I read with interest the opinion piece by Tim Brown on credit ratings in the Business Herald. He raises some valid points, not least of which is that there are successful New Zealand companies which are not rated but which would clearly be investment grade if they were, Fletcher Building being the obvious example, and which have successfully issued bonds in the domestic market.
His corollary to that, with which I also agree, is that it would be an unfortunate consequence of the new regulatory regime if access to the domestic bond market was effectively denied to good quality but unrated New Zealand issuers.
However in making his case, Tim has used examples which would benefit from further commentary.
The recent issue by IAG is used as an example of issuers succeeding merely because of the credit rating. He has, I believe, drawn a long bow when he states that "few investors, or their advisers, would have understood much about the repayment risk". The statement may be accurate of some investors, but I dispute its accuracy with respect to their advisers.
All $325 million of the bonds were placed on a firm commitment basis with financial intermediaries, principally NZX firms. As with virtually all public equity or debt issues, these financial intermediaries were invited to detailed management presentations on the IAG offer, including discussion on the risks of the general insurance market.
Equally as important, the article appears to present the alternatives of reliance on credit ratings or individual adviser research as a binary decision. For the major NZX firms and banks, I would expect that an investment grade credit rating does not of itself 'tick the box'.
Most NZX firms and banks would form a view on whether their advisers should promote an issue to their clients. This analysis will certainly involve the credit rating, but also the proposed pricing, the offer structure and any view a firm or bank may have on a particular issuer or industry sector. This process represents research in addition to an investment grade rating. It is not uncommon for some firms to elect not to support a particular issue that other firms do support, notwithstanding the issuer having an investment grade rating.
The article references many examples where issues with strong credit ratings have collapsed in price. That is undeniable, although the article may have benefited from a clearer delineation between the recent history of "structured" issues (eg, collateralised debt obligations or CDOs and mortgage backed securities or MBS ) and corporate issues. The majority of losses globally resulted from structured issues, and there have not been any structured issues marketed to New Zealand retail investors for some time.
More significantly, the article uses the Credit Agricole issue as an example of an investment grade issue that has performed very poorly, the implication being that relying on the investment grade credit rating proved unreliable. This does not present a complete picture of the role of ratings in the context of that issue.
Credit Agricole had a senior, unsecured rating of AA- at the time of issue, and eight years later has a rating of A+. Hence the rating itself had very little to do with the current secondary market price. The current price reflects the structure of the issue (not to be confused with 'structured' issues as described earlier), which has no maturity date, but more importantly, no coupon step-up if the issue is not called and a fixed margin which is lower than would be required if the same security was issued today.
This price impact is similar to the impact on price of the low coupon government bonds when interest rates were very high in the 1980s.
Notwithstanding the recent financial turmoil and the horror stories of the structured credit markets, reputable credit ratings agencies (and their rating reports), notably Standard & Poor's, Moody's and Fitch, remain the best generally available credit quality benchmarks.
Credit analysis is a skill and the adviser who can outperform the rating agencies is likely to be an exception rather than the norm. For that reason it is understandable that the newly established FMA has focused on credit ratings as a measure of assurance that financial advice is prudent. It naturally follows that authorised financial advisers (or AFAs) will have regard to credit ratings in giving financial advice. While there is a natural human instinct to seek protection from risk, I think we do a disservice to the financial adviser community if we assume the focus on credit ratings is more reflective of adviser self-interest rather than the desire to provide prudent advice to clients.
In this financial crisis environment unrated issuers may have a steeper hill to climb than issuers with investment grade ratings, but I think this important domestic capital market will remain open to them. It will be up to the issuers and their advisers to focus more on the credit characteristics of the issuer rather than the issuer's brand or profile than in the past.
* Disclosure: UBS was the joint lead arranger of the issue by IAG referred to in this article. The views and opinions expressed in this piece are those of the author and not necessarily those of UBS.
Andy Coupe is a senior adviser at UBS New Zealand Limited and has been involved in New Zealand capital markets for 30 years.