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Rating volatility and rating drift of infrastructure vs corporates

Infrastructure ratings are much less volatile than corporate credit ratings and significantly outperformed corporates during the recent crises

Winter 2015 / 2016

15 December 2015

According to Moody's data, global infrastructure ratings were only one-third as volatile as corporate ratings for the 31-year period 1983-2014. More significantly during the financial crisis of 2007-08, the global recession of 2008-09 and the ongoing European sovereign debt crises of 2009-present, corporate downgrades were 6x as great as infrastructure downgrades. This shows that infrastructure ratings are much less susceptible to banking crises and economic downturns.

Exhibit 1. Rating Volatility: Infrastructure vs. Corporate Industrial Issuers

Rating volatility: Exhibit 1 compares ratings volatility for global Total Infrastructure Securities with that of global Non-Financial Corporate issuers ("NFCs" or industrials plus utilities). Total Infrastructure Securities includes US municipal infrastructure, corporate infrastructure and rated project finance debt.(1) For much of the study period, Total Infrastructure ratings have been relatively stable compared with industrials.

According to Moody’s, global infrastructure ratings have been only one-third as volatile as global industrial ratings. US municipal infrastructure has been about one-fifth as volatile as industrials and corporate infrastructure has been about two-thirds as volatile. The spike in infrastructure ratings volatility in 2000-03 was largely attributable to the impacts of US utility deregulation, a boom and bust in power prices (especially in western US states) and wide-scale diversification by utilities into riskier unregulated businesses.

Exhibit 2. Rating Drift, Upgrade Rate and Downgrade Rate: Infrastructure vs. Corporate Industrial Issuers


Rating drift: In sharp contrast to industrials, Exhibit 2 shows that infrastructure downgrades increased only marginally during the recent crises. Leading up to and during the financial crisis of 2007-08, the global recession of 2008-09 and the ongoing European sovereign debt crisis of 2009-present, ratings drift for industrials was negative for 2005-10 and again for 2011-14 (8 years), whereas ratings drift for infrastructure was negative for 2008-13 (5 years).(2) More significantly, the magnitude of negative drift in infrastructure was only marginal at -0.085 at its lowest, whereas industrials were 6x greater at -0.54 at its lowest. This shows that infrastructure ratings are much less susceptible to banking crises and economic downturns. Further, corporate drift was negative during the entire period of 1983-1995, whereas infrastructure drift was close to zero.

Moody’s notes that infrastructure has been more stable throughout the study period and notably more stable than industrials in the 2008-09 global recession. This increases receptivity of infrastructure to the capital markets. Moody’s report September 2011: “Infrastructure issuers tend to enjoy open and welcoming capital markets and rarely experience trouble raising the necessary capital to meet their investment needs.”(3)

Sequoia Economic Infrastructure Income Fund (SEQI) and Sequoia Infrastructure Debt Fund (IDF) have little-to-no exposure to volatile sectors such as traditional energy project finance (SEQI < 5%). The economic infrastructure we invest in are assets that are important in the capital formation and final consumption stages of GDP (e.g., transportation), not the earlier and more volatile sectors such as oil exploration or mining. This significantly reduces portfolio volatility and its correlation to energy prices and the business cycle.

(1) Rating volatility – notch-weighted upgrade rate plus notch-weighted downgrade rate. Measures gross number of notches a cohort or credit has changed. Each whole unit on the y-axis of Exhibits 1 and 2 is one notch (e.g., BBB to BBB+). Notch-weighted upgrade (downgrade) rates are the total number of notches upgraded (downgraded) divided by the total number of outstanding ratings at the beginning of the sample period. The rating volatility for Total Infrastructure Securities during 1983-2014 was 0.15. This means that the average rating change was 0.15 notches. Sources: Moody's, "Infrastructure Default and Recovery Rates, 1983-2014," March 2015 and Moody's, "Glossary of Moody's Ratings Performance Metrics," September 2013.
(2) Rating drift – notch-weighted upgrade rate minus notch-weighted downgrade rate. Measures net number of notches a cohort or credit has changed. Negative means more notches down than up. Sources: ibid.
(3) Source: Moody’s, “The Great Credit Shift – Infrastructure Finance Post Crisis,” September 2011.
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