Buoyant credit growth is essential not only for banks but also for credit rating agencies. In fact, demand for loans is their bread and butter. So, until the going was good, shares of CRISIL, CARE Ratings and ICRA were in vogue, even reckoned as all-weather ones.
Lately, however, these are losing the sheen. They underperformed the broader markets in the past 12 months. The twin problem of anaemic loan demand and a nearly 80 per cent reduction in rating subsidies for small and medium enterprises (SMEs) after the Union Budget significantly impacted them since the June quarter.
CRISIL has been affected the most; it saw only 5.6 per cent increase in its September quarter revenue. Its research division, accounting for nearly two-third of its revenue, reported its slowest growth in recent times, with global banks in the process of assessing regulatory feedback. Adverse currency movement also dampened the segment’s revenue. The rating business grew only three per cent year-on-year, with lower demand from SMEs.
CRISIL has, in fact, pruned its headcount in the SME business, which has helped it improve the segment’s profitability in an otherwise difficult period. Still, with credit growth likely to remain dull even in calendar year (CY) 2018, analysts at IIFL have cut their earnings estimate for CRISIL by five per cent each for CY18 and CY19.
India’s largest credit rating agency isn’t alone when it comes to a paler spell in terms of financials or an earnings downgrade. CARE, country’s second largest rating agency, draws 98 per cent of its revenue from the rating business. It, too, put out a muted show in Q2. CARE’s adjusted revenue just about mirrored the sectoral growth rate of a little over three per cent. This is despite the agency seeing a good 23 per cent year-on-year increase in cumulative client addition during Q2.
ICRA did a shade better. Its rating division posted six per cent year-on-year revenue growth in Q2, at Rs 56 crore. However, adjusted for sale of its information technology arm during the quarter, overall revenue growth was two per cent as its outsourced services and consulting arm dragged down the overall show.
Source: Brokerage points
Going ahead, with private capital expansion plans likely to remain subdued for another year or so, the coming financial year could also be challenging for credit rating agencies. New opportunities have lately opened in the form of dual rating requirements for commercial paper over Rs 1,000 crore and cases referred under the Insolvency and Bankruptcy Code.
Yet, since these are driven by regulatory needs and credit rating agencies might not have exclusivity over a client, pricing will assume importance. A dip in profit looks probable. Companies tapping the bond market also offer an attractive opportunity, though it depends on whether bond yields will remain viable.
Therefore, seen in the light of moderating earnings growth, it’s perhaps time to question the tall earnings multiples the stocks of credit rating agencies command. ICRA is the most expensive of the lot, at over 45 times its FY18 estimated earning. CRISIL trades at 40 times its CY18 earnings; CARE is relatively softer at 28 times its FY18 earnings. Yet, all three are at a premium to the broader market. The next six to 12 months is important to see if credit rating agencies’ financials improve, as an extended phase of single-digit revenue growth might not go down well with investors.