Reliance Comm crisis: Why credit ratings agencies were not caught napping

The role of the credit ratings agencies as the watchdogs of the debt and bond markets is once again in question, this time for failing to red flag the loan default of Anil Ambani-owned Reliance Communications (RCom) to its lenders.

On 29 May, RCom stock fell 20.5% to Rs 20.50 - a record low - triggering criticism against credit ratings agencies for not being in the know of the ensuing financial crisis of the telecom company.

According to a leading financial daily, the Securities and Exchange Board of India (SEBI) has asked ratings agencies to "explain their actions on RCom bonds to know whether processes were followed, and what lead to downgrade of the company’s debt securities and loans by several swift notches”.

Tainted past

The ability and trustworthiness of ratings agencies has been questioned in the past due to their failure to warn the investors of the coming sub-prime crisis in the US.

In India, too, many of the corporate debts escaped the scrutiny of ratings agencies, until it became very obvious through media reports that the company would not be able to service their loans. 

In July 2015, CARE Ratings was criticised for downgrading Jaiprakash Associates Ltd by six notches from a rating of BB to D- at one go, indicating that the agency had not kept track of the company's financials on a regular basis.

Are ratings agencies guilty in the case of RCom too?

Not really. In the case of RCom, the ratings agencies were issuing warnings against the deteriorating profile of company's debt for close to a year.

On 2 June 2016, Moody's investor's service issued a negative outlook to the credit ratings of RCom saying: “The negative outlook reflects our view that ongoing delays in RCom's rollout of its deleveraging plans will keep its financial and credit profile strained over the near term. Moody's will closely review the progress on RCom's stated plans over the next 6-9 months”

This was followed by a downgraded for RCom's corporate family rating and senior secured bond rating to B1 from Ba3 on 30 November.

The ratings agency further announced that the company's ratings would remain under review for further downgrade.

Ratings agencies issued warnings against the deteriorating profile of the company's debt for a year

Explaining the rationale for a downgrade, the agency said, “The downgrade to B1 from Ba3 reflects RCom's weak operating performance in 1H FY2017 (2016-17) , as evidenced by the continued contraction in profitability through 2Q 2017 (second quarter) - primarily at its Indian operations”.

Another international ratings agency Fitch, in December 2016 downgraded RCom's “Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to 'B' from 'BB-.”

According to Fitch RCom's plans to demerge its wireless business into a 50:50 joint venture and sell 51% of its tower business, Reliance Infratel, were to be negative for RCom's creditors, even if receipts from the tower transaction were used to pay down debt.

A continued fall in ratings

On 27 January, Moody’s once again felt the need to revise downwards its credit ratings for RCom’s corporate family rating and senior secured bond rating to ‘B2’ from ‘B1’.

Explaining its downgrade the agency said, “The negative outlook primarily reflects “(1) the uncertainty regarding the timing and completion of the announced restructuring; and (2) the resultant range of leverage and business risk profiles if one or both transactions are delayed or cancelled.”

Ratings agency ICRA too had warned of the deteriorating liquidity position at R Com on 6 May by downgrading the long-term rating for the company to ICRA BB from ICRA BBB for the Rs 5,000-crore non-convertible debenture programme and the Rs 28,116-crore long-term fund- based/non-fund based limits (including unallocated limits) of RCom.

All the downgrades in the case of Reliance Communications suggest that the fall in the value of RCom's debt profile did not come unannounced. 

Which is why SEBI’s search for an explanation has a simple answer considering the ratings agencies had in fact issued a number of warnings to investors of the coming crisis at RCom before it actually struck.