Standard & Poor's has cut its credit rating on sister companies Equitable Mortgages and Equitable Life Insurance to BB- from BB reflecting "poor" asset quality and failure to resolve arrears as promptly as expected.
The two businesses are subsidiaries of Equitable Group, which is wholly owned by the wealthy Spencer family. S&P said its B short-term ratings on both companies were affirmed, with ratings on both companies remaining on negative outlook.
“The ratings action reflects Equitable’s poor asset quality and its failure to resolve arrears as promptly as we anticipated,” Standard & Poor’s credit analyst Mark Legge said.
“This has undermined earnings performance and put some pressure on liquidity," Legge added.
"However, the ratings continue to recognize support received and expected from the Spencer family as sole owners. Equitable’s creditworthiness has deteriorated, in our view, partly as a result of arrears remaining higher than is our level of comfort for the rating."
Legge said the continued softening of the commercial property market, a lack of third-market financing alternatives, and low property-investor confidence had contributed to delays in loan repayments and seen an increase in arrears. The weak property market has also weakened Equitable’s prospects of realizing its security against some lending exposures.
"Importantly, Equitable General Insurance Co. Ltd. (EGIC) offers the group some credit protection against higher lending losses; we expect this insurance will be able to absorb up to another NZ$10 million in lending losses. We see Equitable’s earnings performance as modest and below our previous expectations."
Legge said the Equitable Group had reported a small profit in fiscal 2010 with its operating performance undermined by increased funding costs, lower interest income due to a deliberate shrinking of its loan book and, higher levels of liquidity being held.
"The group’s earnings continue to be squeezed as it maintains high levels of liquidity and, as such, Standard & Poor's does not expect any significant rebound in earnings in the short term. Standard & Poor's believes Equitable has adequate liquidity to meet its needs over the next three months, even if debenture reinvestment deteriorated materially or if scheduled loan repayments were delayed (noting that during this period a higher level of debentures is set to mature and large loan inflows are expected, compared with other months)," said Legge."
Debenture reinvestment rates about 55%
As was the case with many New Zealand finance companies, Legge said most of Equitable’s debentures mature in the three or so months preceding October 2010, when the initial Crown retail deposit guarantee scheme expires.
"The group has deliberately kept liquidity high in the face of asset quality and debenture funding challenges; cash has been kept in the NZ$45 million to NZ$50 million range in recent months. Reinvestment rates appear to be holding up at about 55%, as is new money being invested. Equitable’s liquidity is supported by its access to an undrawn NZ$30 million committed 120-day bank facility," Legge added.
Equitable Mortgages has been accepted into the extended Crown retail deposit guarantee scheme.
Equitable Group chief executive Peter Thomas told interest.co.nz in May that the property lender had survived whilst other property financiers such as Hanover Finance, Strategic Finance and St Laurence had fallen by being "steady, boring and unexciting."
Meanwhile, Legge said in the short term, Equitable's negative outlook reflected the financial challenges it faces in relation to managing its asset quality and liquidity positions, particularly given its short-term debenture maturity profile.
"In the longer term, the outlook reflects the pressure on Equitable's financial profile given the difficult conditions in New Zealand’s commercial property market, which could hamper its effective resolution of loan arrears and undermine the group’s capital position and operating performance prospects," said Legge.
"Additionally, this financial pressure--if not eased--could in our view dilute shareholder incentive to continue to support the group. If shareholder support mechanisms to absorb loan losses do not eventuate or are inadequate, the long-term ratings will likely be lowered, potentially by two or more notches. A significant operational loss--or one that undermined our overall view of Equitable’s risk management capability--would also put downward pressure on the rating, as would a large and unexpected credit loss from the group’s 'core' portfolio."
"Moreover, if the group were to post material operating losses that diluted its capital adequacy position, we would consider lowering the ratings. A return to a stable outlook at the ‘BB-’ level would require both a significant fall in arrears and an improvement in earnings performance. Given the challenging operating conditions, we are unlikely to raise the ratings in the short-to-medium term in the absence of a material shareholder injection of support."
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