After NBFCs, bond market woes likely to weigh on rating agencies' revenues

Non-rating segments to provide some support, says analysts; corporate bond issuance already down 30% in H1FY19

The pressure seen in the domestic bond market is unlikely to be confined to non-banking financial companies (NBFCs). Even rating agencies are likely to feel the heat of recent events due to subdued corporate bond issuance.

Already, during the first half of 2018-19, amid elevated yields, corporate bond issuance (including private placement of debt) is down 30 per cent year-on-year. Typically, when interest costs are at elevated levels, corporate borrowings get slower. This is expected to weigh on the revenue of rating agencies.
 

The three listed rating agencies – CRISIL, ICRA and CARE — could, thus, see pain in the near term. The impact could vary with the share of this business in their revenue and levers in other businesses. The ratings segment, for instance, accounts for 29 per cent of CRISIL’s revenue and above 70 per cent and 95 per cent for ICRA and CARE, respectively. The three earn 55-60 per cent of their ratings revenue from the debt market, estimate analysts.

“Given the recent increase in volatility in the bond market and the difference in yields in debt capital markets and bank loan market, we believe bond issuances could remain under pressure. Most worthy borrowers might prefer to borrow from banks until there is stability in the bond market,” says Dhawal Dalal, chief investment officer, fixed income, at Edelweiss Asset Management.

However, he adds, with the new regulation on 25 per cent of overall borrowing through the bond market in force from April 1, 2019, new issuances should recover to normal levels in 2019-20. For now, some expect bond issuance to drop by 30-35 per cent in the second half of this financial year.
 

Among the few hopes to offset pressure in the ratings business, apart from existing/outstanding bond portfolios on which the agencies earn review fees, is bank credit, which has grown above 10 per cent in five months. There is a caveat. Credit offtake by businesses was up a paltry 1.9 per cent year-on-year in August. This indicates private capex consumption is still to take off.

An expected shift in demand for bank credit from NBFCs (from bonds) and the services sector, though, could augur well for the agencies and needs to be watched.

“Current incremental bank credit year-to-date appears to be driven mainly by personal consumption. Incremental services offtake is yet to see a decisive turnaround and incremental offtake for industry continues to reflect de-leveraging,” says Arjun Nagarajan, economist at SBICAP Securities.

Analysts say CRISIL and ICRA also earn sizably from research and advisory services. Elara Securities says for rating agencies drawing a higher revenue from abroad and from non-rating businesses, a depreciating rupee could partly offset pressure in the domestic ratings business. The rupee fell over five per cent in the September quarter.

Meanwhile, the revenue of CARE is expected by analysts to fall 11 per cent year-on-year in the quarter. ICRA and CRISIL could see 7 to 10 per cent growth. However, an impact is likely on operating profit growth and margins, as the ratings segment has significant contribution to profit (above 30 per cent for CRISIL, 90 per cent for ICRA and 99 per cent for CARE last financial year). So, the actual results and management commentary will be keenly watched by investors.