CRAs Archives

In India, when we go through the content on bonds, shares, and how they are rated, CRISIL comes as a common name. CRISIL Limited is an Indian analytical company providing ratings, research, and risk and policy advisory services. It is listed on both NSE and BSE. It is owned by a quite popular American financial giant, S&P Global.

In this piece, I shall take you through the company’s business model, its recent financials, and the future prospects of the company.

Business Model

CRISIL Limited is a Credit Rating Agency(CRA). The role of a credit rating agency is to ‘rate’ or rank securities like bonds, shares, debt instruments, etc. based on their risk and ability to pay back its investors. Based on the ratings, investors can get an insight into the risk factor of the security they are investing in. Bond issuing companies can even decide the price of the bond or interest they pay based on the rating that the bond gets. It is recommended that you go through a piece we did at market feed on ‘How Credit Rating Agencies In India Earn Money’.

Before we move any further, let me summarize the Credit Rating Industry for you. The industry is an oligopoly. This means that there are barely 4-5 established CRAs in India. It is virtually impossible to compete against these giants. Most of these giants are owned by the ‘Big Three’ credit rating agencies. Those are S&P Global, Moody’s, and Fitch Ratings.

The company isn’t limited to just its India operations. The company receives most of its business from North America and a major chunk of it from Europe as well.

CRISIL, just like any other CRA, makes money through three segments. Ratings, Research and Advisory. Looking at the revenue mix it is clear that CRISIL earns most (~63%) of its revenue from its Research business followed by Ratings and the Advisory.

Rating Business

The cash flow over here comes from two places, Bonds and Bank Loan Ratings. It is mandated by SEBI that every company issuing bonds must be rated by at least one of the Credit Rating Agencies in India. Additionally, whenever a big company borrows money from a bank, the bank assigns the task of rating the borrower company to a CRA, in our case, CRISIL. CRISIL owns close to ~68% of market space in the Rating business. When more bonds are issued, and more companies start borrowing money fuelling banking credit in the economy, CRISIL eventually ends up making money. In India, Banking credit has grown by ~6.2% CAGR and bonds issuances by ~9.35% CAGR, both over a period of 5 years. In the past year, the bond market has increased by 8% YoY, despite a stressful year for businesses.

Research Business

CRISIL allots maximum capital to this segment. In the quarter ended March 2021, CRISIL allotted ~Rs 642 crore against ~Rs 78 crore and ~Rs 89 crore to the Advisory and Rating segment respectively.

The Research segment doesn’t require much elaboration. Most decisions taken in the market are based on research. Research requires data, the data is then analyzed, and a conclusion is reached. Gross Revenue from Research business has grown by 14.2% CAGR over the past 5 years. The company acquired a US-based research and analytics company Greenwich Associates and its subsidiaries for $40 million or Rs 296 crore. This was a major addition to the segment. What makes this segment unique is that it isn’t impacted by the cyclicity of the market. In the financial world, whether the market is down or up, the demand for a good research report never ends.

Advisory Business

CRISIL provides advisory services in s in areas of regulatory reporting, credit risk, and select city infrastructure projects. The advisory business of CRISIL is picking up. CRISIL’s advisory services see great potential growth since they have access to lots of data and research material. This gives them an edge when it comes to giving the right business advice. Even though the contribution to the revenue segment is small, one can expect it to grow in the future.

Financial Vitals

.	Q4 2020	Q3 2020	Q4 2019
Revenue	508.65	612.2	462.6
Net Profit	83.5	110	88.1

All Amount in Rs Crores

In the above-given chart, we can clearly see that the revenue of the company is increasing steadily, but the profit margin isn’t responding to the rise in revenue. Apparently, CRISIL is unable to trim down on its expenses.

Coming to CRISIL’s expenses, more than 65% of it goes into paying for the salaries and benefits of its employees. Another sizable chunk goes in availing ‘Professional Services’ from third parties. CRISIL can utilize its capital more efficiently. In a world of automation and artificial intelligence, maybe it’s time to upgrade its technology.

The stock seems to have gained quite some traction in the past one month more than other months. CRISIL stock has gained ~36% in the past month and ~76% in the past year. The stock traded pretty much sideways for quite a few months before ‘freeriding’ the bull run post the COVID-19 lockdown.

The Big Picture

In the chart give above, we get a clear picture of CRISIL’s financial efficiency. All vital ratios like Return on Equity %, Return On Capital Employed %, Net Profit Margin Annual % have declined over the past decade, yet CRISIL’s stock seems to have rallied more than 36.66% over Despite this, CRISIL seems to be rallying over the past month.

CRISIL stock happens to be in ace-investor Rakesh Jhunjhunwala’s portfolio, the stock seems to have gained a special interest from Foreign Investors and Mutual Fund in the past month. A breakout from a long-borne consolidation spiked interest in retail traders that could have probably caused the breakout. From the data given above, we can concur that the rally isn’t supported by the company’s financials and could possibly be a short-lived one. Another possibility could be that the company turns around its financials in the coming quarter and the quarterly results become supportive of the rally.

Credit Rating Agencies(CRAs) are generally privately-owned entities that do the job of rating securities like bonds, debentures, shares, and other instruments. Believe it or not, but Credit Rating Agencies(CRAs) seem to be running the show globally.

