14 The Economic Times Wealth, June 5-11, 2017
Why credit rating
downgrade should
concern you
A ratings downgrade indicates that the company has weak
financials. It may be best to avoid such firms.
YOGITA KHATRI
redit ratings agencies recently
C downgraded bonds issued by
IDBI Bank and Reliance Commu-
nications, seriously impacting
their stock prices. The counters
fell 22% and 40%, respectively over the past
one month. To help make informed equity
investments, here is what you need to know
about a ratings downgrade.
What leads to a downgrade
One of the key reasons why companies face
credit ratings downgrade is because of their
deteriorating finances, usually high debt lev-
els. It indicates that the company may not be
able to service its debt as per schedule or, in
some cases, may even default. ICRA down-
graded IDBI Banks ratings from AA- to A,
due to a substantial fall in the banks asset
qualitywhich led to high losses. While the
ownership structure provides comfort, the
risk on additional tier-I bonds has increased.
The bank may not be able to service the in-
terest on these bonds, in accordance with
the stated terms, if it is continues to be in vio-
lation of regulatory capital requirements,
says Karthik Srinivasan, Senior VP and
Group Head, Financial Sector Ratings, ICRA.
Typically, limited improvement in a com-
panys cash flows thats riddled with debt
leads to downgrades. Not just banks, the
same standard applies to capital-intensive
and commodity-driven sectors like thermal
power, steel, construction, infrastructure
and mid-sized telecom entities. Taking the
eye off the key ratios such as incremental Re-
turn on Capital Employed (RoCE) or incre-
mental Return on Assets (RoA) for invest-
ment decisions and not initiating action to
recover dues in time may lead to down-
grades, says Deepak Jasani, Head, Retail Re-
search, HDFC Securities.
How does it impact companies
A ratings downgrade hampers the compa-
nys ability to borrow. Lenders may hesitate
loaning to such companies and may not even
roll-over (refinance) existing debt. This
could in turn impact the future growth plans
of the company, says Jasani. The cost of bor-
rowing also increases for such companies be-
cause investors seek higher returns for the
additional risk they take. To get funds from
investors at more attractive rates, these com-
panies need to improve their operational
and financial matrices, says Srinivasan. If
the company does not take quick corrective
Banks with huge NPAs
cr
IDBI Bank
25,206 32,702 25,305
13.21%*
PNB
7.81%
cr cr
Bank of India
6.90%
cr cr cr
Union Canara Bank of
Bank Bank Baroda
18,832 21,649 18,080
6.57% 6.33% 4.72%
*Non-performing assets or NPAs as % of the
banks total assets. Data as of March 2017.
action, it may face further downgrades.
How downgrades impact you
Usually, a rating downgrade is immediately
followed by a fall in the companys stock
price, impacting your equity investments in
the short run. Even your debt mutual fund
investments can be adversely impacted. In-
vestors in debt instruments that witness a
sudden and sharp downgrade will be faced
with losses due to the fall in their prices be-
cause of the downgrade, says Somasekhar
Vemuri, Senior Director, CRISIL Ratings.
What you should do
A ratings downgrade is an alarm bell. You
need to wake up and take corrective action.
However, do not worry if theres just been
one downgrade. A series of downgrades is a
cause for concern, not a single downgrade,
says Jasani. Pay close attention to the recent
credit ratings of a bank or a company and
also its future outlook, which is given in the
rating notes by agencies. It is an indicator of
the likely direction in which the companys
rating is expected to move. For instance, all
long-term ratings from CRISIL carry an out-
look which gives the likely direction in which
the rating is expected to move in the next 12-
18 months.
In order to take corrective action, go
through the explanation provided by the
company in response to its rating down-
grade. Will the company be able to honour
its promises, within the stipulated time
frame? If you think the measures announced
Stocks
GETTY IMAGES
Companies with high are unrealistic, you may exit your invest-
ments once the prices recover, after the ini-
debt-equity ratio tial knee-jerk reaction to a downgrade.
A high DE ratio indicates that a firm may If you are a debt mutual fund investor,
not be able to service its debt. keep an eye on the ratings of the debt invest-
ments made by the fund house. You may
Shriram Trans 4.96 check it once every three months. In case,
the exposure to bonds rated below AAA or
M & M Fin. Serv 5.10 even AA+ is rising, you should check the ped-
igree of the companies in which the fund has
Bajaj Fin 5.21
invested, suggests Jasani. If the funds expo-
Power Fin.Corpn 5.68 sure to lower-rated companies is high, it is
advisable to exit the fund.
Rural Elec.Corp 5.93
How to anticipate a downgrade
Indiabulls Hous 6.27
If the rating outlook is negative, typically
GMR Infra the ratings are likely to be downgraded fur-
7.02
ther, says Srinivasan. You should also do
LIC Housing Fin. 12.14 your own research. For instance, in the case
of a bank, find out its non-performing asset
(NPA) levels or bad loans. If, compared to
Firms with poor peers, its NPAs have been rising, chances are
interest coverage ratio it could face further downgrades. In the case
Higher ICR reflects a higher ability to of a company, pay close attention to its debt-
service debt. equity (DE) and interest coverage ratios
(ICR). The DE ratio indicates the proportion
Reliance Com. 1.10 of the companys assets that are being fi-
nanced through debt, while the ICR indi-
Hindalco Inds. 1.03
cates the ability of a firm to service the debt
JSW Steel 1.01 and repay it as per schedule. A DE ratio of
one is considered optimal. While the higher
GMR Infra. 0.56 the ICR, the better is the ability of a borrower
to service debt.
Jindal Steel 0.18 Be careful of betting on highly leveraged
stocks on the expectation of a turnaround.
-1.70 Tata Steel
In majority of the cases, this turnaround
-2.42 SAIL never happens or happens after the inves-
tors lose patience and exit, says Jasani.
-51.24 BHEL
Data is for 2015-16 (latest available numbers).
Source: Capitaline, Compiled by ETIG Database. Please send your feedback to
The companies are from the BSE 100 basket. etwealth@timesgroup.com