sure that its earnings are comfortably higher than its interest payments. Many text books recommend an interest coverage ratio of 1.5 or more. Related to interest coverage ratio is the concept of debt equity ratio. This will reflect how a company is leveraged. There is no ideal debt‐to‐equity ratio against which a company can be measured. A high debt‐to‐equity ratio generally means that a company has been aggressive in financing its growth with debt. Before investing in such company bonds make sure the company’s financial position is such that it can sustain such high amount of debt. Apart from looking at the financials of a company, it is important to look at the sector that a company belongs to. In the current scenario, real estate, infrastructure, airline etc. are risky investment areas. Last but not the least, check if bond issue that you are considering for investment provides an exit option through listing on stock exchange. Issue size should be large enough for liquidity to get created in the market.
Posted on: Sat, 23 Aug 2014 04:13:55 +0000