The Government's recent announcement that a revised retail deposit guarantee scheme will be available beyond October 2010 to entities that have a credit rating of BB or higher is stark news for the non-bank deposit-taking sector when considered in light of recent credit rating downgrades.
In downgrading MARAC Finance and South Canterbury Finance, each to BB+, Standard & Poor's commented in its rating reports:
"We retain our view that MARAC is one of the stronger finance companies in New Zealand, despite the company's recent asset-quality pressures." and "Despite these challenges, it is our view that SCF is one of the stronger finance companies in New Zealand."
Positive comments aside, the downgrades leave MARAC Finance and South Canterbury Finance one "notch" above the announced BB minimum credit rating needed to access the "extended" retail deposit guarantee scheme next October.
What then for finance companies looking on from the wings?
They know that they are required to have a credit rating by March 1, 2010, that to access the deposit guarantee scheme their rating will need to be BB or higher and that two of the "stronger finance companies in New Zealand" are currently one notch above the minimum threshold.
Some lessons can be learnt from the rating reports for MARAC Finance and South Canterbury Finance, and finance companies should obtain and read those reports.
Underlying both rating reports was a common theme: "...a weak industry environment, where the potential for lending losses is exacerbated by the softening trends in the New Zealand economy. The property development sector is currently experiencing very low business confidence and faces reduced investor demand and limited refinancing options."
Little can be done to address Standard & Poor's view of the industry or the economy, but negative views on exposure to the property development sector, related-party exposures and impaired loans are areas of operation and structure that might be addressed.
Thought should give to the appropriateness of group structures, to clearly separating rated entities and operations from other group activities and to limiting intra-group reliance that may "weak-link" ratings.
Ring fencing and other techniques may be appropriate to clarify the boundaries between group entities and between operations within entities.
Operational and structural elements that attracted positive comment in the rating reports were funding diversity, liquidity, business profile, market position and third party support. Finance companies looking to accentuate the positive might seek to articulate and demonstrate their policies and strategies in these areas.
The downgrade of South Canterbury Finance by Standard & Poor's came just six weeks into a Credit Watch that might have taken up to three months to resolve, and was despite SCF having publicly stated how it would address concerns.
This is a clear warning that in the current economic environment rating agencies want to see action. Consequently, in approaching the rating process for the first time, finance companies demonstrating a track record of improvement may well be better received than those promising to implement untested enterprise changing structures and systems from February 28, 2010.
Finally give a thought to rating volatility. Entities should aim to structure their affairs so that they can "porpoise" along their target rating without coming to harm.
Rating agencies' desires to address a global financial crisis criticism that they moved too slowly on downgrades, coupled with general uncertainty as to the future, are likely to spell increased rating volatility, at least in the short term.
Andrew Robinson is an associate with Duncan Cotterill and was formerly assistant general counsel at Standard & Poor's. He is a member of the finance and banking team. Disclaimer: the content of this article is general in nature and not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.
