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May 22 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has assigned GuarantCo Limited (GuarantCo) an Insurer Financial Strength (IFS) rating of ‘AA-'. The Outlook of the rating is Stable.
The rating reflects GuarantCo’s strong owners, solid capital position, established track record of providing local-currency-guarantees to finance private infrastructure projects in emerging markets and its low investment risk. These strengths are partly offset by the company’s fairly small size and historically weak profitability.
Although GuarantCo is backed by public institutions, it is run on a commercial basis, thus allowing European countries to finance private sector projects in low-income countries without committing their own funds directly. It is indirectly owned by the development agencies of the UK (AA+/Stable), Switzerland (AAA/Stable) and Sweden (AAA/Stable), via the Private Infrastructure Development Group Trust (83.4%) and directly by the FMO (AAA/Negative) (16.6%).
The owners’ commitment to GuarantCo is indicated by their capital contributions made to GuarantCo to date and their plans to further increase paid-in capital to USD330m at end-2016 from USD205m at end-2013. However, there is no formal support, such as the subscription of callable capital (as for multilateral development banks) or unconditional guarantee from the public shareholders to support GuarantCo. Consequently, future financial support from the four development agencies cannot be guaranteed. While the rating reflects strong and committed sponsors, it is not aligned with that of the owners due to the absence of explicit support.
GuarantCo’s capitalisation is strong with a net par to capital ratio (excluding available capital from an USD450m counter-guarantee facility) at 0.8x at end-2013. Fitch regards the drawn tranches of the counter-guarantee facility (USD300m at end-2013) as equity in its capital assessment which results in a very strong adjusted par to capital ratio of 0.3x. Although Fitch expects that GuarantCo’s capitalisation will weaken as it grows, it is expected to remain commensurate with the company’s rating.
GuarantCo is viewed by Fitch as a small, highly specialised financial guarantor. However, the company’s size is not a limiting rating factor as it is a public-sponsored organisation and its mission does not hinge on attaining material business volumes. Its products are intended to support government initiatives established by its sponsors.
As GuarantCo’s primary objectives are to encourage private sector involvement in the domestic financing of infrastructure projects and to promote local capital market development, profitability is not a key performance metric. The company’s profitability has been weak in recent years, largely driven by the low interest rate environment and fairly high fixed costs. However, the company is expected to return to profitability, and a return on capital target has been established over the longer-term at 3%-6%.
The company provides guarantees for mainly non-USD denominated debt issued by below-investment grade issuers (“high frequency, high severity” guarantee portfolio) and it is exposed to unhedged currency risk. Fitch views this risk as manageable as an 8% weakening/strengthening of the USD against guarantee-denominated currencies would have affected net profit and equity by an amount equivalent to only 3.8% of shareholders’ funds at end-2013. However, it is possible that currency risk will increase as the company grows, and Fitch will continue to closely monitor this exposure.
At end-2013, GuarantCo’s investments consisted of cash (75%) and a US Treasury backed money market fund. Fitch expects GuarantCo’s investment risk to remain low.
Fitch views an upgrade of GuarantCo’s rating as unlikely in the medium term given the company’s fairly small size. However, the extension of an explicit support agreement by the company’s ultimate government-backed owners could result in an upgrade.
A downgrade may result from a weakened capital position evidenced by a net par-to-capital ratio, including available capital from the counter-guarantee facility, or in the future callable capital from development finance institutions, exceeding 2x. Also, a reduction in the commitment by the owners to GuarantCo, possibly as a result of a change in government policy priorities, could trigger a downgrade.