Q&A with Mike Weaver, Fitch Ratings

For most companies in the communications sector, debt payments are now a more pressing reality than fund raising. Because of this, the three major ratings agencies--Moody's, S&P and Fitch--have become more important than any Wall Street analyst. Their decisions directly affect everything from credit lines and the ability to raise new debt to a company's stock price. Mike Weaver, head of telecom, technology and media ratings at Fitch Ratings, spoke with Telephony's Money Matters newsletter on what goes into changing credit ratings, the evolving nature of telecom and future upgrades.

Q: What's the process for changing a company's credit rating?

A: With every company, we model them. We have a set of expectations that need to be met to maintain a stable rating or to be upgraded or downgraded. And we monitor their earnings.

When it was more stable, we still monitored, but there weren't enough events happening day-to-day to warrant much ratings activity. Clearly now with all the SEC investigations and restatements and fraud and the bank markets being fairly tight and the [commercial paper] markets at times tightening up, companies run into unexpected problems. We try and anticipate when their financial flexibility has decreased or increased and weigh that appropriately against their credit profile. The relatively large amount of ratings activity over just the past 12 months would reflect the changing fortunes in the telecom industry and the amount of difficulties they've had to address.

Q: Is it true, as some analysts have suggested, that with the change in the industry's fortunes the ratings agencies are fundamentally rethinking the telecom sector?

A: It's not necessarily a rethinking, but more of a focus on this type of example: Say you're a large local exchange carrier, like an SBC or a Bellsouth or a Verizon, which has a high investment grade rating. Say you have a lot of balance sheet strength and are generating free cash flow and are producing very solid credit protection measures. However what you're experiencing is a slowdown in the core business. You're access line erosion is 3% to 4%, maybe total revenues are flat to down, but you're taking enough proactive measures such as cutting expenses so the erosion is not hitting profitability as bad as it otherwise would. What we are looking at is that you can have strong financials, but if you don't have a strong underlying business, than those financials are suspect over the long-term. If there's any weakness in the engine that keeps those financials growing, then we have to view that as a negative and it would have a negative impact on the credit ratings even though, if you look, the numbers appear unchanged.

I think maybe there's also a change in telecom's structure. As more revenues move to data services, particularly on the business side, those revenues are much more susceptible to economic sensitivity than traditional voice has been in the past. It's become more economically sensitive due to greater data service revenue exposure, competitive threats to what was once a very stable residential calling-class and just an overall increase in competition in the industry due to wireless operators.

Q: With some recent downgrades the affected companies have said that the changes aren't based on any new information. How do you justify downgrades when no new information has come out?

A: Clearly the information that a company gives us is one source in our decision-making process. But many times there can be a variety of critical events we're waiting for. We balance those events against liquidity concerns and scheduled debt maturities. A company may come to us and say, "our plan is to renegotiate our bank facility and sell these assets and we'll stabilize our credit ratio and credit profile." We'll be considering that information, but then maybe there's an SEC investigation. And as negotiations on the bank facility go along, we have to use a lot of our own opinion in this analysis. Do we believe they can negotiate a bank facility? Do we believe the asset values that they say they can achieve are going to be achieved? Do we believe the environment is changing or that their forecasts are realistic? What you have is a lot of triggers in the credit profile and not all those triggers are directly related to the company's control.

A lot of times the companies themselves have very low visibility into how things are going to turn out from a business standpoint or from a capital structure or liquidity negotiation standpoint. We may discount very much what they're telling us and move on our own opinions. That's what causes the company to say, 'They're not moving on any new information that we've given them.' Instead maybe we've moved on a new opinion of our own that something has changed in the profile.

Q: What has to happen for you to start upgrading telecom companies?

A: I think that because visibility is very short right now, there'd have to be some tangible evidence that there was a sustained improvement in financial measures for a company, if that's the trigger for an upgrade. Even if we saw improvement in late '03, what you'd probably see a is stabilization of negative outlooks or watches before you see upgrades and then upgrades following maybe six to twelve months of steady financial improvements.

The other thing that could be a source of upgrades is mergers and acquisitions. It appears the FCC is a little more open to consolidation because they don't want everybody to go into bankruptcy. That's certainly not a benefit to the industry. That could drive upgrades in certain areas, maybe not for the very highest rated credits, but maybe some of the lower rated credits could see an improvement in their ratings if there was a combination of businesses.