tag:blogger.com,1999:blog-63156110248873419242024-02-20T05:27:19.275-08:00Credit Rating AgenciesA blog about Credit Rating Agencies and their function in global finance marketsClare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.comBlogger30125tag:blogger.com,1999:blog-6315611024887341924.post-18602842548449841572016-06-24T10:10:00.001-07:002016-06-24T10:11:53.683-07:00The Reality of Brexit: Farewell to the UK's last AAA rating<div style="color: #454545; font-family: Helvetica; font-size: 12px; line-height: normal;">
Moritz Kraemer, chief ratings officer for S&P Global Ratings (the new name for Standard & Poor’s), <a href="http://www.ft.com/fastft/2016/06/24/sp-uk-likely-to-lose-aaa-credit-rating/" target="_blank">stated today</a> that the UK’s AAA rating was no longer “tenable” under the circumstances and would be downgraded at least one notch “within a short period of time”. While it is unclear what effect this downgrade will have, the only certainty is that it will heap insecurity upon insecurity, adding to the markets’ troubles and further raising the cost of government borrowing.</div>
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Other leading CRAs, notably Moody’s and Fitch, had already downgraded the UK prior to the start of the referendum campaign. Moody’s, which currently assigns the UK a rating of AA1, one notch below a AAA score, had previously warned of further downgrades following a vote to leave the EU. Moody’s has also <a href="https://www.moodys.com/research/Moodys-UK-vote-to-leave-the-EU-is-credit-negative--PR_351156" target="_blank">warned</a> that a UK exit of the EU could also see downgrades of UK businesses, impacting on their ability to borrow and, consequently, reducing their ability to invest. The referendum outcome is “credit negative” and could “increase the risk of political fragmentation within the EU if popular support for the bloc fades among member states”.</div>
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Fitch had also downgraded the UK prior to the Brexit debate, and has assigned a rating one notch below AAA since 2013. However it has also warned of short-term disruption and long term risks for the UK. In less dramatic language, Fitch Ratings <a href="https://www.fitchratings.com/site/pressrelease?id=1007950" target="_blank">described</a> Brexit as “moderately credit negative” for the UK, and expects knock-on downgrades for UK entities to be relatively limited in the short term.</div>
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All three CRAs, while repeating the negative effect of the vote, stress the importance of the deal that Britain can strike with the EU as a principal factor in determining mid to long term ratings, both for the sovereign and entities. </div>
Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-7442728796899879542013-12-24T10:12:00.002-08:002013-12-24T10:12:40.534-08:00EU downgraded by S&P's but UK rating affirmed<span style="font-family: Times, Times New Roman, serif;">On 20th December, Standard & Poor's, one of the 'Big Three' credit rating agencies, downgraded the European Union's long term rating to AA+ from AAA, citing reasons of contentious budget negotiations. This signals a slight heightening of the risks that the EU's borrowing capacity on the international markets will not be supported by its Member States. However, S&P's states that the stable outlook on the rating indicates that there are still highly rated sovereigns within the EU who are prepared to support the supranational organisation. The short term credit rating on the EU is affirmed at A-1+ with a stable outlook. </span><br />
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<span style="font-family: Times, Times New Roman, serif;">The deteriorating credit conditions within the EU have also played a role in the downgrade, with weaker credit positions among several of the Member States. This economic appraisal is accompanied by the more political assessment that cohesion across the Union has weakened, elevating the risk profile. </span><span style="font-family: Times, 'Times New Roman', serif;">The long term rating on the EU was revised to a negative outlook in January 2012, however since that time the average ratings of the net contributors to the EU budget has decreased from AA+ to AA. Also, the downgrade of the Netherlands in November 2013 means that there are now only six Member States with AAA ratings. Moreover, since 2006, </span><a href="https://www.globalcreditportal.com/ratingsdirect/renderArticle.do?articleId=1230620&SctArtId=203525&from=CM&nsl_code=LIME" style="font-family: Times, 'Times New Roman', serif;" target="_blank">S&P's claims</a><span style="font-family: Times, 'Times New Roman', serif;">, the revenues contributed by AAA-rated sovereigns as a proportion of total revenues contributed, has nearly halved to 31.6 percent. </span><br />
