Credit rating

A rating is given to a specific debt instrument, such as a bond, a loan or commercial paper, as well as to the issuer behind it. It sums up the agency's view of business risk (the industry and the company's position in it) and financial risk (leverage, coverage and liquidity).

The rating scale

Long-term ratings run from AAA (highest safety) through AA (high safety), A (adequate safety) and BBB (moderate safety), to BB (inadequate safety), B and C (high and very high default risk) and D (in default). Plus and minus signs refine each grade. BBB- and above is called investment grade; anything lower is speculative grade. Short-term instruments use a separate scale, with A1+ at the top.

Outlooks and watches

An outlook (stable, positive or negative) gives the likely direction of the rating over the next 12 to 24 months. A rating watch signals that a rating action is likely soon, often because of an acquisition, a restructuring or a change in regulation.

What a rating report tells you

Every report has a rationale, the key rating drivers, a detailed analysis, the rating sensitivities and the analytical approach. The sensitivities are the most useful part: they state what would cause an upgrade or a downgrade, which makes them a checklist of what to monitor.

Notching and group support

A holding company's bonds are often rated a notch below its operating subsidiary's, because the cash is generated in the subsidiary and the holding company depends on dividends to pay its own lenders. Some Indian companies get a higher rating than their own numbers justify because a strong parent is expected to support them, and that support can disappear if the parent comes under stress.

Why downgrades matter

Many investors, including mutual funds and insurers, face limits on how much low-rated debt they can hold, and some loan agreements contain rating triggers that speed up repayment after a downgrade. A downgrade can therefore force selling and tighten funding, which makes default more likely. The analysis of what credit ratings measure and miss explains this feedback loop.

Common mistakes

• Treating a rating as a guarantee. It is an opinion about the likelihood of default.
• Ignoring the outlook and the sensitivities, which often say more than the letter grade.
• Relying on ratings alone. Ratings tend to lag events, so watch bond spreads and the share prices of the group's listed companies too.

Questions investors ask

What is the highest credit rating in India? AAA, which indicates the highest degree of safety on the long-term scale.

What does BBB- mean? It is the lowest investment-grade rating. A downgrade below it moves the instrument into speculative grade.