Announcements

GCR accords Conduit Capital Limited a first time rating of BBB(ZA), Outlook Stable.

Johannesburg, 22 May 2017 — Global Credit Ratings has today accorded Conduit Capital Limited a first time national scale long term debt rating of BBB(ZA) and a national scale short term debt rating of A3(ZA). The ratings have been accorded a Stable outlook. Furthermore, an international scale LC long term rating of B+ has been accorded; with a Negative outlook.

SUMMARY RATING RATIONALE

Global Credit Ratings (“GCR”) has accorded the above credit ratings to Conduit Capital Limited (“Conduit”) based on the following key criteria:

Driven by an experienced management team and a supportive shareholder base, Conduit has outlined a clear strategy to expand the group into a broader insurance related group, complimented by a portfolio of non-insurance investments that can contribute to long term net asset value enhancement. Nevertheless, performance still remains dependent on its major subsidiary, short term insurer Constantia Insurance Company Limited (“CICL”). The insurer is in the process of growing premium income by developing relationships with key partners and pursuing new niche lines of business, as well as increasing its presence in traditional lines of business.

Whilst profitability was strong over most of the review period, Conduit reported underwriting losses in FY16 and 1H FY17, partly attributed to an unexpected spike in the claims ratios in certain product lines. Management has now implemented corrective action on existing non-performing portfolios, combined with a more dynamic underwriting and risk management approach to new lines of business, as well as to premium pricing, with indications of a return to profitability during 2H FY17. CICL has also invested substantially in systems and administrative capacity to handle the new volumes, but it needs to demonstrate an ability to attract new premiums. Aside from raising profitability, success in this regard should mitigate current business risk, which is highly dependent on two key business partners.

All statutory solvency measures for CICL and the two life companies have been exceeded, as have been the more conservative management solvency targets. The introduction of new statutory solvency measures will likely see CICL’s solvency ratios decrease from 2017 as the capital benefits of solvency reinsurance will largely be mitigated. The insurer should still comfortably comply with the new measures. Moreover, Conduit has demonstrated a commitment to inject capital into its insurance subsidiaries to support growth. Accordingly, GCR affirmed CICL’s claims paying ability rating of A-(ZA) in February 2017.

Conduit follows a value approach to investing, whereby it has acquired stakes in a small number of companies that are expected to outperform over the long term (rather than diversification). While this has seen the portfolio double from its cost price, the combined share portfolio is concentrated, with two counters accounting for 60% of value and the four largest over 86% (including a large portion of its own shares). Concentration, and the large proportion held in relatively illiquid counters, may increase annual return volatility and does reduce the benefit that may exist for unsecured creditors in a sale scenario.

As liabilities assumed by Conduit will rank subordinate to those of CICL, Conduit’s credit rating will be lower than that of CICL, albeit that the level of downward notching implied by the subordination must be considered against the added protection to bondholders by their access to the other group assets. As the unencumbered equity portfolio covers the proposed bond issuance by more than 2x, recovery benefits for unsecured creditors are implied. Accordingly, an issuer rating of BBB(ZA) has been accorded to Conduit.

Upwards rating movement is dependent on a return to underwriting profitability and demonstrated ability to expand the new lines of insurance over the medium term. Strong value growth in the unencumbered share portfolio would also be positively considered. Conversely, the continued high claims experience and the large cost base, in the absence of significant premium growth, will likely lead to further underwriting losses and undermine the group’s growth plans. Furthermore, the international scale rating will be sensitive to changes in South Africa’s sovereign rating and has therefore been accorded a Negative Outlook, in line with the sovereign rating outlook.

NATIONAL SCALE RATINGS HISTORY  
   
Initial/ last rating (May 2017)  
Long term: BBB(ZA); Short term: A3(ZA)  
Outlook: Stable  
International-LC Long term: B+  
Outlook: Negative  

ANALYTICAL CONTACTS

Primary Analyst  
Eyal Shevel  
Sector Head: Corporate and Public Sector Ratings  
(011) 784-1771  
shevel@globalratings.net  
   
Committee Chairperson  
Sheri Few  
Senior Credit Analyst  
(011) 784-1771  
few@globalratings.net  

APPLICABLE METHODOLOGIES AND RELATED RESEARCH

Criteria for Rating Corporate Entities, updated February 2017

Criteria for Rating Short Term Insurance Companies, updated July 2016

Constantia Insurance Company Limited rating reports (2001-2017)

RATING LIMITATIONS AND DISCLAIMERS

ALL GCR’S CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://GLOBALRATINGS.NET/UNDERSTANDING-RATINGS. IN ADDITION, GCR’S RATING SCALES AND DEFINITIONS ARE ALSO AVAILABLE FOR DOWNLOAD AT THE FOLLOWING LINK: HTTP://GLOBALRATINGS.NET/RATINGS-INFO. GCR’S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, PUBLICATION TERMS AND CONDITIONS AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE AT HTTP://GLOBALRATINGS.NET.