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<span style="font-family: Times, Times New Roman, serif;">Currently, 80 percent of EU loans to Member States that are outstanding are to Ireland and Portugal. The CRA believes that the chance of the EU being unable to access credit markets to extend these loans is "remote". However many of the other reasons stated for the increase in risk of long term EU supranational borrowing is notably political. S&P's notes that the willingness of Member States to contribute to meeting the EU's financial commitments on a pro rata basis could be tested in future. Added to this is the proposed referendum in the UK about continued membership of the Union, which the ratings agency describes as an unprecedented step for a sitting Parliament to take, and which could - by implication - have ramifications both for the UK and the EU. </span><br />
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<span style="font-family: Times, Times New Roman, serif;">The EU is currently rated AAA by Moody's with a negative outlook.</span><br />
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<span style="font-family: Times, Times New Roman, serif;">A couple of days later, <a href="https://www.globalcreditportal.com/ratingsdirect/renderArticle.do?articleId=1230648&SctArtId=203926&from=CM&nsl_code=CMT&sp_mid=26159&sp_rid=1097208" target="_blank">S&P's affirmed</a> the UK's AAA/A-1+ (unsolicited) rating, which apparently sits on the back of "exceptional monetary flexibility". However, the negative outlook is retained as the sustainability of the recovery - built on private consumption and property investment - is of questionable sustainability.</span><br />
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<span style="font-family: Times, Times New Roman, serif;"><br /></span>Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-61309980007107163572013-12-17T03:30:00.003-08:002013-12-17T03:44:36.019-08:00Sovereign Risk and Bank Ratings<span style="font-family: Times, Times New Roman, serif;">This post discusses the interplay between ratings assigned (principally by S&P's) to sovereigns and their banks. </span><span style="font-family: Times, 'Times New Roman', serif;">Bank Industry Country Risk Assessments (BICRA) ratings are the starting point for understanding risk in the banking industry. There is a previous blog post on BICRA methodologies </span><a href="http://creditratingagency.blogspot.co.uk/2011/11/s-revised-bank-ratings-criteria-and.html" style="font-family: Times, 'Times New Roman', serif;" target="_blank">here</a><span style="font-family: Times, 'Times New Roman', serif;">. BICRA ratings are relative measures of the industry risk and economic risk of a country's banking system. For BICRA, analysis of economic risk is based on similar indicators to those used by sovereign ratings experts. In sovereign ratings, CRAs look at economic structure, growth prospects and macro policy flexibility to assess the sovereign's ability and willingness to repay its public debts. For banks, the same factors are important in helping to form assessments about loan growth, asset quality and borrowers' ability to repay. The relationship between sovereigns and banks is a relationship that goes both ways - banks play an important role in channeling savings into investment, while operating in a financial system that is regulated by governments. At the same time, the embedded risk from the banking system can be important in gauging the contingent liability of a sovereign. So the relationship is an important one for the resulting ratings of both banks and sovereigns.</span><br />
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<span style="font-family: Times, Times New Roman, serif;">The impact of sovereign risk is most clearly seen in the economic risk assessment part of <a href="http://www.standardandpoors.com/spf/upload/Ratings_EMEA/2011-11-09_CBEvent_CriteriaFIBankIndustryCountryRiskAssessment.pdf" target="_blank">BICRA</a>. Four out of the five analytical areas of sovereign analysis factor in to the 'economic resilience' assessment. The fifth sovereign factor, which is about external performance, features in the 'economic imbalances' score. Sovereign stress can also be factored into the assessment of credit risk in the case where a sovereign rating is falling sharply. At the same time, a sovereign in distress can weigh on the assessment of system wide funding within BICRA if it causes a negative feedback in the wholesale or cross border funding mechanism or the conditions for banking in a particular country. </span><br />
