INSUBCONTINENT EXCLUSIVE:
Two chief executives of the top four credit rating companies in the country are under investigation for suspected manipulation of bond
ratings and corrupt practices
Whether the outcome is a clean chit or conviction would not matter much to the investors who have already lost money, but the unprecedented
events have raised questions about whatever little creditworthiness was left in them post the global financial crisis.
Nearly one lakh crore
rupees of investor money was riding on the ratings provided by the top four credit rating companies, including pension funds and insurance
money that middle-class people saved for retirement and children’s education
Hundreds of crores of pension and mutual fund investments are already sunk in the bonds of Infrastructure Leasing - Financial Services and
mortgage lender Dewan Housing Finance, which carried the highest credit ratings till they got into financial trouble.
Once the alarm bells
rang, the pendulum swung to the other extreme
It led to a kind of indiscriminate action from the rating companies with a raft of downgrades that not only created panic among investors,
it triggered doubts about anyone and everyone in the system with a reasonable amount of debt.
“There are very few occasions where a
company falls off the cliff overnight, but the rating falls off the cliff easily I think that is an issue,” says Romesh Sobti, MD,
“That you have a one-day default and technically you go from A to D
That is very dramatic, you could destroy a company with that.”
As a fallout of the IL-FS crisis, ICRA, the Indian arm of Moody’s, sent
its MD Naresh Takkar and CARE sent its MD Rajesh Mokashi on leave pending investigation after a whistle-blower complaint to the markets
regulator about irregularities in ratings assigned to IL-FS and its group companies.
INFLUENCING RATINGSCredit rating has become the most
important tool for any borrower to reduce his cost of borrowings, so he moves heaven and earth to get the best possible rating for a bond
issuance.
There are many avenues available to influence rating beyond the basic financial fundamentals such as overall debt to equity, cash
flows, assets and other material facts
Beyond this, raters factor in guarantees, letter of comfort from promoters, group companies and many other issues
Many a times rating companies go by the sheer size of the borrower and assign a better rating for fear of antagonising them that would drive
business to a rival.
“It’s not so complicated,” says Aditya Puri, chief executive, HDFC Bank
“If you want more teeth, you ask for it
Models are available and in some cases which happened… the risks were known
They have to be professional and held responsible for their ratings
We have to follow a process.”
That IL-FS and DHFL turned into junk from pristine pure triple A overnight, reflects the unprofessional way
the ratings were assigned
That IL-FS was struggling to get an equity investment for months and was getting its cash flow strained should have been the red flags
For DHFL, the asset-liability mismatch and the credit squeeze should have raised an alarm.
Grant Thornton was asked by the new IL-FS board
led by Uday Kotak to review the role of five rating agencies — CARE, ICRA, India Ratings, Brickwork and Crisil — which assigned a total
of 429 ratings during the period between 2011 and 2019
The report alleges that pristine ratings were assigned to IL-FS and its subsidiaries despite clear signs of distress.
While rating
professionals can get carried away by the sheer size of issuers, making more subjective factors decide the rating than pure financial
metrics, presence of personalities and close proximity of professionals of issuer and the rater also matter substantially
It’s partly the eye on the revenue for the rating firm, and in a few cases gratification beyond business for the company.
But rating
professionals have other problems too
In fact, there have been instances where investors were agitated that a particular bond was about to be downgraded
It would hurt their scheme’s net asset value and could trigger investor shift to other mutual funds.
“There are instances when we were
about to downgrade, and the mutual fund manager would say don’t do it,” said an executive at a rating company who preferred anonymity
“They did not want to mark down the value of their investments
It’s not just that we were hesitant
Fund managers did not want the true picture to be projected either.”
REVENUE MODELSCredit rating companies as we know had their origins in
the early 20th century when the US economy expanded beyond the known regions and unknown companies began to raise funds through bond sales
to grow faster.
Henry Poor’s publishing company began to come up with the financials of railroads for investors’ benefit and these were
That subsequently expanded to cover utilities and all other fixed income investments.
Economic liberalisation led to the advent of credit
rating companies with Standard - Poor’s floating the first rater — Crisil
Then came Moody’s with ICRA and others such as Fitch Ratings.
“It should not be so easy to get a AAA rating,” says Rajnish Kuamr,
“In US and Europe, companies are not given triple A so easily as it is in India, we have to adjust to the new realities.”
Although debt
rating was a profitable business, the scope to expand revenues and profitability through other research and consultancy services was mouth
watering to be left aside
Raters at one stage managed to convince the regulator that they could rate initial public offerings without factoring in the price.
When
consultancy and other services could be offered simultaneously to the same set of companies whose bonds are up for rating, conflict of
interest begins to emerge
One of the suggestions to ensure that conflicts do not lead to compromise on quality, experts suggest the investor pays instead of the
“We can look at a model where the lender pays for a rating, otherwise today the issuer pays for the rating
I want to lend to company X, I should pay for your ratings,” says Sobti
“Risk forecasting has to be a much more refined art
Some element of prediction based on current business models, flaws that have emerged due to management decisionsit needs to be brought in by
these agencies.”
A quick glance at the revenue mix of rating agencies shows how a substantial amount of their profits is now coming from
businesses other than ratings
Crisil made pre-tax profits of Rs 48 crore each from rating and research services at June-end
ICRA made pre-tax profits of Rs 14.28 crore from research and other services and Rs 7.2 crore from outsourced and information
services.
REGULATOR’S BLIND EYEThe role of rating firms is becoming all the more important with the RBI pushing corporates to diversify
their borrowing profile by accessing more funds from bond sales.
This comes at a time when a series of mistakes by the rating companies is
raising doubts about how much to rely on them
If one doesn’t rely, why have them perform a role at all?
“Even if one person in the system does not do his job well, the system
collapses,” says Amitabh Chaudhry, CEO, Axis Bank
“If we relied on each other earlier and now if we can’t rely, or someone is saying please don’t rely, then that exercise becomes
meaningless,” says Chaudhry.
In July 2017, Sebi had issued show-cause notices to Crisil and CARE Ratings for not following proper process
while evaluating the Amtek Auto debentures
Both later settled with the markets regulator after CARE paid Rs 43 lakh and Crisil paid Rs 28 lakh
The casualty was JPMorgan’s mutual fund business in India, as the US bank exited due to losses.
Despite such happenings, the regulator has
been tinkering with regulations on the fringes to enhance rating standards
In the past year or so, Sebi has prescribed guidelines, including probability of default benchmarks in the short and longrun
It introduced practices such as computation of cumulative default rates, procedure to track timely recognition of default, disclosure of
rating sensitivities in press release, disclosure on liquidity indicators and tracking deviations in bond spreads
But whatever is happening is not completely new
There have been mistakes, but they are being repeated time and again without a reasonably long-term solution.
“What is new,” asks Puri
“What happened in the crisis overseas? The way we look at it is we don’t depend only on rating agencies but that is because we are a
But traders will have to depend on them
They (regulators) will have to tighten the screws on them
Whether issuer pays or lender pays, it should be done with integrity
They have to be professional and held responsible for their ratings.”
Henry Poor, the father of modern credit rating industry, after all
