Have rating agencies been caught napping on corporate debt?
In the past year, there have been multiple instances where corporate debt ratings have been cut sharply in one revision
Mumbai: How far can you rely on ratings when making an investment decision?
The question, one which has been debated globally since the 2008 global financial crisis, has come back to haunt Indian debt investors after JP Morgan AMC was forced to restrict redemptions from two investment plans following CARE Ratings’ decision to suspend the rating of Amtek Auto Ltd. Another credit assessor, Brickwork Ratings, lowered the company’s rating by 12 notches in one shot.
For anyone holding debt securities of Amtek Auto (JPMorgan AMC holds ₹ 193 crore of Amtek bonds), this meant a swift and sharp drop in the value of the securities.
The case of Amtek Auto is not an isolated one.
In the past one year, there have been other instances where ratings have been cut sharply by three notches or more in one revision.
In July, CARE Ratings downgraded Jaiprakash Associates Ltd by six notches from a rating of BB to D-, a rating that reflects a default in the debt security. Non-convertible debentures of Bhushan Steel Ltd also saw their rating drop by six notches following a revision by CARE Ratings in December 2014. Punj Lloyd Ltd faced a similar drop in ratings in July.
Monnet Ispat and Energy Ltd, Bhushan Power and Steel Ltd, 20 Microns Ltd and Shree Renuka Sugars Ltd are other companies that have seen rating downgrades of more than three notches each in the past year.
CARE Ratings, which has rated a number of these companies, says it does a thorough exercise for all rating assignments, taking a comprehensive view of the company, its business, financials, prospects, strategies, management and governance.
“After the initial exercise is done we need to do a surveillance until such time the debt is repaid. This is an annual exercise which is mandatory as per regulation. We also do closely monitor the companies based on quarterly results and are in constant touch with the company officials, bankers, auditors, and trustees,” said T.N.Arun Kumar, chief general manager at CARE Ratings, in an emailed response to questions from Mint.
Kumar added that many companies that have seen sharp downgrades (such as Bhushan Steel, Jaiprakash Associates, Amtek Auto, Bhushan Power and Steel, Monnet Ispat and Punj Lloyd) have been rated by multiple credit rating agencies.
“Rating actions are generally taken when there is exceptional stress and swift changes in credit quality. We would not like to comment on the process in any specific case due to confidentiality issues,” said Brickwork Ratings in an emailed response.
Despite the surveillance procedures being in place, warnings from rating agencies to investors seem to have come with a delay.
For instance, in the case of Amtek Auto, the company on 14 August reported a surprise loss of ₹ 157 crore in the June quarter along with a surge in interest cost. The company has also seen a steady deterioration in its interest coverage ratio, an indicator of its ability to service its debt.
Rating agencies did not lower their ratings until August.
“It is definitely surprising to see ratings for listed companies being downgraded by multiple notches. It means rating agencies need to read between lines the financial disclosures made and not just rely on management comments. For Amtek, in particular, questions now being raised on the company’s overseas investments should have been raised earlier by rating agencies,” said Shriram Subramanian, founder and managing director of InGovern, a proxy advisory firm.
In response, CARE Ratings says that Amtek’s rating profile had accounted for the impact of overseas acquisitions.
“In respect of Amtek Auto, CARE had been rating its debt instruments for close to two decades and has been having discussions regarding overseas acquisitions and the impact of the same on its financial risk profile on a continuous basis. The ratings (till the point in time they were live) did factor in the impact of such acquisitions,” said Kumar, adding that unexpected changes do take place, which result in sharp changes in factors critical to determining the credit profile of a company.
Amit Tandon, managing director, Institutional Investor Advisory Services, a proxy advisory firm, said the fee structures followed by a rating agency may be leading to high initial ratings being assigned to debt issuers, which in turn lead to sharp downgrades later.
“Typically, the company pays the rating agency a token amount, and is later required to pay an agreed fee if it uses the rating assigned. This is followed by an annual fee for each year the company uses the rating. Having the rating accepted and used is critical,” said Tandon.
