Gary Feltham, who buys and sells bonds in Calgary, has little patience with companies that say bond-rating agencies are being hard on them, as Telus Corp. did last week when Moody's Investors Service Inc. cut its bonds to junk.
"What else would you expect them to say?" Mr. Feltham said, arguing that being downgraded will be healthy for Canada's No. 2 phone company.
"It's painful while it occurs, but in the end it's going to be a good thing."
"In light of this, given the [falling] price of the equity and the debt, the management, or more likely the board, will be forced to take more aggressive action, which is a good thing."
Mr. Feltham manages three funds -- Mawer Canadian Bond Fund, Mawer Canadian Income Fund and Mawer High Yield Bond Fund -- with about $70-million invested mainly in government and corporate bonds, some of them issued by Telus.
He declined to put a figure on his exposure to Telus but took a more relaxed view of the situation than Telus's chief financial officer, Robert McFarlane, who was "extremely disappointed" with the "unwarranted" action of the New York-based agency. He accused Moody's of inconsistency, of not following past practice, of failing to take Telus's strengths and prospects into account.
Rating agencies are businesses, not public institutions; no one appointed them to pass judgment on companies, but their decisions draw big audiences at times like these. Among the issues:
Downgrades can be self-fulfilling prophecies, weakening already weak firms as traders get the message and dump shares and bonds.
Raters are skittish about the pace of change in certain industries, notably telecommunications, as boom-time strategies increasingly come to grief.
They were being accused not long ago of sloth, notably when major U.S. agencies cut Houston's Enron Corp. to junk only four days before it made the biggest bankruptcy filing in U.S. history.
Financial markets are much less forgiving than they were three years ago, when investors were scrambling to catch profits, not running to avoid losses. This mood magnifies raters' power to alter the fates of companies.
The impact of a junk (non-investment-grade) rating was seen immediately in the price of Telus's benchmark 7.5-per-cent bond maturing in 2006.
The bond began July at $88.79 per $100 of face value and was still worth $72.05 before Thursday's downgrade. It was quoted on Friday at about $57.25, a price that implied a yield of more than 25 per cent a year to the buyer, assuming the company can pay its debts.
Jeff Waldman, who manages the Talvest Bond Fund and Talvest Income Fund, with combined assets of about $170-million, says the damage would have been far less in, say, 1999.
"The capital market sentiment at that time was 180 degrees different and you could have had a rating action like Moody's back then and it would have been meaningful, but it would not have been as influential. . . .
"I mean, look back then at what was going on with the startup companies and their easy access to capital, even though they had no revenues, no profits, no sales -- they had a concept -- yet they were drawing billions from investors. Here you have a company that has real revenues, has real cash flow, has real interest coverage and investors are frightened away by this report."
Speaking from his Toronto office, Mr. Waldman speculated that rating agencies, especially those in the United States, feel a need to make snap judgments because they don't want to be sued for negligence.
"Their rating implies a certain level of confidence that the company will be able to fulfill its obligations, and if they keep their rating static during a particularly negative bout of information, the perception by users of the information is 'Oh, well, yes, there's bad news out there, but the agencies think it's not going to have an impact because they haven't changed their ratings,' " he said.
Moody's cut Telus to Ba1 (the top tier of junk) while three other agencies still give it medium-grade ratings two notches higher. The three are Dominion Bond Rating Service Ltd. of Toronto and Standard & Poor's Corp. and Fitch Ratings, both of New York.
Mr. Feltham said raters have not changed their approach but show less charity to companies they rate. "In the ones that are borderline, they may be more likely to go for the lower rating."
In announcing the Telus downgrade, Moody's seemed to have doubts about the company's plans or its ability to execute them, he said. "They're not going to come straight out and say 'We think this is bad management' or 'They're doing a poor job,' but that's how I interpret it."
Donald Carter, a vice-president of Moody's Canadian subsidiary and one of the architects of the downgrade, said it was based partly on general telecom troubles and was not a rush to judgment.
"I wouldn't say we're quick on the draw. We're trying to be responsive to the speed of changes in the industry," he said.
"Now in terms of self-fulfilling prophecy, I wouldn't agree with the statement. However, we don't forbear our rating decisions based upon the possible outcomes of the decision. Our responsibility is to be accurate in our ratings for the marginal bond investor, the person or firm who is about to make a decision to buy or sell bonds."
© The Globe and Mail
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