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<span style="font-family: Times, Times New Roman, serif;">Some banks can be directly affected by a change in the sovereign rating. This can be the case where banks receive extraordinary government uplift in their ratings (if the government has provided a solid guarantee to the bank -it is "too big to fail") then a change in the rating of the sovereign may see an immediate change in the rating of the bank. At the same time, for banks whose SACP is at or above the sovereign rating, (there are not many of these but they do occur) there is a direct relation between the sovereign and the bank and once again, ratings can change very quickly on news of a downgrade. There can also be a more indirect impact in cases which involves evaluating how the new conditions in which the banks are operating affect the BICRA. At the same time, if the economic risk score changes, this can impact on a bank's capital position. Similarly, if asset quality worsens, it may also affect the bank's risk position and capital and risk position are some of the bank-specific factors in S&P's analysis. </span>Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com1tag:blogger.com,1999:blog-6315611024887341924.post-24589218377843418082013-12-17T03:23:00.001-08:002013-12-17T03:23:31.259-08:00Bank Ratings and the Role of Government Support<span style="font-family: Times, Times New Roman, serif;">The credit crisis changed the way S&P's factors government support into its bank ratings. Going back to 2008 at the height of the credit crisis, it is fair to say that many people were surprised at the level of support given to banks not just in the US but globally. Until that time, government support of US banks was not explicitly incorporated into the ratings given to those banks. But towards the end of 2008 and following a series of government bank support initiatives, the extraordinary support given to the large, systemically important banks was included in the ratings. </span><br />
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<span style="font-family: Times, Times New Roman, serif;">In November 2011 new bank rating criteria was introduced, making the criteria more transparent, and including for the first time explicit reference to government support. The Stand Alone Credit Profile (SACP) was also revised and tightened and altered to include either group support or government support. Governments were identified as 'high support' or 'supporting' (as in the US) in certain instances and banks were defined as being of high, moderate or low systemic importance. </span><br />
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<span style="font-family: Times, Times New Roman, serif;">The potential for extraordinary government support continues to be factored in to the ratings of high systemic importance banks in the US. This is because despite progress made under the Dodd-Frank Act with regards to liquidations, S&P's believes that a crisis today would still require some form of government support to minimise contagion risk. However, there is the possibility that support could be removed from the ratings of the banks' holding companies and depending on how regulation evolves on resolution, support may be removed from the ratings of high systemic importance banks. Government support is not set to be removed from the ratings assigned to operating companies though.</span>Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-13749152584087408652013-12-16T04:22:00.000-08:002013-12-16T04:22:10.128-08:002013 round up<span style="font-family: Times, Times New Roman, serif;">During 2013 there have been 18 downgrades and only 8 upgrades, which has mirrored the preponderance for more downgrades since 2011-12. </span><span style="font-family: Times, 'Times New Roman', serif;">The balance of outlooks hasn't really changed - about 2/3 are stable, and of the remaining 1/3, most are negative non-stable outlooks. In Europe, there are now - at the end of 2013 - far fewer negative outlooks than there were at the beginning of the year, although some of these are due to downgrades having taken place. There are a few more positive outlooks at the end of 2013 in Europe than had been the case in January. The opposite has occurred in the Asia-Pacific region, where there are more negative outlooks at the end of 2013 than the beginning.</span><br />
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<span style="font-family: Times, Times New Roman, serif;">There have been drives by both S&P's and Moody's to make their sovereign rating methodologies more transparent and generally clearer, as <a href="http://www.bloomberg.com/news/2013-09-13/moody-s-revises-sovereign-rating-method-to-better-assess-risk.html" target="_blank">global bond yields showed</a> that investors actually ignored 56% of Moody's and 50% of S&P's rating and outlook changes last year. This was in particular when the CRAs said the governments were becoming more or less safe. </span><span style="font-family: Times, 'Times New Roman', serif;">The revised methodologies haven't seen vast alterations in sovereign ratings, and are readily accessible. The CRAs state that they want their methodologies to be so transparent that investors can use them to estimate their own version of a sovereign rating that should be no more than three tranches away from the rating assigned by the CRA.</span><br />
