Rating companies get 6 months to withdraw, lower ‘propped up’ loan ratings

Mumbai: The Reserve Bank of India (RBI) has given credit rating companies six months to either downgrade or withdraw bank loans ratings that were propped up through arrangements that the regulator thinks are “diluted or non-prudent support structures.”

With this, hundreds of companies are likely to find their borrowing cost rise and ratings on their bank loans drop at least two notches by early 2023.

The central bank expressed its views in a July 26 letter to CEOs of rating firms, a banker familiar with the matter told ET.

RBI had earlier voiced its reservations about ‘credit enhancement’ mechanisms like ‘letter of comfort’ and ‘letter of undertaking’ given by promoters or parent firm to the borrowing entity as well as supports like pledge of shares. Corporates lower their cost of debt, often significantly, through these structures.

In last week’s response to queries raised by rating agencies, the central bank also pointed out the absence of statutory recognition under the Indian Companies Act 2013 to the ‘obligator co-obligator’ structure that many infrastructure companies, organising projects in multiple special purpose vehicles (SPVs), use to raise money. A ‘obligator co-obligator’ structure is a financial innovation, which has caught on in recent years, helping infrastructure developers to pool in cash flow from various SPVs. In the event of cash shortfall in the escrow account of one SPV, funds can be drawn from another SPV with surplus cash to service loans and escape default.

Expressing its “regulatory concern” – probably stemming from the IL&FS blowout – RBI’s July 26 note said that ‘obligator co-obligator structure’ “has evolved only as a market practice” without statutory backing. “Given that each company (i.e. SPV) is a distinct legal entity, legal challenges in sharing the cash flows in the event of any financial stress, change in ownership, litigations by minority shareholders etc. cannot be ruled out. Further, in case of an adverse development in any of the SPVs/entities, the reputational risk will have a negative effect on all the other SPVs/entities thereby affecting the cash flow of the whole group. Hence, rating companies shall not derive rating comfort from such structures,” said RBI.

If a rating downgrade is unacceptable to the borrower, the agencies may withdraw the rating once the withdrawal is solicited by the borrower. At the time of withdrawal, rating agencies have to issue a press release disclosing the reason for the rating withdrawal. Banks prefer to give loans that are rated as unrated exposure requires lenders to earmark extra capital.

Within the RBI-stipulated 6-month time frame (beginning July 26, 2022), rating companies have to finalise internal policies and convert all existing ratings to ‘standalone ratings’ or ‘withdrawn’. Even ‘corporate guarantees’, the timeline for invocation has to be specified to justify a higher rating on new loans with guarantee support.

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