GLOSSARY OF TERMS/ACRONYMS USED IN THIS DOCUMENT AS PER GCR’S Corporates GLOSSARY

Accounting A process of recording, summarising, and allocating all items of income and expense of the company and analysing, verifying and reporting the results.
Assets A resource with economic value that a company owns or controls with the expectation that it will provide future benefit.
Benefits Financial reimbursement and other services provided to insureds by insurers under the terms of an insurance contract.
Bond A long term debt instrument issued by either: a company, institution or the government to raise funds.
Capacity The largest amount of insurance available from a company. In a broader sense, it can refer to the largest amount of insurance available in the marketplace.
Capital The sum of money that is invested to generate proceeds.
Claim A request for payment of a loss, which may come under the terms of an insurance contract.
Credit Rating An opinion regarding the creditworthiness of an entity, a security or financial instrument, or an issuer of securities or financial instruments, using an established and defined ranking system of rating categories.
Diversification Spreading risk by constructing a portfolio that contains different investments, whose returns are relatively uncorrelated. The term also refers to companies which move into markets or products that bear little relation to ones they already operate in.
Equity Equity is the holding or stake that shareholders have in a company. Equity capital is raised by the issue of new shares or by retaining profit.
Illiquid Markets or financial instruments are described as being illiquid if there are few buyers and sellers. Assets may also be considered illiquid. It may be difficult, or even impossible, to find a reliable price for an illiquid security.
International Scale Rating LC International local currency (International LC) ratings measure the likelihood of repayment in the currency of the jurisdiction in which the issuer is domiciled. Therefore, the rating does not take into account the possibility that it will not be able to convert local currency into foreign currency or make transfers between sovereign jurisdictions.
Liabilities All financial claims, debts or potential losses incurred by an individual or an organisation.
Long-Term Rating A long term rating reflects an issuer’s ability to meet its financial obligations over the following three to five year period, including interest payments and debt redemptions. This encompasses an evaluation of the organisation’s current financial position, as well as how the position may change in the future with regard to meeting longer term financial obligations.
Loss The happening of the event for which insurance pays.
Net Asset Value The value of an entity’s assets less its liabilities. It is a reflection of the company’s underlying value and is usually quoted on a per share basis.
Policy The legal document issued by the company to the policyholder, which outlines the conditions and terms of the insurance.
Portfolio A collection of investments held by an individual investor or financial institution. They may include stocks, bonds, futures contracts, options, real estate investments or any item that the holder believes will retain its value.
Premium The price of insurance protection for a specified risk for a specified period of time.
Rating Outlook A Rating outlook indicates the potential direction of a rated entity’s rating over the medium term, typically one to two years. An outlook may be defined as: ‘Stable’ (nothing to suggest that the rating will change), ‘Positive’ (the rating symbol may be raised), ‘Negative’ (the rating symbol may be lowered) or ‘Evolving’ (the rating symbol may be raised or lowered).
Reinsurance The practice whereby one party, called the Reinsurer, in consideration of a premium paid to him agrees to indemnify another party, called the Reinsured, for part or all of the liability assumed by the latter party under a policy or policies of insurance, which it has issued. The reinsured may be referred to as the Original or Primary Insurer, or Direct Writing Company, or the Ceding Company.
Risk The possibility that an investment or venture will make a loss or not make the returns expected. There are many different types of risk including basis risk, country risk, credit risk, currency risk, economic risk, inflation risk, liquidity risk, market or systemic risk, political risk, settlement risk and translation risk.
Shareholder An individual, entity or financial institution that holds shares or stock in an organisation or company.
Short Term Current; ordinarily less than one year.
Short-Term Rating A short term rating is an opinion of an issuer’s ability to meet all financial obligations over the upcoming 12 month period, including interest payments and debt redemptions.
Solvency With regard to insurers, having sufficient assets (capital, surplus, reserves) and being able to satisfy financial requirements (investments, annual reports, examinations) to be eligible to transact insurance business and meet liabilities.
Statutory Required by or having to do with law or statute.
Underwriting The process of selecting risks and classifying them according to their degrees of insurability so that the appropriate rates may be assigned. The process also includes rejection of those risks that do not qualify.

SALIENT FEATURES OF ACCORDED RATINGS

GCR affirms that a.) no part of the rating was influenced by any other business activities of the credit rating agency; b.) the ratings were based solely on the merits of the rated entity, security or financial instrument being rated; c.) such rating was an independent evaluation of the risks and merits of the rated entity, security or financial instrument.

Conduit Capital Limited participated in the rating process via face-to-face management meetings, teleconferences and other written correspondence. Furthermore, the quality of information received was considered adequate and has been independently verified where possible.

The credit ratings have been disclosed to Conduit Capital Limited with no contestation of the ratings.

The information received from Conduit Capital Limited and other reliable third parties to accord the credit ratings included:

  • Audited financial statements for F16, and four years comparative numbers
  • 1H FY17 unaudited published accounts
  • GCR rating report for Constantia Insurance Company Limited
  • Investment and capital allocation policy document
  • Details of investment portfolio at January 2017
  • Group organograms
  • Five year forecast model for Conduit

The ratings above were solicited by, or on behalf of, the rated client, and therefore, GCR has been compensated for the provision of the ratings.

GCR accords Conduit Capital Limited a first time rating of BBB(ZA), Outlook Stable.

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