Mumbai: The high ratings given by CARE Ltd , one of the four big credit rating agencies in India, to Deccan Chronicle Holdings Ltd (DCHL) have once again raised questions about the credibility of rating agencies and their ability to red-flag risks.
The Financial Express newspaper first reported this on 11 September. CARE awarded AA and A1+ ratings to various instruments of DCHL. An AA rating (for long- and medium-term instruments) signifies “high degree of safety” regarding “timely servicing of financial obligations” according to the agency’s website. An A1+ rating is the highest for short-term debt instruments and “carry the lowest credit risk”.
The ratings were altered a week after DCHL first defaulted on a payment on 26 June, but by then, the damage had been done. Subsequently, CARE even suspended the ratings as “the company was not cooperating”, said Milind Gadkari, general manager, ratings, who was directly involved in giving Deccan its rating.
Today, a significant proportion of the Rs.5,000 crore debt Deccan raised from several banks including ICICI Bank Ltd, Canara Bank, Andhra Bank, Axis Bank Ltd, Yes Bank Ltd and IDBI Bank Ltd has turned bad or runs a risk of doing so. With chances of an improvement in DCHL’s financial health appearing remote, lenders are in negotiations with the company for a possible loan restructuring.
While Deccan’s misfortunes have been blamed on rampant and indiscriminate expansion and diversification, some analysts say the huge exposure banks have to the company may have something to do with the high rating it enjoyed.
“Many private banks have taken hit because of the top quality ratings which DCHL enjoyed till sometime back,” Santosh Singh, an analyst at Espirito Santo Securities Ltd. “Some of the lenders like IDFC (Infrastructure Development Finance Corp. Ltd) which had invested in the DCHL papers are today in a situation where they may have to write off the entire amount.”
CARE defended its rating actions, saying inadequate information provided by DCHL could have influenced its ratings decisions.
“Our ratings to DCHL were based on the balance sheet of March 2011 as well as the sound market position of the company,” said Gadkari.
“We have also been looking at the quarterly numbers of DCHL and the published debt numbers time to time. Today, looking at the reported debt levels, about Rs.70 crore interest cost for whole of FY12 seems surprising. In hindsight, the company might have been hiding some numbers and probably this would have influenced the ratings,” he added.
That’s a plausible explanation, but it doesn’t help the banks.
Indeed, the guidance of rating agencies is a critical input for the Indian banking system, which is already reeling under mounting bad loans.
The total amount of loans restructured by Indian banks under the corporate debt restructuring (CDR) mechanism crossed a staggering Rs.1.68 trillion, on a cumulative basis, on 30 June, registering an addition of Rs.17,957 crore in the three months since April. Bad loans of Indian banks rose 51.6% in the 12 months ended June to Rs.1.5 trillion, up from Rs.98,245 crore last year.
And it isn’t just banks that have been the victim of badly done ratings.
In the past, there have been instances where raters differed over the ratings of instruments and companies, sending confusing signals to investors.
For instance, in July 2011, credit rating agencies differed over the ratings of perpetual bonds, a relatively new instrument for Indian companies although banks have been using these instruments to raise funds for at least the past three years.
The differences stemmed from the option that allows an issuer to defer payments or even stop making payments on perpetual bonds, depending on the nature of the security, without being declared a defaulter.
Crisil Ltd had assigned top investment grade of AA/positive to Tata Power Co. Ltd’s Rs.1,500 crore perpetual debentures issued that promised an 11.4% return with a step-up provision if not redeemed after 10 years.
Another rating agency, India Ratings and Research (formerly known as Fitch Rating India Pvt. Ltd) sounded a warning on corporate perpetual bonds, without naming the Tata group company. “They are...inherently riskier than other debt obligations, and should, therefore, be treated with considerable caution by investors,” it said.
To be sure, some of the ratings, and some of the differences over ratings can be attributed to the intense competition between rating agencies.
In August 2011, one agency, Icra Ltd, alleged that its rivals were diluting professional standards to garner business.
