Is debt dead?

If you have invested in corporate debt, you are probably wondering where you stand right now.

Like many others, you assumed that ‘AAA’ rated instruments implied top quality paper; your funds were safe.

Then credit rating agencies went and downgraded the ratings of some debt programmes, without much warning and suddenly, funds that were safe now carried some element of risk.

Wasn’t this exactly what investors were trying to avoid by investing in paper with sound ratings?

So, what has changed?

Recently, CARE Ratings dropped the credit rating of DHFL’s Non-Convertible Debentures (NCDs), Fixed Deposits (FDs) and long term bank facilities, amounting to Rs 1.2 lakh crore.

Following the ratings downgrade, the stock of DHFL nosedived. But the weakening of investors’ sentiment in the bond market has been a greater cause for worry.

A fall of 33% in the price of NCDs came as a rude shock to individual and institutional investors alike.

DHFL has been in the news from September 2018. In the aftermath of the IL&FS fallout, DSP Mutual Fund had sold short term debt paper of the housing finance company at a steep discount—unusual for credit instruments of the highest quality.

Did DSP Mutual Fund sense any crisis (which credit rating agencies couldn’t)?

Well it’s anybody’s guess.

That said, recent instances of the debt market fiascos highlight the limitations of credit rating agencies and credit appraisal processes. The most glaring eg being IL&FS which went from a AAA rating to D, indicating Default.

Any company can go through a financial crisis and may not have adequate money to discharge its liabilities. But the management will make all possible efforts to honour the company’s debt obligations as soon as it can.

How many of you think that companies from the Tata Group could default?

There have been instances in the past wherein Tata group companies sailed through choppy waters yet they never let their debtors and depositors down.

You would be surprised to know, credit ratings of debt raised by many Tata group companies are several notches below the highest credit rating of “AAA”.

On the other hand, a company such as IL&FS enjoyed the highest credit rating until some of its subsidiaries defaulted.

Sharp downgrades make matters worse for individual investors investing in bonds and corporate fixed deposits.

Sudden downgrades—a futile exercise…

Where does all this leave you?

| From here on, you may want to look beyond just the credit ratings appended to debt paper.

• Investing in top-rated debt instruments issued by companies with questionable corporate governance records is just like having a tryst with a home wrecker.
• More often than not, factors such as complex corporate structures and concentration of decision making in the hands of a few don’t bode well for debtors.
• High existing debt is also a big red flag. Chances of losing money are high in a company that doesn’t generate free cash flows consistently.

It’s high time conservative investors get real about risks involved in investing in corporate debt.

Like any other form of investing, never underestimate the need to do your homework or take expert advice while investing in fixed income products too.

Disclaimer: Ventura Securities Ltd has taken due care and caution in compilation of data for its web blog. The information has been obtained from different sources which it considers reliable. However, Ventura Securities Ltd does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. Ventura Securities Ltd especially states that it has no financial liability whatsoever to any user on account of the use of information provided on its web blog. The information provided herein is just for the knowledge purpose and shouldn’t be construed as investment advice under any circumstances.