Crappier Than the West's: PRC Credit Rating Agencies

You have to be pretty bad to outdo Western credit rating agencies in terms of honestly rating securities free from conflicts of interest. However, it is unfortunately possible. In the wake of the first mainland China bond default, investors are beginning to question the assumption that the state will rescue these firms and that their ratings can be relied upon:

“China’s rating system has problems similar to those in the U.S. in 2008,” Guan Jianzhong, the Beijing-based chairman of Dagong, said in a phone interview yesterday. “There’s cut-throat competition and it’s not about who accurately evaluates the risks, but comes down to prices and ratings.”

The U.S. Financial Crisis Inquiry Commission said in 2011 that inflated credit grades were partly to blame for the worst downturn since the Great Depression, as rating companies lowered standards to win business amid a housing boom that fueled issuance of mortgage-backed bonds. China ended in 2012 a four-year ban on sales of asset-backed securities and credit assessments are of growing importance as market forces play a greater role in pricing risk in its $4.2 trillion bond market.

In a manner of speaking, the pressures for Chinese credit rating agencies to inflate ratings is even higher. For, Chinese issuers are not allowed to raise money in capital markets unless they get at least an AA- rating. Talk about high expectations...that are probably not always entirely met through legitimate means:

Dagong, which cut its U.S. sovereign rating to A- from A on Oct. 17, was set up in 1994 and is one of China’s three biggest rating agencies. The other two are China Lianhe Credit Rating Co. and China Chengxin International Credit Rating Co., which is partly owned by Moody’s Investors Service.

Issuers in China must obtain a rating of AA- or above in order to secure authorities’ approval to sell debt, Guan said. He warned in 2010 that grades assigned to bonds issued on behalf of local governments were misleading and failed to reflect the risks faced by investors. “The problem is getting worse,” Guan said. “Ratings on companies have been upgraded rapidly not because their repayment abilities have improved, but for the sake of getting bonds sold at lower rates, for getting the business done.”

Again, note that the person who made those comments is not some bond analyst but the head of one of China's largest credit rating agencies.

The only real advice I can offer is to do due diligence yourselves on these companies. Ultimately, you will have only yourselves to blame and not some credit agency if these issuances go kaput. Caveat emptor!