By Gareth Vaughan
CBL Insurance Ltd, an Auckland-based credit surety and financial risk provider that does the bulk of its business in Europe and has grown the gross premiums it writes from NZ$2 million to NZ$104.6 million in 10 years, is "disappointed" with a two notch credit rating downgrade from Standard & Poor's but says the move will have a "negligible effect" on its business with a boost seen from the recent election of a Socialist president in France.
S&P has cut CBL to BB- with a negative outlook from BB+. S&P also said CBL, which is licenced under the new Reserve Bank prudential regulation regime for insurers and was formerly known as Contractors Bonding Ltd, has governance that's "less than adequate" with its board lacking independence from management.
CBL bought European Insurance Services Ltd, which provides residential builders warranty insurance in France and Spain, for €22 million (about NZ$36 million) last June in a deal half funded through loans from BNZ and fellow National Australia Bank subsidiary, Britain's Clydesdale Bank. A quarter of the deal was funded through an issue of CBL shares, and the balance via a €5 million earn-out payable over three years.
In downgrading CBL from its highest speculative, or junk, rating of BB+, S&P said benefits from the acquisition on CBL's operating performance and competitive position have been "more than offset" by a resulting deterioration in the company's financial risk profile with weak risk-based capitalisation after adjusting for goodwill, and a complex business model and strategy managed by a small team. This is despite what S&P acknowledges as a strong and consistent underwriting performance from high margin business.
S&P says an insurer rated 'BB' has marginal financial security characteristics. Although positive attributes exist, adverse business conditions could lead to "insufficient ability" to meet financial commitments.
'Our clients know and trust us'
In an emailed response to questions Carden Mulholland, CBL's chief financial officer, told interest.co.nz CBL was disappointed with the downgrade. This was especially because, in contrast to S&P's comments that CBL would struggle to meet its earnings targets, Mulholland said as of April the group was 26% ahead of its 2012 revenue target and 24% ahead of its profit forecast.
"We expect that it (the downgrade) will have a negligible effect on business," Mulholland added. "Our clients are very loyal and know and trust us."
Established in New Zealand in 1973 as a credit and surety insurer to local businesses, CBL's current shareholders - led by its chairman Alistair Hutchison and managing director Peter Harris - acquired the firm in 1996 and started expanding internationally in 2000. Aside from Auckland it has offices in London and Kuala Lumpur.
International business makes up 94% of revenue, which stood at NZ$51 million for the year to June 30, 2011. More than three quarters of the nearly NZ$105 million of gross premiums written in the June 2011 year, up 153% year-on-year, came from Europe at 77%, with 4% from Asia, 6% from Australia and New Zealand, 9% from Latin America including Mexico, and 2% from the Middle East and Africa.
Key products the firm offers are contractor and construction bonds, builders warranties, property deposit bonds, rental guarantee bonds, travel and cargo agents and income protection. According to S&P, it had a June year return on equity of 20.33%.
'Reduced tolerance and ability to absorb shocks'
S&P said CBL's total adjusted capital was materially eroded by goodwill from the acquisition and increased deferred acquisition costs. The company faces amortisation of €600,000 per quarter on the €11 million acquisition financing, S&P said, although Mulholland said CBL has repaid the money borrowed to help fund the deal.
"CBL now has reduced tolerance and ability to absorb shocks because of its weak risk based capitalisation, financial leverage, modest financial flexibility from entrepreneurial ownership, as well as concentration and credit quality risk regarding its investment assets," S&P said.
It puts CBL's financial leverage ratio at about 47% after recent debt repayments. And although acknowledging CBL's key managers are experienced in their market and focused on its targeted niche business, S&P said it considers the company's governance to be "less than adequate" compared to peers, with key-person risk further compounded by a lack of board independence from management.
CBL's biggest shareholder is listed as Hutchison's Federal Pacific Group, which also owns 19.99% of GFNZ Group Ltd, formerly Geneva Finance, whose CCC- credit rating S&P recently placed on credit watch with negative implications. The credit rating agency said its move reflected GFNZ’s reliance on the proceeds from a yet to be completed receivable finance deal with Federal Pacific Group needed to meet about NZ$5 million in scheduled repayment to debenture holders and Bank of Scotland in September.
The Companies Office website lists CBL's directors as Hutchison, Harris, the Auckland-based Anthony Hannon, and the British-based Adam Massingham.
'Perfect time to make a Euro-zone acquisition'
Mulholland, who according to CBL's website is a banking and financial risk specialist who has previously worked for Macquarie Bank, plus both the Bank of New York and Barclays' Life in London, said the way S&P calculates adjusted capital is by eliminating goodwill and deducting that value from capital.
"It is a technical adjustment only and effectively treats the asset as having no value. It is an inescapable fact that in buying a successful services company, the purchase price will include an amount of goodwill," he said.
CBL said it undertook a "successful" capital raising last year to help fund the European Insurance Services deal, is meeting its Reserve Bank regulatory requirements, has no current need to raise capital, and is more liquid now than ever. And despite the Euro-zone sovereign debt crisis, Mulholland said 2011 was a good time to make an acquisition in Europe.
"Last year was a perfect time to purchase European Insurance Services, and the value of the business has increased significantly since we purchased it. Residential building permits have been increasing steadily in France over the past 18 months, and with the change of government, more and more social housing than ever is expected to be built. We write very little business in Spain." See more from CBL on the acquisition here.
Socialist candidate Francois Hollande defeated incumbent conservative Nicholas Sarkozy in last month's French presidential election. The Socialists also look set to win a majority in France's National Assembly.
NZ$4.4 mln annual profit
Meanwhile, in a seven page summary of its annual financial view on the company's website, CBL reports a NZ$4.4 million 2011 calendar year profit after tax, up from NZ$503,000 in 2010. The summary shows total assets of NZ$110.8 million including goodwill of NZ$31.7 million, total liabilities - including NZ$18.6 million of bank loans - of NZ$82 million, and total equity of NZ$28.7 million including NZ$4.5 million of retained earnings and reserves. Mulholland declined to provide interest.co.nz with a copy of the full annual review.
Also on its website CBL describes Hutchison as a financial services specialist in insurance, international currency services and micro banking. It says he was once a member of the Board of Governors of the World Bank, International Monetary Fund and Asian Development Bank, and was Financial Secretary of the Samoan Government. Harris a described as a financial risk and structured credit underwriting specialist with an investment banking background who is responsible for developing CBL’s international business.
On its negative outlook for the new CBL rating, S&P said this reflected its expectation that it will take CBL "some time" to build up sufficient capital through retained earnings with its increased exposure to a weakening European economy cited as a potential drag on earnings. The rating could be lowered further if there was any further erosion of capital, or if CBL failed to meet scheduled amortisation or repayments on bank debt or other contingent liabilities.
On the other hand the outlook could return to stable if CBL demonstrated a sustainable and material improvement in capitalisation, and evidence of a sustainable boost in competitive position and operating performance stemming from its European acquisition.
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