Fitch Ratings has affirmed Old Mutual ‘A-‘ Long-term IDR and Old Mutual Life Assurance Company (South Africa) and Skandia Life Assurance Company Ltd’s IFS and IDRs. The Outlook is Negative. A full list of ratings actions is at the end of this comment.
The affirmation reflects Old Mutual’s significant decrease in financial leverage and anticipated improvements in fixed-charge coverage, and continued strong earnings. The Negative Outlook reflects Fitch’s Negative Outlook on the South African sovereign rating. Fitch originally revised Old Mutual’s Outlook to Negative from Stable on 16 January 2012 on the back of the revision of the Outlook on South Africa’s Long-Term Foreign-Currency IDR of ‘BBB+’ to Negative from Stable.
The repayment of GBP1.5bn of debt since early 2010 led to a decrease in financial leverage from 28% at end-2010 to 21% at H112 on a pro forma basis and based on Fitch’s methodology. Fitch considers Old Mutual’s current financial leverage as low for its rating level.
Old Mutual’s fixed-charge coverage is strong for the insurer’s rating level (8.3x for 2011) and Fitch expects it to improve in 2013 in light of the significant debt reduction during 2012. Fitch also assesses the group’s hard-currency cover to measure its ability to service its non-rand-denominated debt obligations based purely on its non-rand earnings. Fitch views Old Mutual’s hard-currency cover as low at 2.3x in 2011 but, thanks to the planned reduction of debt, expects this ratio to improve to about 2.5x to 3x in 2013, which is considered commensurate with Old Mutual’s rating.
Old Mutual has significantly reshaped its business profile over the last two years. Following the sale of its US life business in 2011 and Nordic business in 2012, the group derives about 80% of its operating earnings from South Africa, compared with only around 60% in 2010. The remainder of the earnings are largely from Europe and US asset management. The group’s reliance on emerging markets has therefore increased, and its operating scale and geographical diversification have reduced. However, these negative impacts are more than offset by the reduction in credit risk and financial leverage, resulting from the disposal of the US life business and the use of some of the proceeds of the Nordic disposal, respectively.
The IFS rating of the group is one notch higher than the South African local currency sovereign rating in recognition of Old Mutual’s geographical diversification, albeit reduced, with a still sizeable proportion of earnings generated in the UK and Europe. The additional notch also reflects the group’s ability to share with policyholders potential investment losses on its investments in the South African financial markets, and the financial flexibility from being listed on the London Stock Exchange.
Old Mutual’s group capitalisation has continuously improved since end-2008, reaching a regulatory solvency ratio of 168% at H112 (2008: 122%). Fitch considers Old Mutual’s capitalisation as commensurate with its rating category. In 2011, 25% of Old Mutual’s total non-unit-linked investment portfolio of GBP29.2bn was held in equities. However, as most of Old Mutual’s non-unit-linked investments back with-profits business, where investment performance is largely shared with policyholders Fitch is not overly concerned about Old Mutual’s relatively high equity allocation.
A downgrade of South Africa’s Long-Term Foreign- or Local-Currency IDR would most likely trigger a downgrade of Old Mutual’s ratings. A downgrade could also result from a lack of progress by Old Mutual toward achieving hard-currency interest cover of at least 3x, or if there were greater-than-expected earnings pressure on its South African operations from volatile investment markets, weak consumer confidence and recessionary fears. Further reduction in the geographical diversification of earnings, or a deterioration in the quality of international earnings, could also lead to a downgrade. Given the Negative Outlook on South Africa’s sovereign and given that Fitch expects Old Mutual’s hard-currency interest cover to remain below 3x in the near term, the agency considers an upgrade unlikely at present.