“Some of the issues relating to excessive competition are possibly resulting in some rating agencies taking a liberal interpretation of the principles, which are well established internationally,” Icra managing director and chief executive officer (CEO) Naresh Takkar had said then.
India has four major rating agencies—Crisil, Icra, CARE and India Ratings. Brickwork Ratings India Pvt. Ltd is the latest entrant into the rating space.
Crisil, in which global rating agency Standard and Poor’s, holds a 53% stake, and Icra, in which Moody’s is the single largest shareholder with a 28.51% stake, are listed on the bourses. CARE plans to list by end of the year.
The business is dominated by Crisil with a market share of at least 50%. The number of companies rated by Crisil was 10,542 as on 30 September. The latest figures for Icra are not available. As on 30 June 2011, it had rated 3,965 companies.
Though credit rating is not mandatory under Basel II banking norms, banks prefer that the loans they it issue be rated because they are required to provide a risk weight of 100% on unrated loans (which means they have to provide Rs.100 for every Rs.100 they lend).
Pratip Chaudhuri, chairman of State Bank of India (SBI), the nation’s largest lender, is not too worried about the calls taken by rating agencies.
“Rating agencies are only giving an opinion. The only thing I have against them is when they suddenly downgrade companies after supporting (them) for many months with (a) good rating.” In October 2011, Moody’s had downgraded SBI citing deteriorating asset quality.
Still, because banks prefer that their loans be rated, it makes sense for a company seeking money to get rated and, more importantly, get a good rating.
Rating agencies admit that there is some bit of rating shopping—the practice of companies approaching agencies and accepting the highest rating. Under current norms, a rating agency can publish the rating it awards to a company only if the company accepts the rating.
“The issue of rating shopping is something we have to always guard against. Rating shopping does exist in the system. Especially when a new rating agency enters business, there are chances of it happening,” said Roopa Kudva, managing director and CEO of Crisil. “The industry as a whole needs to keep raising its standards. A slip by one agency can have an impact on other agencies as the existence of whole industry is based on credibility.”
Expectedly, new agencies deny that they are solely responsible for this phenomenon, and although every rating agency is convinced there is a problem, it sees its competitors as largely responsible for this.
“It is not correct that new rating agencies dilute professional standards to garner business. There have been instances of even larger rating agencies awarding higher ratings to some companies who don’t really deserve that. If we have awarded higher ratings to a company, that is based on our own assessment and inspection of their details,” said Vivek Kulkarni, head of Brickwork Ratings.
And a rating agency willing to cater to a customer’s need for a higher rating may not survive in the long-run, said Icra’s Takkar. “In the short term, you will be able to show better revenue, but you lose credibility in the long term.”
Indeed, “it is grossly incorrect to state that rating agencies are moving away from best practices or compromise on professional integrity in order to garner more business in the face of competition,” CARE said in an emailed statement.
Still, whatever the reason, rating agencies do get things wrong, like they famously did in 2008 when they gave high ratings to complex instruments whose failure eventually set off the global financial crisis.
Concerns on auditors
The rating agencies believe the fault lies elsewhere—and especially with auditors. They claim that the poor quality of audited numbers often misleads them from arriving at accurate ratings.
“The disclosure standards of companies certainly play a role. If an accurate picture of accounts is not presented, opinion of rating agencies can be misled,” Takkar said.
“We do not accept all the audited figures at face value. We do make adjustments to the extent it is practical. If the underlying accounts do not reflect true and fair picture, then there rating opinion could be impacted,” he added.
Crisil’s Kudva agrees.
“A major concern is that very few of the companies that are getting rated are listed. Many a time we have seen that some of the unlisted companies are not sharing the information we ask for and this creates difficulties. As rating agencies, our role is not to audit the numbers. If the auditor is a complete fraud, you have no way of knowing.”
There’s nothing that stops rating agencies from highlighting inconsistencies in the books, said Shinjini Kumar, director (banking regulations) at audit firm PricewaterhouseCoopers Pvt. Ltd.
“I think the blame game isn’t good for anyone. If a rating agency is not getting good information, instead of taking a view, they should be upfront with the stakeholders and talk about the poor quality of data and governance,” said Kumar.