Crisil and Rating agencies

Crisil is 51% owned by S&P, and is S&P's subsidiary in India. It is the biggest player in Indian domestic ratings business, but is not a pureplay on it. Only 20% of its biz is domestic ratings, another 20% is outsourcing revenue from S&P global, almost 40% is financial research outsourcing (Irevna), while the rest is consulting and advisory revenue. As ratings has a higher margin than other revenue streams, the contribution at the EBIT line is different: domestic ratings - 35%, S&P outsourcing - 25%, research oursourcing - 40%. Stock is currently at 15x CY09 earnings, so depending on one's view of Irevna, it is either cheap or expensive. It is one of the stocks in India that I have continued to hold since 2007. If one is bullish on India and infra spending, then either Crisil or Icra (Moody's sub, and this is purely domestic ratings) are probably a good bet.

One of the most surprising things since the financial crises exploded in August 2007 is that while various parts of the financial industry - banks, brokers, insurance companies - have seen their business models and ownership structure change irreversibly, the rating agencies continue to exist and do what they have been doing for the past 100 years. There are some half-hearted proposals here and there to change the way rating agencies work, and there are some shorts now (Einhorn) targeting rating agencies. But there doesn't seem yet to be a regulatory or legislative urgency to change anything the way ratings system work. The question is: if equity markets can work without ratings, why can't debt markets?

Recently, BIS published a report titled "Stocktaking on the use of credit ratings" (hat tip: Prof Verma). What is clear is that ratings are used more pervasively in the US than in any other country. If Fed was to decide that it will stop using credit ratings in its decision making process and instead recruit a team of inhouse credit specialists (for e.g. to figure out eligible collateral for TALF), that would be a death sentence for the rating agencies.

If this team of inhouse credit specialists were to make their ratings public, it would become an FDA style agency for the credit markets. This is what rating agency bears say should anyway be the case, because today we have govt. designated monopolies earning non-regulated returns.

There is however, a very big risk with a govt owned rating agency. If the ratings of the govt agency turned out to be bullish or faulty - and they will at least once in the next 100 years - then investors will go the US govt to be reimbursed. So, if Fed decides to set up a team of inhouse credit specialists, its recommendations would likely remain private.

What is the benefit of rating agencies to investors? Maybe rating agency help reduce costs - in the sense that not all bond funds, banks etc have to hire smart credit analysts to buy bonds. However, that is extremely undesirable as we can see. Ratings create a false sense of security.

Net net, till the regulators decide to do the hard work of analysing bonds and loans to calculate the capital cushions of various financial institutions, I don't think rating agencies go away. Having more NRSRO's won't reduce S&P and Moody's dominance in the next 2-3 years. What can certainly change is the way these companies are compensated. That is something that doesn't seem to be happening today, but it can change anytime.