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

D Quantifying the impact of credit rating downgrades on
the cost of debt
Figure D.1 Percentage increase in the cost of debt due to a credit rating
downgrade (basis points)a
BBB+ to BBB (US)
BBB to BBB- (US)
AA to A (AU)
A to BBB (AU)
0 20 40 60 80 100 120 140
a We note that due to the global financial crisis, yield differentials between different credit ratings
have increased substantially. Hence, getting the rating wrong is a more significant issue now than
before the global financial crisis.
Data source: Bloomberg’s fair value curves, IPART analysis.
50 IPART Financeability tests and their role in price regulation
10 year
5 year
The analysis indicates that the size of increase in the cost of debt depends on the base
credit rating, the country of issuance and the maturity. For example, a change from a
10-year maturity BBB to a BBB- credit rating for US-issued corporate debt would
result in an increase in the cost of debt of 68 basis points. A change from a 5-year
maturity AA to A credit rating for Australian issued corporate debt would result in
an increase in the cost of debt of 107 basis points.
Given that for the businesses we regulate, the cost of debt generally accounts for 60%
of the WACC and that the WACC can account for 40% to 60% of the overall revenue
requirement of a regulated utility, increases of this magnitude may have a material
impact on the business’s financial viability.