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<span style="font-family: Times, Times New Roman, serif;">This poses questions, not least surrounding the changing role of CRAs in the sovereign bond markets. By making their methodologies so transparent that any investor can use them to assign their own rating, have S&P's and Moody's become simple providers of a list of pointers investors should consider when summing up the risks of investment? Moreover, when using the CRA methodology, the CRAs claim that investors should be able to estimate "within a three notch alpha numeric range" the likely rating assigned to a sovereign. But this indicates three notes above or below, which covers quite a wide variation in rating. The difference between three notches - according to the alpha numeric ranges set out by any of the Big Three agencies - encompasses a substantial variation in the level of risk. Added to this, once an investor has taken the time to use the methodology for herself to estimate the sovereign risk rating, she then finds a potential three notch divergence between her result and that assigned by the CRA. And there appears to be little she can do to square this circle. In short, the transparency ends here. </span>Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-73893328217812222192013-09-30T04:14:00.000-07:002013-12-09T10:27:05.471-08:00The state of Europe after the Eurozone crisis - a round up of developments<span style="font-family: Times, Times New Roman, serif;"><br /></span>
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<span style="font-family: Times, Times New Roman, serif;">The longest recession in 40 years in Europe appears to have stabilised, but the search for recovery continues. Greece is taking delivery of a third bailout from the Eurozone, albeit tiny in comparison to previous loans. However, exports, consumer spending and corporate investment are still low, hinting that a recovery is still some way off. </span></div>
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<span style="font-family: Times, Times New Roman, serif;">In the banking sector, Basel III minimum leverage ratios are being welcomed, having been recognised as a buffer against future crises. In the US, for example, minimum leverage requirements well in excess of 3% have been proposed, hinting that the Basel requirements are still seen as inadequate. It does also hint that the implementation of a globally comparable leverage ratio - as set out in Basel III - is unlikely to be met with uniform regulations around the world. </span></div>
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<span style="font-family: Times, Times New Roman, serif;">In the EU, an <a href="http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ecofin/137627.pdf]" target="_blank">agreement reached between the Member States</a> on June 27th 2013 on a proposed directive states that in future financial crises, bank and financial institution bail-ins will be the default position, preserving depositors' money and sparing the taxpayer. Bail-outs are not ruled out, however, as the agreement gives national governments substantial flexibility to determine how best to resolve a situation. As such, governments can still determine that a taxpayer-funded bail-out is the best solution, and considering that the agreement on bail-ins is not likely to come in to force until 2018, there is still plenty of time for taxpayers to be left firmly on the hook. Moreover, <a href="http://www.standardandpoors.com/spf/upload/Ratings_EMEA/2013-07-02_UnderTheNewEUResolutionAccord.pdf]" target="_blank">S&P considers</a> that EU member governments with sufficient financial capacity will continue to support major creditors of systemically important banks, at least until balance sheets recover, and banks are made more resolvable through structural reforms. </span></div>
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<span style="font-family: Times, Times New Roman, serif;">While mortgage agreements and real estate sales are increasing again in the US, the same is beginning to take place in the UK. US new home sales were up 7.9% in August, and were up 13% on the year. (Source: Census Bureau, from S&P Ratings Direct). Lower interest rates in the UK have been partly responsible for the increase in lending, along with the <a href="http://www.bankofengland.co.uk/markets/Pages/FLS/default.aspx" target="_blank">Bank of England "Funding for Lending" scheme</a> which aims to target lending to the real economy, in particular SMEs. Moreover, the govenrment-backed mortgage scheme, has also aimed to boost lending to those who could otherwise not afford to get on the housing ladder, although this has been met with accusations that it will only fuel, rather than address, the housing bubble.</span></div>
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<span style="font-family: Times, Times New Roman, serif;">This all sounds remarkably positive, given the travails of the past few years. However a <a href="http://www.standardandpoors.com/spf/upload/Ratings_EMEA/2013-08-14_LimitedGrowthProspectsCrimpEuropeanCorporates.pdf" target="_blank">recent report</a> by S&P on the state of the Eurozone is less optimistic. The report concludes that slowdowns in emerging markets, and an economic rebalancing in China, may "start to reduce the credit support provided by global diversification in recent years". The mantra that a diversified economy will weather economic storms better may prove little use should China - along with other developing economies - slow down their consumption, leaving demand stagnant throughout the global economy.</span></div>
