Caution Ahead. Photographer: Valentin Flauraud/Bloomberg

Large Corporate Defaults: Did Indian Credit Rating Agencies Give Investors Fair Warning?

Indian lenders and bond-holders have been hit by a series of corporate defaults over the last few years and, as a consequence, credit rating agencies are under scrutiny for not alerting investors in time.

A Parliamentary Standing Committee on Finance recently suggested a review of regulations governing rating agencies. This involves a suggestion to consider an investor-pays model or a mandatory rotation of auditors. The panel also called for stronger supervision.

Despite the fact that credit rating agencies have all the systems and procedures in place they may still fail, said JN Gupta, co-founder and managing director of Stakeholder Empowerment Services. The reasons for such failures may range from lack of data availability to competitive pressures.

“The solution lies in looking into past failures and making systemic changes so that those failures are not repeated,” Gupta said.

To understand past failures, BloombergQuint compiled data of prevailing ratings on large corporate debt just before they went into default. This includes companies which were referred by banks for insolvency proceedings in 2017 and more recent defaults like that of Infrastructure Leasing and Financial Services.

While the list is not exhaustive, it gives a reasonable view of the track record of rating agencies in foreseeing these defaults.

RBI Directed Insolvencies

In 2017, the Reserve Bank of India directed banks to refer 40 firms (in two lists sent out in June and August) for insolvency proceedings. These accounts were those that had been tagged as non-performing for atleast a year before that. An account is tagged as a non-performing account (NPA) when it is 90-days overdue.

Given the timeline of these accounts being classified as NPAs, ideally, rating agencies should have flagged off the elevated risk of default in these accounts by at least 2015.

But Did they?

Of the 40 insolvent companies that were notified by the central bank for insolvency proceedings, BloombergQuint reviewed the credit rating reports for 35 companies. Credit rating information for five of these insolvent firms was not available.

These 35 companies fall into two buckets:

  1. Where ratings were moved to default before they were referred for insolvency.
  2. Where ratings were either not current (i.e. were withdrawn or suspended or not reviewed) or remained above D at the last available rating.

For the first set of 23 accounts, ratings were moved to D before 2015 only in five cases. Ten firms saw ratings downgraded in 2015, while the others were downgraded only later.

Also with the exception of Monnet Power, the move to default included a multiple-notch downgrade at one instance, which leaves investors in a lurch.

For six of the remaining 11 insolvent companies, detailed below, the last available rating before the firm went into insolvency, was above D.

In five cases, ratings were either withdrawn, not reviewed or suspended by the concerned rating agency for various reasons. The most common reason cited for this was lack of information and non-cooperation from the issuing company.

These companies include: Alok Industries, Bhushan Power and Steel, Jyoti Strctures, Uttam Galva Metallics among others.

While rating agencies may be justified in withdrawal and suspension of ratings for lack of information, investors suffer if they have already invested in the securities based on the initial ratings.

For the purpose of accountability, a break-up of individual agencies rating these firms is also important to track.

The data shows that CARE Ratings had rated the maximum number of the top 40 insolvent firms at 27. ICRA had ratings on four of these firms, while CRISIL had outstanding ratings on two. Brickworks and India Ratings had rated the remaining.

The IL&FS Default

After the large corporate insolvencies, the next big rating accident to hit the Indian markets was the default by IL&FS and its group entities.

CARE, India Ratings and ICRA all had ratings on some of the largest IL&FS group companies. Agencies downgraded the credit rating of these subsidiaries to ‘Default’ status in September 2018. However, a few months prior the debt instruments of these IL&FS companies were rated sub-investment grade. But the eventual downgrade to ‘D’ saw a multiple notch adjustment in one shot.

The parent entity IL&FS remained AAA-rated until August 8, 2018. It defaulted on inter-corporate deposits just a month after that.

Credit ratings within the ‘BB’ or are considered to have a “moderate” risk of default, while those in the ‘A’ category are termed as ‘adequately safe’ debt instruments.

Reliance ADAG Group

While Anil Ambani’s debt burdens have not eased for over a year and a half now, rating agencies downgraded the securities straight from BBB to D in many cases.

On February 01, 2019, Reliance Communications filed for bankruptcy which caused the share price of the company to plunge by 48 per cent in a single-day. Shares of other group companies also fell, leaving mutual funds stuck with bonds backed by equity of these group firms.

Also read: Reliance Group Reaches Standstill Pact With Lenders Over No Sale Of Pledged Shares

Also read: Anil Ambani To Subhash Chandra — Promoter Debt Risk Ignored By Some Rating Agencies?

Information Asymmetry

Rating agencies continue to blame the lack of access to timely and in-depth information for the failure to flag-off a company’s weakening finances.

Under the issuer-pays model, agencies provide credit ratings to corporates and their subsidiaries after receiving all the necessary information from the company itself. Thereafter, they can only rely on other publicly available information of the corporate and its entities.

This, experts say, is a major point of failure of the ‘issuer-pays’ model.

Rating agencies do not have access to the Central Repository of Information on Large Credits system, which is used by all lenders to report loan defaults by their corporate borrowers.

“Once the information comes in we have to act on it, but the issue is that bankers and other lenders do not inform us on time, said a senior executive with a rating agency while speaking on condition of anonymity.

This executive further added that banks often delay passing on information of default to rating agencies because it elimninates room for any “ever-greening.”

Shriram Subramanian, founder and managing director, InGovern Research, said that rating agencies need to go beyond evaluating companies on a standalone basis and need to understand the industry dynamics.

Further, rating agencies need to look at promoters’ holdings and the knock on effect of the promoters taking on debt in other group companies. They need to enhance the sophistication of their rating ability,  he said.