Johannesburg, 17 July 2020 – GCR Ratings (“GCR”) has affirmed Constantia Insurance Company Limited’s (“Constantia”) national scale financial strength rating of BB(ZA), with the rating maintained on Negative Watch. Furthermore, GCR has affirmed Conduit Capital Limited’s (“Conduit”) national scale long term and short-term issuer credit ratings of B(ZA)/B(ZA), with the ratings maintained on Negative Watch and Rating Watch respectively. At the same time, the international scale long term issuer rating for Conduit has been affirmed at CCC+ and maintained on Negative Watch.
|Rated Entity / Issue||Rating class||Rating scale||Rating||Outlook/Watch|
|Constantia Insurance Company Limited||Financial strength||National||BB(ZA)||Negative Watch|
|Conduit Capital Limited||Long term issuer||National||B(ZA)||Negative Watch|
|Short term issuer||National||B(ZA)||Rating Watch|
|Long term issuer||International||CCC+||Negative Watch|
The rating action follows a reduction in the South African Country and Insurance sector risk assessments.
The South African country risk score was lowered to 7.0 from 7.5 previously, in a market alert released on the 27th of May 2020. Click here to access the link. On the 4th of June 2020, the South African insurance sector risk score was also lowered to 8.0 from 8.75 previously. Click here to access link.
Combined, the above country and sector risk scores comprise the operating environment score, which is a key input into GCR’s ratings.
The ratings were affirmed and maintained on Negative Watch, with GCR having applied stresses to the assessment to cater for continued weaknesses in the financial profile, which could be compounded by heightened country and sector risks associated with the weak economic environment.
The ratings reflect weakness in earnings following successive years of underwriting deficits at Constantia, with FY19 and 1H F20 having been further impacted by large fair value losses on listed equity investments. Weak earnings in turn adversely impacted liquidity and capitalisation, with cash holdings lowering to R116m at 1H F20 (FY19: R195m) and the insurance entities’ Solvency Capital Requirement (“SCR”) coverage ratios remaining below 1x. GCR nevertheless notes the turnaround strategy that has been implemented, as well as initiatives that are underway to address capitalisation and liquidity weaknesses, including the expected recapitalisation of Constantia through a corporate transaction that is expected to be finalised in the near term. However, the ratings have been maintained on Negative Watch to reflect potential for negative rating action if these initiatives do not materialise as and when expected.
Constantia’s underwriting performance has been impacted by a very high operating expense ratio, which offset improvements in the net loss ratio and led to persistent deep underwriting losses (continuing in 1H F20). The insurer started to implement portfolio remedial action in 2Q F20, which together with material cost cutting is expected to stabilise underwriting performance and cash generation. The extent to which this addresses earnings volatility is expected to be a key medium term rating consideration.
The large net losses led to a weakening in Constantia’s risk adjusted capitalisation metrics, with SCR coverage remaining below the minimum regulatory requirement. GCR has factored in the planned recapitalisation in the coming months (with SCR expected to improve to above 1.5x). However, we expect the associated exposure to property and the elevated equity market risk to impact on capital quality.
Operational cash flow strain led to weak liquidity levels, noting the limited tradability of the majority of the investment portfolio. GCR expects this to be partly addressed by proceeds from the sale of equities and improved operational cash flow.
Constantia’s intermediate market share and premium diversification are viewed to be partly offset by a level of revenue volatility (after the aggressive growth reported in earlier review years), the portfolio’s poor earnings and geographic concentration to South Africa. The ratings are restrained by the high related party exposures.
The corporate transactions that are underway are expected to enhance premium scale in the insurance operations, which together with portfolio corrective actions are expected to improve underwriting profitability over the next six to twelve months. However, this would need to be demonstrated over the medium term in order to be factored into the ratings, and earnings are also still likely to be exposed to equity market volatility. The ratings are, therefore, very sensitive to ongoing capitalisation and liquidity pressure in the absence of a sustained turnaround in operating performance. The Negative Watch reflects the potential for negative rating actions if the planned initiatives to address earnings, capitalisation and liquidity are not executed in line with expectations over the short term.