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<span style="font-family: Times, Times New Roman, serif;">China's growth has slowed noticeably and perhaps more significantly, expectations for China's growth have also fallen. The consensus is that forecasts have fallen by one percentage point over the last year to 7.5%, however this continues to decline. This compares to a GDP of over 9% in 2010-2011, and although the Chinese leadership seems comfortable with current figures, their focus will be on balancing internal demand and consumption with international trade. </span></div>
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<span style="font-family: Times, Times New Roman, serif;">A Eurozone slump, along with negative US fiscal policy developments, slower growth in China or a disorderly reduction in quantitative easing are currently the top risks for global credit conditions. This has had implications for European sovereign creditworthiness, along with corporate credit ratings above the sovereign. Corporate trends in Europe are still mainly negative. Fifty-six percent of S&P rating actions in the second quarter of 2013 were ratings downgrades, while over two-thirds of industry sectors carry "stable-to-negative" or "negative" outlooks. Moreover, <a href="http://www.standardandpoors.com/spf/upload/Ratings_EMEA/2013-08-14_LimitedGrowthProspectsCrimpEuropeanCorporates.pdf" target="_blank">S&P expects</a> the Eurozone to remain in recession for the rest of 2013 and has downgraded its real GDP forecast from minus 0.5% to minus 0.8% for this quarter. The ratings agency expects a weak recovery in 2014 with a GDP of 0.8%, but expects that potential growth will remain impaired long in to the future. Furthermore, <a href="http://www.standardandpoors.com/spf/upload/Ratings_EMEA/2013-08-14_LimitedGrowthProspectsCrimpEuropeanCorporates.pdf" target="_blank">according to S&P</a>, there is still a one in three possibility that the Eurozone could experience a sharper and deeper recession in the remainder of 2013 that could last into 2014, seeing the recovery pushed back even further into the future. Owing to the structural nature and depth of the Eurozone crisis, the agency estimates that it is unlikely for a recovery to occur earlier, or for GDP figures to improve substantially in the short to mid term. </span></div>
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<span style="font-family: Times, Times New Roman, serif;">A <a href="https://www.moodys.com/research/Moodys-EFSF-creditworthiness-supported-by-euro-area-member-states-irrevocable--PR_283367?lang=en&cy=emea" target="_blank">recent report by Moody's</a> affirms the provisional AA1 rating of the European Financial Stability Fund (EFSF) based on the contractual elements, including the "irrevocable and unconditional" guarantees by the Eurozone member states, as well as their creditworthiness and commitments to the EFSF. The strong political commitment of Eurozone member states to the Fund is also important, as Moody's assesses that any default would entail "significant pecuniary and political costs" for Europe. However, the rating is subject to a negative outlook, reflecting the negative outlooks on euro area sovereigns that are guarantors to the Fund. The three largest shareholders in the fund, Germany, the Netherlands and France, all have negative outlooks, with Finland being the only eurozone country with a stable outlook currently. </span></div>
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Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-68844842820498763852013-04-11T04:03:00.001-07:002013-12-09T10:27:18.276-08:00Diverging Opinions: S&P refuses to follow Moody's, instead reaffirming the UK's AAA<span style="font-family: Times, Times New Roman, serif;"><br /></span>
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<span style="font-family: Times, Times New Roman, serif;">A few weeks ago, Moody's downgraded the UK one notch to AA1, depriving it for the first time of its top AAA rating. It was roughly a month before the Chancellor was due to deliver his budget, and we wondered what Moody's knew that we didn't. Well, maybe not a great deal. In a counter move, Standard & Poor's yesterday announced that it would be maintaining the UK's AAA rating, albeit with a negative outlook and a one in three likelihood of downgrade over the next 18 months. The agency expects the UK economy to grow by 1.6% per year for the next three years - below estimates provided by the Office for Budgetary Responsibility. It also states that any easing of the austerity program may precipitate a downgrade. Fitch Inc has altered the UK's status from "negative outlook" to "negative watch", indicating that a downgrade may yet be imminent, but allowing the UK to cling on to the top rating for a little longer.<b></b></span></div>