Standard and Poor(S&P), Moody’s, and Fitch group are known as the ‘Big Three’ and own close to 80% in the international credit rating. Each of the three has a setup in India, that is:

CRISIL, an S&P Global Company
India Ratings(Ind-Ra), a wholly-owned subsidiary of Fitch Ratings
ICRA, a subsidiary of Moody’s
CARE, not owned by either of the Big Three.

CARE, CRISIL, and ICRA are listed on National Stock Exchange(NSE) and Bombay Stock Exchange(BSE).

CRAs have been controversial for almost half a century. They have been deemed responsible for a few of the many financial or industry crises throughout history; Penn Central Rail Road Crisis and the infamous 2008 Housing Market Crisis to name a few. In India, the IL&FS crisis is said to have taken place due to improper credit ratings.

In this piece, we explore how credit rating agencies make money, what is so special about them and how they perform on Dalal Street.

The Business Model

Broadly speaking, a CRA has three sources of revenue:

Ratings
Research
Advisory

Ratings

Every time a company issues a bond, it has to get rated by a CRA as per norms set by regulatory agencies globally. Based on risk and credit analysis, credit ratings of bonds range from AAA(+/-), AA(+/-), A(+/-) to………. CCC, CC, C D. AAA is considered as the highest grade, and D is considered the lowest grade. If a bond is rated higher, generally it shall receive more buyers in the market since it is less risky. If the bond is rated lower, it shall be deemed risky and generally receive fewer holders.

Every time a company issues a bond, it has to get the bond rated for a price. The rating markets follow the more popular ‘Issuer-Pays Model’ where the issuer or the company issuing the bond pays the CRA to get itself rated. This wasn’t always the case though,

In the 1970s, there was an ‘Investor-Pays Model’ that lost popularity over time, where the buyer of the bond had to actually pay the CRA to access the ratings.

Another major source of income for CRAs is Bank Loan Ratings. Every time a company or an individual borrows money from a bank, a Credit Rating Agency has to rate the borrower based on several factors. Bank refers to the credit report before granting a loan.

Apart from bonds and loans, CRAs have to rate MSMEs, companies, other debt instruments, shares and even the economy of countries. All of these contribute to the revenue stream.

Research

If you have ever gone through a Red Herring Prospectus(RHP) or a report a company files before an IPO, chances are that the report contains research done by a CRA. Banks, companies, and even governments hire credit rating agencies to conduct research on a requirement basis. Sometimes CRAs release reports in the public domain for marketing and maintains their position and reputation in the market.

There have been instances where CRAs have released a negative outlook towards a company or a sector its share price fell on the stock markets. This is how important a research report by a CRA is. A research report by an established CRA gives a clear picture to investors as well as organizations to make well-informed decisions.

Advisory

CRAs have all the data they need in the world. This gives them a better insight into global markets than many businesses. This is why businesses even avail advisory services offered by CRAs. This is done on a contractual basis for the necessary period.

Credit Rating Agencies As An Investment Option

Credit Rating Agencies despite running the show haven’t been running up themselves when it comes to investor returns. Their stocks have caught up only in the past year because of the bull run seen in the Indian markets. Even there, the stocks of ICRA, CRISIL and CARE ratings have barely managed to beat the NIFTY 50 benchmark index. Coming to return on investment for the past one year, CRISIL has returned ~76%, CARE Ratings returned ~69% and ICRA returned ~29%. Even here, the shares did not spike up in one go, rather they moved up in a consolidated manner over a period of time.

The Revenue and Net Profit of CRAs haven’t been consistent for the past three years. This is since CRAs aren’t selling a straightforward product. They are selling an opinion. If their customer doesn’t like it, they can always move on to the rival CRA and get a better rating.

The Big Picture

In 2008, there was a global financial crisis. It all started when CRAs gave a higher rating to bonds with a poor asset or credit quality. They were bribed/incentivized to do so. Yet, there was no action taken against them even after a global downturn.

In India, something similar happened during the IL&FS crisis in 2016. CRAs gave the now failed IL&FS securities a good rating despite knowing of poor asset quality and financial condition of the company. IL&FS did not pay back the money it had borrowed from banks and lenders. Finally, it led to a major credit crunch in the system where banks and financial services companies were hesitant to lend money and the economy remains affected by it even in 2021.

The sector runs in an Oligopoly. Apart from the Big Three, there are only a few independent CRAs, this means that only a few entities get all the business. Barriers to entering the market are high and opportunities are less. Even if the CRAs play foul, SEBI can atmost fine them as they did in the IL&FS crisis in 2016.

In popular opinion, there is rising support for the ‘Regulator Pays Model’ for CRAs where market regulators like SEBI(India) or SEC(USA) would pay the credit rating agencies to rate bonds. The benefit of it could be that CRAs would not play foul or give false ratings to companies. The disadvantage could be that the reports of the CRAs could be influenced by the opinions of the ruling majority or the government.

How do you think we can solve the loopholes in the credit rating industry? What are the growth opportunities for them? Let us know in the comment section in the marketfeed app available on Android and iOS.