Negative rating action is likely to follow if earnings and/or operational cash flow pressures persist, or if capitalisation does not improve in line with expectations. We may also lower the ratings if the group or company is acquired in majority by an entity with lower creditworthiness. The national scale ratings could improve following a sustained turnaround in earnings that underpins a strengthening in the financial profile, but this would only be likely over the longer term. Positive rating action on the international scale long term issuer rating is not expected over the outlook horizon, given our assessment of the level of debt subordination to policyholder liabilities.
|Primary analyst||Susan Hawthorne||Senior Analyst|
|Johannesburg, ZA||SusanH@GCRratings.com||+27 11 784 1771|
|Committee chair||Matthew Pirnie||Group Head of Ratings|
|Johannesburg, ZA||MatthewP@GCRratings.com||+27 11 784 1771|
Related Criteria and Research
|Criteria for the GCR Ratings Framework, May 2019|
|Criteria for Rating Insurance Companies, May 2019|
|GCR Ratings Scales, Symbols & Definitions, May 2019|
|GCR Country Risk Scores, May 2020|
|GCR Insurance Sector Risk Scores, July 2020|
Constantia Insurance Company Limited
|Rating class||Review||Rating scale||Rating||Outlook/Watch||Date|
|Claims paying ability||Initial||National||A-(ZA)||Stable||March 2006|
|Financial strength||Last||BB(ZA)||Negative Watch||March 2020|
Conduit Capital Limited
|Rating class||Review||Rating scale||Rating||Outlook/Watch||Date|
|Long term Issuer||Initial||National||BBB(ZA)||Stable||May 2017|
|Short term Issuer||A3(ZA)||—|
|Long term Issuer||International||B+||Negative|
|Long term Issuer||Last||National||B(ZA)||Negative Watch||March 2020|
|Short term Issuer||B(ZA)||Rating Watch|
|Long term Issuer||International||CCC+||Negative Watch|
Risk score summary
|Rating Components & Factors||Risk scores|
|Country risk score||7.00|
|Sector risk score||8.00|
|Management and governance||(1.00)|
|Capitalisation||The provision of capital for a company, or the conversion of income or assets into capital.|
|Cash||Funds that can be readily spent or used to meet current obligations.|
|Equity Investment||An instrument that signifies an ownership position of shares of stock in a company that is either listed or traded on a stock exchange (also known as a counter) or are unlisted.|
|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.|
|Fair Value||The fair value of a security, an asset or a company is the rational view of its worth. It may be different from cost or market value.|
|Issuer Ratings||See GCR Rating Scales, Symbols and Definitions.|
|Issuer||The party indebted or the person making repayments for its borrowings.|
|Liquidity||The speed at which assets can be converted to cash. Market liquidity refers to the ease with which a security can be bought or sold quickly and in large volumes without substantially affecting the market price.|
|Rating Outlook||See GCR Rating Scales, Symbols and Definitions.|
|Rating Watch||See GCR Rating Scales, Symbols and Definitions.|
|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.|
SALIENT POINTS OF ACCORDED RATINGS
GCR affirms that a.) no part of the rating process was influenced by any other business activities of the credit rating agency; b.) the ratings are based solely on the merits of the rated entity, security or financial instrument being rated; and c.) such ratings are an independent evaluation of the risks and merits of the rated entity, security or financial instrument.
The credit ratings have been disclosed to the rated party. The ratings were solicited by, or on behalf of, the rated entity, and therefore, GCR has been compensated for the provision of the ratings. The rated entity participated in the rating process via virtual management meetings, and other written correspondence. Furthermore, the quality of information received was considered adequate and has been independently verified where possible.
The information received from the rated entity and other reliable third parties to accord the credit ratings included:
- Group and company audited financial results as at 30 June 2019;
- Four years of comparative group and company audited financial statements to 30 June;
- Unaudited management accounts for Constantia to 31 December 2019;
- Condensed reviewed results for Conduit to 31 December 2019; and
- Other relevant documents.