Article of the month
Benefits of investing in ‘mid-rated’ corporate bonds
Executive summary
India’s corporate bond market outstanding increased by more than 50% in the past five years to Rs 44 lakh crore outstanding as on September 30, 2023. This growth has been on the back of heathy economic growth.
On the face of it, the growth appears to be good news. But a deeper look reveals it may be too early to cheer.
Data suggests 94% of the bond issuances are rated in the highest safety (‘AAA’) and high safety (‘AA’) rating categories.
Issuances below ‘AA’ rated category are generally avoided by bond investors, as they club mid-rated issuances (which includes ‘BBB’ and ‘A’ category ratings) with issuances rated in the ‘non-investment grade’, i.e. ‘BB’ or below categories. This could be attributed to investors’ perception that debt protection metrics of these mid-rated issuers are more volatile and carry materially higher default risk.
CRISIL Ratings has carried out an in-depth objective study of ‘mid rated’ corporates, with this article focusing on the steadiness of debt protection metrics in ‘A’ rating category and the attractive risk-adjusted return opportunities that investments in this category offers. CRISIL Ratings will focus on performance of ‘BBB’ rated category issuers in a subsequent article.
Let us try to understand why the Indian bond market needs ‘mid-rated’ corporate issuances.
First, bond issuances by mid-rated companies will enable better portfolio diversification for investors and will help deepen the financial markets for long-term development. Mid-rated companies are also on the lookout to develop alternative sources of finance beyond bank loans, given the government's focus on infrastructure buildout and rapid economic expansion. Therefore, there exists a ‘win-win’ opportunity for both investors and companies.
Second, an analysis of the CRISIL Ratings portfolio shows that performance of ‘A’ rated category corporates have been strong and resilient, with low default rates over the past decade. Their debt protection metrics have also improved significantly over the past five years. For instance, mid-rated ‘A’ category rated corporates today showcase leverage metrics that are similar or better than ‘AA’ category rated corporates a few years ago. This indicates prudence in capital allocation/capital expenditure (capex) decisions by mid-rated issuers.
Third, there has been a positive shift in Loss Given Default (LGD) trends in the Indian context over the past decade. LGD is a measure of loss that lenders or investors incur post default on debt instruments. India is transitioning in terms of LGD, aided by a stronger insolvency and bankruptcy regime. The insolvency process also serves as a deterrent for issuers resorting to wilful default, thereby improving credit discipline among corporates. Although there is still room for improvement in the insolvency process, the improved LGD will boost investor confidence in mid-rated corporate bonds.
Last, Securities and Exchange Board of India (SEBI) has initiated confidence building measures by launching the Corporate Debt Market Development Fund (CDMDF) to tackle the issue of liquidity, especially in times of market dislocation. This underlines the government intent to add depth to bond markets with an eye on the collective benefit to the economy, companies and investors.
Therefore, investment in ‘A’ rated category issues makes a case for intelligent investment, especially in the current market scenario, where mid-rated bonds offer higher risk-adjusted returns compared with the ‘AA’ rated category. For the record, mid-rated ‘A’ category bonds offered 2-3 times higher risk-adjusted returns compared with ‘AA’ category rated bonds over the past three years. These returns are resilient in the backdrop of mid-rated corporates strengthening their balance sheets even as interest rates increased, supporting their case for an investment.
Analytica