Large cap credit ratings looking flaky

Watercare Services, GPT, Qantas, and Telstra have come under rating agency scrutiny.

Standard & Poor's revised the outlook on New Zealand utility, Watercare Services' 'A-/A-2' and 'AA/A-1+' long- and short-term corporate credit and guaranteed debt ratings respectively, to developing from negative, on Friday. Watercare Services has NZ$200 million of bonds outstanding in its domestic market, although NZ$100 million will mature next month and NZ$50 million will mature in October.

The developing outlook reflects uncertainty surrounding the implications of Watercare's proposed transition to a sole, integrated water and wastewater provider in the Auckland region. Positively, the proposed absorption of all the region's water retailers is likely to improve the company's business risk profile. However, these benefits may be offset if the restructuring results in a more aggressive capital structure, if the credit quality of Watercare's owner weakens, or if the company's price setting framework weakens.

GPT Group had its long- and short-term credit ratings cut by Moody's Investor Service to 'Baa3/P-3' from 'Baa2/P-2' but unfortunately this does not conclude the review for possible downgrade initiated on March 6. "GPT's ratings have been lowered by one notch primarily in view of the group's tightening headroom over its financial covenants," said Clement Chong, a Moody's VP/Senior Analyst. Unfortunately the challenging operating environment for the commercial property sector, coupled with constrained access to equity capital, is likely to lead to further tightening in GPT's covenant headroom, absent any meaningful initiatives undertaken by the group.

Moody's said the group's covenant headroom is sensitive to a number of factors that may materialise in the short-to-medium term. These include: material adverse movement in investment property valuation; potential write-down of investments, in particular its loan receivable from the Babcock & Brown joint venture; and currency movements. For these reasons the ratings remain on review for further possible downgrade.

The profit warning delivered by Qantas last week led to S&P cutting its long- and short-term credit ratings assigned to the company, to 'BBB/A-3' from 'BBB+/A-2', and leaving the rating outlook as negative.

S&P said the downgrade reflected its view that Qantas' financial profile will come under significant pressure from the deterioration of trading conditions in the airline industry. An earnings drop-off of this magnitude (forecast pre-tax profit of $100-$200 million, from previous guidance of about $500 million) and the associated cash outflows related to restructuring, are likely to result in materially lower cash flow generation over the next two years and a weaker financial risk profile than was factored into the 'BBB+' rating.

Moody's lowered its long-term credit rating on Qantas to 'Baa2' from 'Baa1' in February this year, largely anticipating the profit warning. Moody's noted its concern that the operating conditions faced by Qantas were extremely difficult and likely to worsen.

Moody's said after Qantas announced its revised profit forecast that the 'Baa2' rating captures the risk of a reduced earnings outlook for the year. The stable outlook assigned to the rating considers the operating flexibility that Qantas retains within its capital expenditure program, and Moody's expectation that the company's financial profile should remain manageable within the rating at this stage of the economic cycle. This is subject to global and domestic conditions not deteriorating more sharply or for a longer duration than currently anticipated.  

While Moody's and Fitch have expressed relatively sanguine views of the impact of the Federal government's new national broadband network plan on Telstra - in other words there was no immediate rating impact - S&P last week revised the outlook on the 'A' long-term credit rating assigned to Telstra to negative from stable. This brings S&P's ratings on Telstra into line with those assigned by Moody's (A2/Negative/P-1), with S&P affirming its 'A-1' short-term rating on Telstra. Fitch rates Telstra A/Stable/F1.

S&P said, "The outlook change reflects the significant uncertainties posed by the Australian government's proposed $43 billion National Broadband Network initiative, and its impending review of telecommunications regulation in Australia. The announcements raise significant uncertainties regarding Telstra's longer-term position in the provision of local fixed-line telecommunications infrastructure in Australia, and also the future structure and composition of Telstra."

S&P added, "While these issues are not expected to have a material financial impact in the next couple of years, we expect that over the two-year horizon of a negative outlook, the future operating and regulatory landscape for Telstra will become sufficiently clear for the long-term rating to be determined. Downside risk to the rating is not expected to exceed one notch."

While offshore it was Dexia Municipal Agency, American Express, Ambac and Goldman Sachs.

Fitch Ratings affirmed its 'AAA' ratings on Dexia Municipal Agency's (DMA) obligations foncieres on Friday, after downgrading parent company, Dexia-Credit Local. DMA still has $1.5 billion of such obligations outstanding in the Australian market.

Fitch noted the obligations issued by DMA benefit from a privilege under French law whereby holders rank ahead of all other creditors. The law also prohibits a parent company's bankruptcy from being extended to the subsidiary.

Fitch affirmed the 'A+/F1' long- and short-term issuer default ratings that it assigns to American Express Co. along with the 'B' individual rating but revised the outlook on the ratings to negative. American Express Credit Corp., which has some $900 billion of bonds outstanding in the domestic market and carries the same ratings, has also been affected.

The outlook revision reflects the expectation that rising credit costs and declining billed business volume will reduce earnings potential and capital generation over the near term. The pace of deterioration in the company's credit card portfolio surpassed that of peers in 2008, given the heavier exposure to borrowers in California and Florida, outsized portfolio growth in 2006 and 2007, and the inclusion of a higher-loss small business portfolio, said Fitch.

Fitch went on to note that the recognition of quarterly operating losses, absent non-recurring items, a weakening liquidity profile, and/or notable reductions in capitalisation, as measured by tangible equity ratios, could result in negative rating action. Conversely, ratings stability will be driven by a recovery in portfolio credit metrics and a reversal of negative spending patterns.   

Moody's concluded its review for possible downgrade initiated in early March, by lowering the insurance financial strength rating assigned to Ambac Assurance Corporation to 'Ba3' from 'Baa1'. The rating outlook is developing.

The downgrade primarily reflects weakened risk adjusted capitalisation, as Moody's loss estimates on RMBS securities have increased significantly. This increases the estimated capital required to support Ambac's sizable direct RMBS portfolio and also its large portfolio of ABS CDO risks. Moody's noted that the claims-paying resources of Ambac remain above expected loss estimates, though this cushion has been significantly eroded, and losses in more severe stress scenarios would exceed available resources.

The developing outlook reflects the potential for further deterioration in the insured portfolio as asset performance develops over the intermediate term. It also incorporates positive developments that could occur including lower variability in mortgage-related asset performance, the possibility of commutations or terminations of certain ABS CDO exposures, and/or successful remediation efforts on poorly performing RMBS transactions. There is also the potential for various initiatives being pursued at the US federal level to mitigate the rising trend of mortgage loan defaults.

Following Goldman Sachs' announcement of its first quarter results and its intention to issue US$5 billion of common stock, S&P affirmed the 'A/Negative/A-1' ratings it assigns to the group. S&P said the results represent an impressive turnaround from the fourth quarter and the month of December, which was reported separately due a change in Goldman's year end date. Nevertheless, the outperformance of the Fixed Income, Currency and Commodities division relative to the others was noted.

In relation to the capital raising and intended partial repayment of TARP preferred stock, S&P noted that Goldman's adjusted total equity would be materially bolstered as S&P excludes the TARP preferred stock from its calculation of capital. However the ratings will continue to benefit from the assumption of extraordinary support from the US government, in need.