The Hindu Business Line : This CAMEL is worth the ride

Seasoned investors and investment analysts must be familiar with the acronym CAMEL — an excellent aide de memoir for one setting out to invest in a debt instrument. Company, its Assets, its Management, its Earnings and its Liquidity are all subsumed in this pithy expression, goading one to examine them threadbare before making up his mind.

CAMEL then serves as an excellent analytical tool in the hands of a credit rating agency as well. The world over credit rating has been associated with debt instruments.

The Securities and Exchange Board of India (SEBI) must be complimented for pioneering the idea of rating equity. Last year, SEBI ushered in an optional rating regime for IPOs. It has now removed the option, thus making the rating of IPOs mandatory.

Two objections

Critics have two fundamental objections to this. First, equity, according to them, is a different kettle of fish vis-à-vis debt. While a debt instrument is amenable to rating, equity by its very nature defies rating, they aver.

According to them, while rating of a debt instrument focuses on the balance sheet, rating of equity necessarily has to focus on the profit and loss account, which is constantly in a state of flux. The apprehension is exaggerated.

Dividing accounts into watertight compartments such as the profit and loss account and the balance sheet is never done given the symbiotic relationship between the two. At any rate, while the priorities and concerns may be different, investors in equity as well as debt set store by the fundamentals of the company, which is what the CAMEL ride is all about.

Second, according to them, a rating exercise of IPO that skirts the issue of its pricing is simply meaningless. There is considerable force in this. SEBI ought to have mandated scrutiny of the issue price as well because this precisely is the area where a garden-variety investor flounders.

It is not enough to grade an IPO on the scale of 1 to 5 on the back of CAMEL, which is fine in the case of rating of a debt instrument, given the fact that the bane of the Indian primary market is the mind-boggling premiums charged by issuers, sometimes even in the face of mounting losses on the smug and self-serving alibi that the future is bright.

There is no harm in telling the investor that while the company deserves the highest rating, that is five, the premium charged is excessive. Similarly, there is no harm in telling him that the company deserves the lowest possible rating — that is, one — but the premium charged is reasonable.

Both contain a seminal message — the first puts the prospective investor on guard and should he burn his fingers in the secondary market, he has to blame himself, and the second also tells him that while the price is reasonable, the company is not investment grade.

Premium minefield

What perhaps has held SEBI back from making the rating agencies stick out their necks on the pricing front is the innate dicey nature of the secondary market — if the quotations are way above the offer price which was rated excessive, the rating agency will have to look sheepish, and contrariwise should the quotation be way below the offer price which was rated as concessional, once again the rating agency would have to blush.

It is perhaps to spare the rating agencies the blushes that SEBI has steered clear of the premium minefield. But then the rating agencies can always insert a disclaimer, a la the disclaimer SEBI itself issues while conferring its imprimatur on vetting of a prospectus, specifically harping on the peculiarities of the secondary market. Be that as it may, the point is even sans help on the price front, rating would be found useful at least to the extent it throws up a report on a company after authentic information has been dredged by experts.

Hot on the heels of the SEBI mandate making rating of IPOs mandatory, the quotation for CRISIL, the leading rating agency, registered a sharp increase, prompting cynics to say that the SEBI move would only end up shoring up the fortunes of rating agencies.

Such comments are as unfortunate as the dirge that SEBI has taken the capital market back to the days of dirigisme.

The secondary market, despite a few warts, functions fairly satisfactorily, thanks to the efforts of SEBI in the main. It is but natural that it should now be concerned with the primary market given the symbiotic relationship between the two.

(The author is a Delhi-based chartered accountant.)

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