Finance and Investments

Credit Rating Agencies in India

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Few notes on Credit Rating agencies  (CRA’s – CARE, ICRA, CRISIL) based on my limited knowledge:

  • Net Profit Margins across industry ~ 50%, Return on Equity across industry > 35%,  all companies are sitting on huge cash and work with negative Working Capital.
  • There’s huge operating leverage in terms of manpower, Major Cost of Rating Agencies is manpower (50-60%), if revenues do not grow with increase in wages and additional employees, margins are hit badly.
  • Major costumers for Credit Rating Agencies lie in financial services space (NBFC’s for Ratings, Investment Bank & Assest Management for research). Whenever Financial Services industry is hit, Credit Rating Agencies will follow the suit.
  • The growth of CRA’s is dependent of the growth of credit, which is in turn dependent on growth on economy.
  • Ratings is a volume game. Pricing competition in this segment is quite high with rating yields as low as 4-5 bps. Hence, CRAs have to generate sufficient volume to sweat the assets (analysts effectively).
  • Increasing Interest rates and decreasing CAPEX are bad signs for Credit Rating Agencies.
  • Highest market share of Crisil, followed by CARE & then ICRA
  • Rating business is linked to the borrowings from the banks and debt markets.
  • Areas of revenues from Ratings (upfront & surveillance fees) are Bank loans (low margin business) & Issue of debt (high margin business) in capital markets. As a thumb rule, upfront & surveillance fees each constitute 50% to the Revenue. Q3 & Q4 are generally strong quarters.
  • Issue of debt in Capital Markets is high margin business especially from large corporates as prospective investors value the ratings provided by strong Credit Rating agencies. Hence, Credit rating agencies are able to charge a premium on Debt Issuance. Note that majority of debt issuance in corporate space is from NBFC’s
  • Bank Loan ratings (BLR) are low margin because banks do not value much of Credit Ratings and hence all rating agencies compete only on price.
  • CRISIL is Owned by S&P, and ICRA is owned by Moody’s (Strong sponsors, CARE don’t have one), CRISIL owns 10% of CARE Equity
  • CRISIL has diverse revenue sources – Ratings (30%), Research (55%), Advisory (15%). CRISIL has grown strong in research by acquiring IREVNA, PIPAL and Coalition in the past. S&P outsources major portion of global  research to CRISIL.
  • CARE had lowest employee cost and hence highest margins, however, during FY 18-19, the company gave 25% hike across the board and profitability will be impacted to that extent going forward.
  • Retained earnings are invested in fixed return instruments by all companies. These companies do not need this cash for growth, but neither are able to invest in high return projects.
  • Total 8 Listed and Unlisted players in Credit rating industry in India.
  • Probable reason of low valuation of CARE may be missing strong parent, lower reputation compared to CRISIL & ICRA or lower growth prospects by the market.
  • To manage the growth, rating agencies will have to hire more employees. Although employee count is not correlated to revenues 1on1, growth in business will translate into more employees. Infact employee cost may be the biggest expense of these companies.
  • Quality of ratings may be compromised by new players to gain business.
  • Prior to BASEL2 norms (2007), Bank Loan rating was not required.
  • Charges by rating agencies are generally a percentage of value of debt/loan to be rated. e.g. 0.1 % of  debt upfront fees, .03% yearly surveillance fee. The maximum charges are defined by regulators is available in rating companies website in regulatory section.
  • Currently growth is tepid in this industry and will largely depend on new regulatory requirements and growth in the economy.
  • If one is looking for Rs 100 debt for which it has to pay 10 paise for rating (0.1% rating fees), will he roam in market to find best deal? I dont think he will….however, he may look for multiple rating agencies if his balance sheet is weak and he knows that he may not get minimal rating.
  • Business is more about managing relation rather than pricing in normal circumstances. Ratings is a sticky business, there is a first mover’s advantage and to get companies on board. Once the relation is established, it requires a lot of persuasion and convincing for other credit rating agencies to take that slot.
  • Significant entry barriers, one because of regulatory approvals to start business, second, to build relationship with clients who have established relationship with existing players.
  • S&P has strategically outsourced its research & analytics arm to CRISIL, however, that’s not the case with ICRA & Moody.
  • In FY18, Total number of Corporate bond issuances was Rs.6.04 lakh crore as against Rs.6.70 lakh crore in FY17. The major share of the corporate bond issuance in FY18 continued to be by the financial sector comprising primarily of banks and NBFCs (nearly 70% share in total) and the funds raised by them were being used for onward lending. In FY18, commercial papers to the tune of Rs. 22.9 lakh crore were raised, 32% higher than the issuances of Rs. 17.4 lakh crore in the
    previous year.
  •   Overall quantum of debt rated in CARE ratings in FY18 was Rs. 16.48 lakh crore (Rs 6 lakh Cr – Debt Issues, Rs 6 Lakh Crore – Bank Facilities , remaining others)  involving 10,243 instruments (Bank facilities ~8000, Debt issues ~ 350 and remaining others). Till date, CARE ratings has rated a large volume of debt of around Rs. 108.47 lakh crore as of March 31, 2018 and has completed 67,151 rating assignments since inception.
  • FY 11-12 was dampener for the industry with rising inflation, FY 18-19 is dampner for the industry with default of IL&FS and tarnished brand image of CARE & ICRA.
  •  In 2012, RBI came out with guidelines relating to Internal Risk Based (IRB) approach for Bank loan ratings. This means bank can rate the loans given based on RBI guide lines. How much it affected Credit Rating Agencies by now (FY 19), needs to be checked.

