Financeability tests and their role in price regulation - IPART - NSW ...

D Quantifying the impact of credit rating downgrades on
the cost of debt
D Quantifying the impact of credit rating downgrades
on the cost of debt
As this paper discusses, we currently base our assessment of a regulated business’s
short-term financial viability by projecting its annual credit rating over the
determination period, and considering whether this rating falls below our
benchmark credit rating for ensuring financial viability. The reason we do this is that
any change in the credit rating theoretically increases the probability of default on
loan repayments, which means that any new or refinanced debt will attract a higher
interest rate. This will increase its overall interest costs, which may lead to further
deteriorate in its financial position.
To help quantify the potential impact of a change in the credit rating on the cost of
debt, we have analysed the likely increase in a business’s cost of debt due to a
downgrade in its credit rating (based on the yield differentials for 5 and 10 year
bonds purchased on the US and Australian markets as at 22 June 2010). We included
US data as there is limited data available for the Australian market. We were only
able to quantify the impact of 3-step credit rating downgrade (from AA to A or from
A to BBB) for the Australian market, again due to the limited data available.
Figure D.1 shows the results of this analysis.
Financeability tests and their role in price regulation IPART 49