South Canterbury's investment grade rating put on CreditWatch negative (Update 1)

Ratings agency Standard and Poor's has put South Canterbury Finance's BBB- rating on CreditWatch negative, a move that could strip the Timaru based finance company of its coveted investment grade rating and unsettle many investors with NZ$1.7 billion of South Canterbury debentures. (Updated with comments from CEO Lachie McLeod.) The negative creditwatch action followed South Canterbury Finance's  announcement of a NZ$37 million loss for the just completed financial year to June 30 and its decision to look for fresh equity from a new shareholder. This followed a NZ$58 million provision for bad debts linked to the slumping property market. A CreditWatch negative listing implied a "one-in-two chance" of a rating downgrade in the next three months, S&P said, adding a downgrade of more than one notch was possible. Chief Executive Lachie Mcleod told interest.co.nz in an interview on Wednesday morning the ratings warning was a "probably precautionary move" and "not unexpected." "We're still happy that we're BBB-. If they'd had some major concerns they would have dropped us a notch immediately," Mcleod said, adding there was now three months to work through the ratings agency's concerns.

Standard and Poor's said there were increased risks in the South Canterbury loan book. "The CreditWatch action reflects our view that there is now an increased risk that some of the nonperforming assets could translate into lending losses ultimately," Standard & Poor's credit analyst Derryl D'silva said in a statement. "Further, SCF's decision to shift its holdings of liquid assets from cash to higher risk and high-yield investments has increased the risk profile of the company and weakened its liquidity," D'silva said. "The investments have also resulted in an increase in related-party exposures, which have moderated SCF's capitalization, and are a weakness at the 'BBB-' rating level." Additionally, an existing rating trigger on SCF's US$100 million private-placement facility compounded the liquidity concerns, S&P said. "The trigger specifies that if the rating on SCF were lowered to below 'BBB-', funding providers may review or withdraw their funding support for SCF," it said. "Such a downgrade would likely exacerbate the consequent negative rating momentum, whereby a small negative ratings movement could magnify significantly because of liquidity difficulties that may emerge." However, South Canterbury's "sound business profile and geographic diversity" were factors supporting the rate. "The 'BBB-' rating is supported by our expectation that SCF's primary shareholder, Mr. Allan Hubbard, will remain steadfast in his ability and willingness to support SCF if required," S&P said. "The shareholder has injected NZ$40 million in capital to absorb the impact of the increased credit costs. At the same time, he plans to have a legal underwriting agreement (which is yet to be executed) that is expected to stand as security for any further specific loans that could become impaired." "The ratings may be lowered by one or more notches should SCF fail to address pressures concerning its liquidity and its weaker capital adequacy position stemming from related-party exposures and rising credit costs," D'silva added. "In addition, the ratings may be removed from CreditWatch if SCF's underwriting agreement with its major shareholder were successfully executed, and if SCF reduced or eliminated its related-party exposures such that it decreases the pressure on its capitalization level." McLeod said South Canterbury had around NZ$170 million of related party lending to companies owned by Allan Hubbard's interests, including Helicopters NZ and Dairy Holdings. South Canterbury had always had this related party lending, but this was now more of a focus for Standard and Poor's in the wake of media coverage in recent months, he said. "It's had a focus on it and we have to get them down over the next 6 to 12 months, but it's not that easy to refinance helicopters at short notice," he said. South Canterbury would release its full results for the year in about 6 weeks and an underwriting agrement for Hubbard to put in more equity would be disclosed with the results, he said. Here is the link to South Canterbury Finance's full half yearly report. Your views and insights? We practice a form of collaborative journalism and welcome your thoughts and insights in the comments below on this article and the core documents we have linked to.