Illustration by Binay Sinha
It is not just equity investors
who look for a strong parentage while subscribing to an initial public offering (IPO). In fact, lenders have also been extending funds to subsidiaries, which may have been overrated owing to a strong parentage.
As of March 2019, Rs 26 trillion worth of debt was rated at above investment grade, courtesy parent support. The catch, however, is that this parent support is not explicit.
According to data available with Business Standard, across the seven ratings agencies in the country, 231 subsidiaries had a rating of A or above as of March 2019. The combined debt of these 231 subsidiaries stood at Rs 26 trillion. They belong to 58 parent entities and have been rated assuming promoter or parent implicit support.
“Depending on factors like if there is name sharing, past track record of timely support to subsidiaries and other credibility factors, standalone ratings can improve by few notches,” said Shubham Jain, senior vice-president and group-head, Corporate Ratings, ICRA.
Implicit support leads to a subsidiary being rated. Support from the promoter or parent company is factored in without any stated guarantee from the promoter or partner.
Explicit support, on the other hand, has a documented guarantee in place. With the recent regulations, rating agencies have started giving explicit support details, but not in case of implicit support.
Jain added, “There is a methodology in place, which involves discussion with the management of the parent on whether there is intent to support, and if the said investment is core to the company before building in the implicit support.
The trend so far, on timely support, has been favourable, with fewer cases of the implicit support methodology proving to be detrimental.” L&T Halol Shamlaji Tollway is an example, where a strong parentage subsidiary defaulted for reasons beyond promoter control.
In a July 2015 rating action, ICRA noted, “The promoter has stated its commitment to financially support the project until the traffic ramps up to the expected levels. This is being positively factored in, considering the longstanding experience of the promoter – L&T IDPL – and the financial flexibility derived from being part of the L&T Group.”
The rating, however, moved from BB plus in July 2015 to a default rating in September 2015. “In the case of big conglomerates, rating agencies derive comfort from the fact that the subsidiary belongs to a reputed promoter of a conglomerate and factor that in their ratings. This, however, is not a sure guarantee extended by promoters for debt repayment,” said an industry official, requesting anonymity.
Few proxy advisers see other concerns around implicit support. “My concerns around implicit support are it needs to have a two-way effect. If the rating for a special purpose vehicle (SPV) is being uplifted by a notch or in any measure due to a promoter/parent company’s strong rating, then there has to be a pull effect, too,” said Amit Tandon, founder and managing director for Institutional Investor Advisory Services.
He added, “Rating agencies need to factor in the promoter company’s exposure in terms of implicit support to various subsidiaries and the risk involved and rated accordingly.”