CRISIL and ICRA highlight fewer corporate defaults: Should debt fund investors be happy?

The trends in credit ratings can provide insight into corporate health, at minimum for the rated companies, and not just MSMEs, during uncertain times. CRISIL recently released a report that states that the annual default rate has dropped to 2 percent in 2020-21, from 4.5 percent for 2019-20. CRISIL reported that there were 116 defaults between 2020-2021 and 4.5 percent in 2019-20. This is a relatively low number. This is encouraging considering that 2020-21 was a year of pandemics. The default rate applies to all companies rated, not just those with higher ratings. Nevertheless, it is clear that the improvement in fundamentals was not the only reason for the increase, but other factors.Relief measures can be compared with other countriesFrom March 2020 to August 2020, there was a loan moratorium. One-time restructuring was permitted until December 31, 2020. There was also deferment of asset classification norms of the Reserve Bank of India, apart from Long Term Repo Operations and Targeted Long Term Repo Operations. The Emergency Credit Guarantee Scheme was also established. It allowed for the relaxation of default recognition norms by SEBI/NCLT for rating agencies. This scheme will remain in effect until March 2021. CRISIL also stated that the default rate will likely rise in the future. Pandemic-induced relief measures can only be used for a limited time. In certain segments, the slowdown caused by the pandemic will manifest slowly, which could adversely affect the rating scenario for 2021-22.Similar data from ICRA shows that FY2020 and FY2021 saw a sharp increase in the percentage of entities that were downgraded by ICRA (versus the historical averages), however, the trend in rating action since November 2020 suggests that there has been an incremental decrease in downgrade pressures. In the last two quarters of 2020-2020, the proportion of rating upgrades has increased. ICRA's FY2021 portfolio had 44 defaults, compared with 83 the year before. CRISILs echo the sentiment of ICRA. They say that the lower number of defaults is largely due to the ease provided by regulators to credit rating agencies (CRAs), in terms of default acknowledgment, and the timely alternative financing availed entities by lending institutions to manage liquidity. ICRA's outlook is not positive. However, it does state that India Inc.'s overall credit quality is improving.Looking to the futureThe default trends and credit rating in FY2022 will be up for debate. This is the first time that we have had a pandemic like this. However, the year ended with a better credit rating and defaults. Although slippage is possible in the medium-term, they may not be as severe as indicated by RBI's Financial Stability Report (FSR), released January 2021. This was merely an interpretation of certain parts of the FSR. We are referring to the FSR that was the subject of much discussion in the market. It was the RBI's call for Bank NPAs rising from 7.5 percent in Sept 2020 to 13.5% in Sept 2021. We are focusing on two key aspects of FSR.One, the NPA for banks, currently at 7.5% as of September 2020 in the baseline scenario, is expected to rise to 13.5% in September 2021. The adverse scenarios are conservative estimates based on hypothetical adverse economic conditions. . . Model outcomes are not forecasts. It was also noted that projected ratios can change in non-linear ways.What's the best thing for debt investors?We need to see all of this from the perspective of a typical debt investor in order to understand it. Unless it is bonds issued through a microfinance institution, where it is dependent on the pool of individuals, investments are not usually made in MSME instruments. Most investments are made through mutual funds and are done after thorough due diligence. There is nothing to be concerned about. Investors should conduct their basic checks before investing in debt mutual funds. Direct bonds are another way to get exposure. Higher-rated bonds are known for having a history of low defaults over a prolonged period. There are some sectors that are less affected than others, and those with higher stress levels. Investors can choose to invest through mutual funds or make judicious calls with direct bonds. The system has helped to manage a difficult year. Future support can also be expected.