Positive Developments

  • The developments that augur well for the business have been the focus of the government and the regulators (SEBI and RBI) on deepening and development of the bond market.
  • The RBI has issued directives on Commercial Paper (CP) in August 2017 where if for a company, CP issuance during the year totaled Rs.1,000 crore or more in a given year, the issuer shall obtain credit rating for issuance of CPs from at least two CRAs registered with SEBI and should adopt the lower of the two ratings.
  • The requirement of Independent Credit Evaluation (ICE) by Credit Rating Agencies (CRAs) for stressed assets that bring up a resolution plan, is a significant opportunity for CRA’s
  • With increasing regulatory push for part financing incremental borrowing, in case of large exposures through capital market financing, including bonds, augurs well for CRA’s.
  • Rating requirement for Infrastructure Investment Trusts (InvITs) and Real Estate Investment Trusts (ReITs) are factors likely to deepen the domestic debt market.

Risks :

  • Any economic slowdown in India may impact the volume of bank credit or debt securities issued in the domestic capital markets, and hence, have an
    adverse impact on CRA’s.
  • Majority of Rating Agencies customers are NBFC’s that are adversely hit during tight liquidity conditions.
  • CRA’s are dependent on the condition of the financial markets in India. Any increase in interest rates, foreign exchange fluctuations, defaults by significant issuers/borrowers, may negatively impact the issuance of credit-sensitive products.
  • The bank loan rating business may get impacted if there is a credit slowdown or change in rating related regulation resulting in transition to internal rating models for providing capital.
  • The domestic debt capital market, is skewed towards higher-category credit-ratings. This may continue to constrain the volume of issuance in the Indian debt market. However, to encourage raising funds from bond market, the regulators may to move from ‘AA’ to ‘A’ rating for investment eligibility.
  •  Currently, accessing overseas debt markets by certain Indian borrowers/issuers is regulated, and any change in the prevailing regulatory regime, liberalizing
    access to overseas markets for the raising of debt funds, may adversely impact the issuance of debt instruments in the domestic market.
  • CRA’s business is largely dependent on the recognition of brand and reputation. In this regard, prominent investment-grade defaults, multi-notch downgrades or failure to appropriately assess the creditworthiness of instruments rated by CRA’s could negatively affect reputation and, position as a quality credit rating agency. This, in turn, may adversely affect business, operations, and financial condition.
  • Non-payment of fees by clients – In the event of downward revision in ratings, there would be a threat of non-cooperation of clients to continue with the rating
    exercise, which may result in loss of revenue. For new assignments, CRA’s collects initial fees in advance before rating is assigned and it does not carry the risk of non-payment of fees by clients. However, CRA’s are bound by regulations of carrying out reviews and surveillance in a timely fashion. This may, at times result in carrying out rating reviews without receipt of fees.
  • Note – CARE ratings book revenues from surveillance, only when cash is received.

Open Questions :

  1. Which company will grab the biggest pie of the growth going forward? and why?
  2. How can the companies be differentiated? How is CARE, ICRA , CRISIL and FITCH (India Ratings) different from each other?
  3. How to look at the numbers?  For example, when we compare FY18 vs FY19 numbers for CARE, Total volume of Debt rated increased from 16 Lakh Crore (FY18) to 19 Lakh Crore (FY19). The rise was across vertices (Long Term Debt, Short Term Debt, Bank Ratings). Also , if we look at number of instruments rated, the figure were more or less same  excluding other category (~ 9000 Instruments).  However the revenues declined in FY19 compared to FY 18. Why?
  4. Same is the story comparing Q1 2019 to Q1 2020. If Revenue is not a function of Volume of Debt Rated or Number of instruments rated, then what is it related to?However, when I looked deeper, I realized , based on the data available that revenues looks related to number of instruments rated.
  5. Do customer (debt raising companies) care who is providing the rating? I think they don’t as long as they get the rating they need. However, I think the people who are buying the debt do care of the CRA. Will it mean that after ICRA and CARE CEO going out for indefinite leave with IL&FS fiasco, CRISIL will take away the business.
  6. In case of Bank Ratings, even customer buying debt (banks) do not care who the CRA is , then why companies other than CARE, ICRA and CRISIL, not able to garner market?
  7. Why CRISIL, ICRA and CARE collectively command 90% market share? Why other players are not able to take away market share?
FY 17-18 Revenue from Rating Services (Rs Cr) Consolidated Profits (Rs Cr) Cash( Rs Cr) Market Cap (Rs Cr) PE
CARE 320 150 500 3330 22
ICRA 220 100 600 3400 34
CRISIL 480 150 600 14000 45

Good read – Analysis on CARE

https://dhruvapandey.wordpress.com/2018/10/27/my-assesment-on-care-rating-ltd/

How to profit from the NBFC crisis – Analysis of CARE Ratings

Written by AMIT SAXENA

October 4, 2018 at 7:45 am

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