Brickwork Ratings: Treading The Fine Line Between Technicality And Reality

Early on Wednesday it emerged that two fixed maturity plans of Kotak Mahindra Asset Management Company would not be in a position to redeem the entire amount invested in these schemes because of a delay in repayments by certain entities of Subhash Chandra-led Essel Group. Kotak Mahindra AMC was not alone. HDFC Asset Management Company decided to give its investors the option to roll over the maturity date of their FMPs due to the scheme’s exposure to debt securities of Essel Group companies.

Later in the evening, Brickwork Ratings, which has rated many of these instruments, issued an update. After having downgraded some of these entities in February, the rating agency reaffirmed the ratings of debt instruments issued by four Essel Group companies. These entities included:

• Konti Infrapower and Multiventures Pvt. Ltd.
• Cyquator Media Services Pvt. Ltd.
• Sprit Infrapower and Multiventures Pvt. Ltd.
• Edison Infrapower and Multiventures Pvt. Ltd.

In a note at the top of each of these rating reviews, Brickwork said that the maturity date of non-convertible debentures issued by these entities has been rescheduled ahead of the day of maturity. Indeed, fund houses such as Kotak Mahindra AMC have agreed to reschedule these payments, presumably due to their inability to make the payments when originally due. Repayments on different instruments were due at various points in time between March and July.

Brickwork concluded the rating notes on these instruments by saying that the ratings are on credit watch with developing implications.

Did Brickwork Do The Right Thing?

Since the NCDs had been rescheduled, there was no payment due which was subsequently missed. Hence, there is no default or ‘D’ rating. So far so good.

But Brickwork has retained the ratings of these structured obligation at A and above. According to the rating agency’s website, this rating signifies “an adequate degree of safety regarding timely servicing of financial obligations.” “These instruments carry low credit risk.”

Stop. Re-read. Think.

An instrument where creditors (mutual funds in this case) have been forced to agree to a standstill on selling underlying securities, and where repayment has been rescheduled, has “adequate degree of safety regarding timely servicing” and “low credit risk”?

The rating agency along with the mutual funds that invested in these securities will likely argue that the quality of underlying assets is good and that discussions are on to bring in strategic investors.

The rating agency said as much in its rating note on each of these entities. “BWR will monitor the development specifically with respect to outcome of strategic stake sale by promoters in a time bound manner and expected valuation and also compliance of covenants in line with the understanding with the lenders, and will review the ratings based on outcome,” it said.

But remember that the stake sale is yet to materialise. It has been in discussion since November but a deal has not been closed. A valuation is yet to be agreed upon.

In that scenario, would it not be prudent for a rating agency to be more circumspect and at least downgrade the security to a rating level which implied “moderate degree of safety”, as reflected in a BBB rating. Or a rating level which implied “moderate risk”, reflected in a BB rating?

Common sense would say so, although technicalities may bail the rating agency out on its decision.

Treading A Fine Line

This is not the only time that Brickwork has chosen to tread a fine line.

In February, BloombergQuint reported that Brickwork had rated a majority of the equity-backed bonds, which were proving to be a pain-point for mutual fund investors. The rating agency said it had about a 50 percent marketshare in rating such instruments. Data sourced from the markets had suggested a higher share.

In conversations with BloombergQuint, experts in corporate finance and the ratings industry felt these instruments were not easy to rate and are highly risky. Anil Singhvi of ICAN Advisors called them ‘weapons of mass destruction’.

Brickwork, however, defended the product and said that default rates are low. The overall rate of default for such instruments stands at 0.19 percent, in value terms, as of the year-ended March 2018, the rating agency said.

The rating agency has also had a run in with the Securities and Exchange Board of India.

In an order in August 2018, SEBI imposed a fine of Rs 3 lakh on Brickwork. The regulator had flagged off two issues — a delayed downgrade and a breach of the code of conduct.

The regulator, in its order, said that Ravi Shankar, founder director and a member of central and external rating committees at Brickwork, gave approvals on the fee charged for rating reviews. In 71 of 106 cases involving a rated amount of around Rs 86,842 crore, Shankar gave fee approvals, SEBI said.

This is in violation of rules. Employees of rating agencies directly involved with the rating of a company can’t initiate or participate in discussions regarding fees or payments from a client, according to SEBI norms.

SEBI also said that the rating agency delayed recognition of default in debt repayment by Bhushan Steel Ltd. and Gayatri Projects Ltd. The agency, in its explanations, said the delay was due to the company not cooperating to assign a fair rating. The regulator still found a 15-day delay.

Rating: Only One Input

While rating agencies — in this case Brickwork — must be questioned on their rating actions, the eventual responsibility must lie with investors who use these ratings. Institutional investors, such as mutual funds, have enough credit appraisal tools at their disposal to make their own judgment on credit quality if they disagree with a rating approach.

Trouble for the system emerges when both fail in their respective assessments. That’s when investors are left holding the bag.

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.