Credit ratings over-rated: Infratil's Brown fears "tick-box" advice

Monday 12th March 2012 2 Comments

The Infratil group, which is the biggest issuer of debt that trades on the NZDX market, says its track record and wide analyst coverage are worth more to its corporate bond investors than having a credit rating.

Of the group made up of Infratil, TrustPower, Wellington Airport and Z Energy, only the airport has a rating on its debt, at BBB+ .On assessment of the costs and benefits, Infratil is in no hurry to get a rating, says Tim Brown, who heads up the firm’s debt capital market activities.

“On our metrics we’re in the BBB type space,” Brown told BusinessDesk. “If we felt that the market was mispricing our bonds, because they were not rated, we would certainly rethink our position.”

Counting the investment company’s wider interests – controlling stakes in TrustPower and Wellington Airport, and a 50% holding in Z Energy – Infratil-linked entities have $1.65 billion of bonds that trade on the NZDX, making it the biggest issuer in the market. That amounts to 10 percent of the market capitalisation of the NZX’s debt market.

Ratings companies – Standard & Poor’s, Moody’s Investors Service and Fitch Ratings – were widely criticised when the global financial crisis revealed the shortcomings of their risk assessment of complex derivatives and the entities that issued them.

Infratil’s Brown says he has reservations about the approach of ratings agencies to New Zealand corporates and about whether investors should be buying bonds “on the basis of three letters or fewer.”

“Do people look past an ’A’ credit rating to understand the assumptions,” he asks.

Infratil’s assets are in the energy and transport sectors. The accounts show that energy assets comprise about 60% of the total and generate about 68% of Infratil’s consolidated earnings. Its investments are managed for a fee by Morrison & Co., the investment bank founded by Lloyd Morrison, who died last month.

Morrison’s personal brand and an investment portfolio that includes the airport, power company and the main Auckland and Wellington bus services have created a ready appetite for Infratil’s debt.

Its offer late last year of November 2017 bonds, paying annual interest of 8 percent, was oversubscribed.

The company has done three issues of NZDX-listed debt in the past 18 months - $75 million of the 8 percent November 2017 bonds, $50 million of June 2017 bonds with a coupon of 8.5 percent and $100 million of June 2016 bonds paying 8.5 percent.

“Going by the last issue there was still good, steady demand for their bonds,” said David Speight, director at Direct Broking, the brokerage owned by ANZ National Bank. “I would put that down to their brand presence – and the current interest rate environment – ie relatively low rates on banks term deposits.”

New Zealand’s largest lenders, all carrying a credit rating of AA-, are offering between 5 percent and 5.85 percent for five-year TDs, depending on the amount invested, according to interest.co.nz. Building societies with BBB- ratings offer 6.15 percent to 6.25 percent.

The NZDX’s market value is about 28 percent the size of the NZX equity markets, at $57 billion, based on NZX’s metrics for February. In terms of activity, turnover of securities on the NZDX amounted to just 0.6 percent of market value last month. By contrast, turnover of equities was 3.7 percent of market capitalisation.

Brown says most retail investors in corporate bonds hold them to maturity unless they need the money. He cites a recently matured Infratil 5-year bond where over 80 percent were still owned by the original investors.

However, there do seem to be institutional impediments to investors seeing bonds as an instrument they could trade. Brokerage is likely to be a greater proportionate cost. The lack of turnover also means less broker research.

Brokers managing the distribution of bonds have a conundrum when it comes to making a recommendation.

They could do the research and recommend accordingly, avoid research and give no recommendation, or use rating agency credit ratings as a proxy for independent research and recommend accordingly.

Brown says he hopes the Finance Markets Authority’s push for a regime that sheets home liability doesn’t just result in a ‘tick-the-box reliance on credit ratings.

“This is, however, a very tricky space,” he said. “Imagine you are a broker or financial adviser. You sell someone a bond and earn perhaps 1% on the trade. A couple of years later the bonds are trading at 50% of par value. It is entirely rational that the broker will be very risk averse, given the small level of income relative to the potential downside if the investor litigates or calls in the FMA.”

The relatively small amount of upfront income for the broker also makes paying for research difficult.

“The entire profit of doing a bond issue could be eaten up in costs,” Brown says. “It is this difficulty which has resulted in some brokers/advisers deciding to either not give advice or to rely on “free” ratings.”

The FMA needs to work out “how the ‘line of responsibility’ is to run,” he said.

The NZDX market came through the global financial crisis remarkably unscathed but the market has evolved. Five or 10 years ago, there were many sub-investment grade, or “junk” issuers in the New Zealand debt market.

Now those types of issuers are like hens’ teeth and unrated companies contemplating taking a bond offer to market now may find it a challenge to drum up interest.

As of today, all Infratil’s dated bonds are trading at more than 100 percent of their face amount. TrustPower’s 6.75 percent December 2015 bonds were quoted on the NZDX website at $105.426 per $1 face value.

Morrison & Co, the manager of Infratil, is a survivor from another age. When it emerged in the early 1990s it had few peers. Since then, it has seen the rise and fall of firms using the external management model, including Babcock & Brown, Orco and Macquarie.

BusinessDesk.co.nz

Comments from our readers

On 12 March 2012 at 5:09 pm Siena said:

Kiaora. I invested in Infratil infrastructure Bonds that will be maturing in November 2017 and my Trust has already received its first interest payment last month. I purchased the Bonds firstly because of the Late Mr. Lloyd Morrison and his obvious preference for a shift towards a 'Green Economy' of which I totally support and also as the chairman, David Newman said in the Disclosure Prospectus, "it is the character of Infratil's businesses that provide facilities and services, that are important to their communities" and for which there is a growing demand that needs to be catered for. 'Home Sweet Home'

On 13 March 2012 at 1:22 pm Mike Dever said:

The credit rating agencies are incompetent, which they’ve repeatedly proven. But they are also irrelevant. Look at the market's reaction after the U.S was downgraded. U.S. debt rallied. That is because the markets already set the credit worthiness of any borrower that has outstanding paper. The price is out there. The price of credit default swaps is out there. That is the 'real' credit rating of a sovereign or corporate borrower. Ratings are both redundant and dumber than the crowd-sourced price that already exists.