Thanks Amit,
I tweeted my views because I am genuinely concerned about all the gaming that has happened in the ratings space. And I have been expressing those views for a long time on Twitter and elsewhere. The impact is so huge. So many people have lost money because they trusted the rating companies e.g. old people who needed the income in the debt funds.
Now we have a situation where the trust has gone. When I say gone, I mean gone are the lucrative ratings of NBFC debt raised from bond funds. I mean lucrative ratings of structured products. They have disappeared or gone down very very substantially. Why? Because people have lost tens of thousands of crores of rupees by investing in low-grade bonds or structured products which they assumed were high-grade because they trusted the AAA ratings. And now they don’t want them anymore.
6 months ago, if you went to the website of some of the rating companies and took a meaningful sample of the outstanding ratings in terms of size of debt rated, you would have found that a very large component came from NBFCs and unlisted promoter entities you have never heard of. All that business is gone. Or very substantially gone.
A ratings business has very high degree of operating leverage. The most significant cost is people cost. If business shrinks and they don’t let people go, the margins collapse. People don’t realize just how risky that makes a business model with high op lev. It’s easy to see the high ROE, zero debt, asset lightness. But when trouble comes - and it has come - op lev can really hurt.
Then there is the stigma factor. Many raters don’t want to be associated with “tainted rating companies.” So even if you are not an NBFC or a promoter entity who was shopping around for a AAA rating, but you are a conservative manufacturing company with modest amounts of debt which needs to be rated, you may not want to get it rated by a “tainted rating company” anymore. So you not only lose business from charlatans, you also lose business from the good guys.
Things were really crazy. There are only two AAA companies in the US and none of them are banks. Or NBFCs. Even BERKSHIRE HATHAWAY is not AAA! Over here in India, there were dozens in the BANKING and NBFC Space. Such has been the degree craziness on the part of some of the rating companies here.
To think that after all this has happened, the earnings of some of the aggressive ratings companies won’t fall very significantly would also be super aggressive. At least I feel so.
The only thing a rating company has is reputation. If reputation goes, earnings go. If earnings go, valuation goes. The business may survive, but it takes a long long time for things to get back to normal.