These assigned initial ratings are then revisited on a regular basis, which could be quarterly for listed companies and annually for unlisted companies.
“If the rating agency has failed to revise these initial ratings in a timely manner, it might mean the analyst was optimistic, but more likely it was shoddy analytical work,” Tandon added.
CARE Ratings, on its part, denies any conflicts arising from the fee structure.
“CARE has policies to avoid conflict of interest which arises between business development and analytical functions and there is a clear vertical separation of teams for the two functions. Analysts’ compensation is not based on the quantum of fees collected as per the compensation policies laid out,” said Kumar.
Ananda Bhoumik, managing director and chief analytical officer, India Ratings and Research Pvt. Ltd, says that concerns raised by proxy firms are valid.
“The point that proxy firms are making is valid, but agencies, specifically the global firms such as India Ratings, have made sure there are enough checks and balances,” said Bhoumik.
In July, Shree Renuka Sugars, which rated by India Ratings, was downgraded from A to BBB- in one single revision in July.
“Shree Renuka’s rating was first put on a Negative Outlook in 2012, indicating that the credit profile had started to weaken. Since then, as the sugar industry continued to struggle, the rating was downgraded over time. Rating volatility typically increases as we move lower on the rating scale,” said Bhoumik.
Brickwork Ratings said that the ratings process begins with a mandate from client.
“It is true the issuer pays the fees for rating. There are a very few instances of investor paying model in CRA (credit rating agencies) and they have not been largely successful. Please note that conflicts of interests do not go away in the investor pay model too,” the rating agency said in its emailed response.
A sharp cut in ratings forces investors in debt securities to write down the value of their investments in one go.
Unlike in the case of equities, where trading in the secondary markets determines movement in the value of an investment on a daily basis, for debt securities, the value is reset based on the rating assigned by credit assessors.
While a gradual reduction in ratings can alert investors to possible trouble ahead, a sudden drop leaves them with limited exit options.
Raman Uberoi, business head, large corporates, at Crisil Ratings, agrees that aggressive initial ratings could be one of the reasons for such multiple downgrades in the rating of certain companies and adds that a robust system of assigning and monitoring ratings is essential.
“Not all rating agencies are equal. If you are seeing multiple notch downgrades in a more frequent manner from some rating agencies, you should not put all the rating agencies in the same light,” said Uberoi.
Crisil is the largest credit rating agency in India, according to its website.
Other prominent rating agencies that operate in the country include Icra Ratings, India Ratings and Research (a Fitch group company), CARE and Brickwork Ratings. Data on the market share of these rating agencies is not available.
The sharp downgrade in ratings is particularly surprising in the case of listed securities where a lot of information is available in the public domain, say executives from the industry, adding that the practice of withdrawing a rating is questionable.
“For listed companies, where there is information that is readily available, one should not get into a situation when there is stress and one needs to withdraw or suspend that specific rating,” said Naresh Takkar, managing director and chief executive officer, Icra Ratings.
Takkar says that there are multiple sources of information available to rating agencies, such as financial results, management interactions and dialogues with bankers, among others.
Icra was the rating agency for 20 Microns, which was downgraded from BB+ to D category in a single revision in March.
“It was a non-investment rating which defaulted; as a matter of policy for all defaults we downgrade to D so it will appear as multi-notch. Also it (multiple notch downgrades) can happen in exceptional cases,” Takkar said.
Uberoi of CRISIL agrees that withdrawing or suspending ratings is not justified for publicly traded companies.
“Information availability for listed companies is strong with quarterly disclosures, some are also well covered by equity analysts, which should help an agency take a rating action on a regular basis rather than suspending ratings,” said Uberoi.
Kumar of CARE Ratings, however, argues that it is not uncommon for companies rated in higher categories to be downgraded or even suspended.
“This is common for all the CRAs,” he said, adding that such a suspension may happen for reasons ranging from an unexpected change in the company’s profile to a sudden change in government policy.
“In such cases, ratings are adjusted to reflect the current credit profile based on a new set of assumptions,” said Kumar.
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First Published:18 Sep 2015, 05:46 PM IST
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