Bottom Shekel / A Muted Warning Siren

Three months ago, as Credit Suisse stock tumbled, the anxiety level at the IDB group turned acute. Yet credit rating agency Standard & Poor's Maalot settled for a laconic message to the investing community that it was keeping an eye on things and would advise investors on developments. It graded NIS 3.8 billion worth of bonds issued by IDB Holding Corporation, the company at the top of business tycoon Nochi Dankner's corporate pyramid, and by its direct subsidiary IDB Development Corporation, at A-minus, with a negative outlook.

On Wednesday last week, IDB Holding published its financial statement for the third quarter. It had lost NIS 1.8 billion and had developed an equity deficit of NIS 1.1 billion (surplus liabilities over assets ). The figures aroused concern in the market about IDB Holding's ability to meet its liabilities and the price of its bonds fell hard.

credit suisse - AP - December 9 2011

Taking its own sweet time

How did Maalot react to the new "developments" at the company, while its bond yields soared to frightening heights? It didn't, not until the press called and, even then, only a week later.

This Tuesday, Maalot sent out an email with five careful sentences that read like the company is walking on eggshells.

"The financial robustness of a holding company indicates, among other things, its ability to repay and/or refinance existing debts," the credit rating agency wrote.

Okay, that first sentence is clear. Financial robustness = the ability to repay debt. It's just a pity that an announcement that brief would waste a whole sentence on that enlightenment.

"We are examining the real leverage (not booked ) that relates to the estimated value of the held operational companies, versus the debt at the level of the holding company itself. Looking at the consolidated financial report and at the tier-1 capital provides a partial view only, one that may mislead and is of little added value for an operational holdings company like IDB group, as some of its companies are not listed in its balance sheet at their fair value. Therefore, the significance of the booked capital is less relevant, analytically speaking."

Those three sentences explain that it doesn't matter what the financial statements (the books ) say; what matters is what the company's assets are worth (the "fair value" ). In other words, Maalot is telling us that the deficit in the company's shareholders equity, its surplus liabilities over assets, aren't that relevant.

There is economic logic in that argument, though it's a little bizarre to see Maalot so cavalier about accounting practices. The problem is that Maalot doesn't disclose its method for calculating IDB Holding's fair value. Nor does it disclose whether the fair value it calculated means its credit rating for the company is appropriate.

Moreover, the net asset value of IDB Holding Corporation (the value of its stock market-listed assets minus its liabilities ) is negative.

Finally, the fifth sentence. Maalot writes: "An equity deficit can serve as a warning sign, but is not necessarily a material indicator for the financial robustness of an operational holding company."

That is also rather surprising. A deficit in shareholders equity, for the first time in IDB Holding's history, is nothing more than a warning sign in Maalot's eyes. As far as it's concerned, one of the most important parameters in accounting, from the dawn of the profession, has been relegated to a possible warning sign, no more, that may not be important.

A real understatement

That is what's known as understatement. I have to wonder what my bank manager would say if I told him that the hole in our equity was just a warning sign that didn't mean anything.

It is a pity that Maalot learned nothing from the terrible financial crisis of 2008, a crisis that arose - among other things - from the behavior of the credit rating agencies.

Asked to elaborate, Maalot stated that based on S&P's methodology, it distinguishes between the manner in which the credit risks of an "industrial" company are analyzed and how to financially analyze an operational holding company. "If a company has the trappings of a conglomerate, we analyze its financial ratios by means of its consolidated financial statements," Maalot said.

"If the company under examination has more financial flexibility, and if we categorize it as an operational holding company, the analysis will focus on the estimated value of its operational holdings (tradable and privately-held ), against total debt at the level of the holding company," Maalot went on.

"In the case of IDB, leverage is measured by consolidation of total financial debt at the level of the group's five central holding companies, seen against the estimated value of the operational assets held by those five central companies. Accordingly, when analyzing a holding company, the consolidated financial data lose much of their added value when gauging financial status."

Is that clearer now?