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In our previous edition we explained the integration of Environmental, Social and Governance (ESG) factors in the analysis of stocks. How does this work for credits and does ESG information really impact an analyst’s opinion? ‘Not always, but in some cases it definitely has a material impact’, says Taeke Wiersma, Head of Robeco’s Credit Research team.
To grasp the role of sustainability information, we need to understand the process first. Each analyst in the credit team covers one or more sectors, up to a maximum of 40 names. He or she analyzes an issuer’s credit fundamentals within the context of its rating, expressing his view in an F-score, which ranges from -3 to +3. The F-scores are established after extensive discussion in a credit committee.
So what about sustainability? ‘The F-score is based on five building blocks, i.e. the company’s business position, strategy, financial position, corporate structure and its ESG profile’, Wiersma explains. This doesn’t mean that ESG data - or any of the other building blocks - necessarily has a 20% weight in the decision-making process. ‘Its weight depends on how material its impact on a company’s fundamentals is. This is part of the discussion in the credit committee.’
Like any true-blooded fixed income analyst, Wiersma mainly focuses on downside risk. If the ESG component does impact the F-score, it usually lowers it.
How does it work then? ‘Let’s take the example of a big American bank I recently analyzed’, Wiersma suggests. ‘The first four building blocks led to a neutral score. To assess its ESG profile, I first looked at the information provided by RobecoSAM, including the sustainability score, and discussed it with the sustainability investing analysts. I typically screen this information on negative elements, such as weaknesses in corporate governance or environmental policies. They function as a warning signal. I also looked at the ESG sustainability ratings from EIRIS, a global ESG research platform. While RobecoSAM’s sustainability assessment looks from an investor perspective, this external source of information has a more general stakeholder perspective, which can reveal additional reputational risks.’
Wiersma supplements his research by analyzing media sources to make a final conclusion on whether the bank has a satisfactory sustainability performance. ‘In this case it didn’t’, says Wiersma. ‘The bank turns out to be involved in numerous litigations and settlements, having misrepresented the quality of mortgage packages it sold. It is subject to multi-billion settlements, which have a material impact on the bank’s profitability.’ As a result, Wiersma lowered the issuer’s F-score from 0 to -1.
‘Of course this is not a typical example’, Wiersma adds. ‘More banks are involved in litigation but most of them are profitable enough to manage the resulting fines and settlements. Still, this governance example shows that, if material enough, the ESG component can single-handedly affect the F-score’, Wiersma concludes.