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<span style="font-family: Times, Times New Roman, serif;">So why did the largest two ratings agencies come to different conclusions about the UK economy?</span></div>
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<span style="font-family: Times, Times New Roman, serif;">I discussed the downgrade by Moody's in a <a href="http://creditratingagency.blogspot.co.uk/2013/02/its-finally-happened-moodys-downgrades.html" target="_blank">previous post</a>, and will focus on S&P's decision here. </span></div>
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<span style="font-family: Times, Times New Roman, serif;">S&P's reaffirmed the UK rating because “the Government remains committed to implementing its fiscal programme, and has the ability and willingness to respond rapidly to economic challenges”. This is despite the fact that the national debt as a percentage of GDP in 2016 is expected to rise from 85% to 95% while the deficit falls to only 4.2%. While this clearly remains within the 'acceptable' limits of fiscal consolidation according to S&P's, the agency warned that should the pace slow any further, a downgrade will follow. The top rating was apparently spared on the back of the UK's wealthy and diverse economy, the flexibility of fiscal and monetary policy, as well as flexible and adequate product and labour markets. These were taken into account by Moody's as well though, indicating perhaps that S&P's has placed slightly more weight on the willingness and political commitment of the government to stick to its austerity plans, come rain or shine.</span></div>
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<span style="font-family: Times, Times New Roman, serif;">Standard & Poor's also made mention of the EU referendum promised to UK voters by David Cameron. The agency's assumptions are based on the premise that corporate sentiments are unaffected by the uncertainty created by the referendum. In other words the CRA acknowledges that the referendum creates uncertainty - that businesses are cautious in uncertain climates - but goes on to conclude that this is not the case here. Why? Much of the literature on investment emphasises the role of certainty and predictability in creating a suitable investment climate to attract businesses and long-term investment. Uncertainty surrounding the future of the UK within the EU, and a potential end or alteration to the free movement of goods, people, services and capital across British borders within the European Union could seriously harm the UK.plc's outlook. Not that there is much Mr. Cameron can do about this now, having made the promise to the electorate. S&P's does state that should it's assumptions about business here prove wide of the mark - and investment does suffer as a result of uncertainties - a downgrade could follow.</span></div>
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<span style="font-family: Times, Times New Roman, serif;">Oddly enough, having chronicled this, the next question is 'does it matter'? Well, in short, not really. Even the downgrade by Moody's had been factored in by the markets prior to its announcement, and the expectation that S&P's and Fitch will follow suit is widely assumed. Will it cause markets to reappraise their levels of risk associated with UK bonds, now the AAA has been confirmed? Unlikely. Besides, the AAA rating is becoming an increasingly rare specimen these days. The stigma of suffering a downgrade has been severely diluted by the sheer quantity of downgrades that have taken place over the past few years. </span></div>
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<span style="font-family: Times, Times New Roman, serif;">But this state of affairs does lead to another - perhaps more important - question. If the markets are regularly factoring in risk assessments to their operations weeks (usually) before any announcement on downgrades by the CRAs, and if the impact of a downgrade has been reduced to the extent that sovereigns are no longer worried by an announcement, are we witnessing the slow demise of the role of CRAs in international markets? </span></div>
Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-51293785230088337472013-02-22T15:30:00.000-08:002013-12-09T10:27:33.982-08:00Links to this blog...<br />
<span style="font-family: Times, Times New Roman, serif;">This blog was recently mentioned by Richard Levick in his <a href="http://www.forbes.com/sites/richardlevick/2013/02/11/sps-ordeal-is-there-life-after-eric-holder/" target="_blank">post for Forbes</a> on the fallout from the announcement that the US Department of Justice is bringing civil charges against Standard & Poor's.</span><br />
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<span style="font-family: Times, Times New Roman, serif;">I also wrote a <a href="http://blog.nutmeg.com/2012/03/06/can-credit-rating-agencies-remain-relevant-2/" target="_blank">guest editorial </a>some time ago for Nutmeg about if and how credit rating agencies can remain relevant in the future.</span></div>
Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-31710137131058785702013-02-22T15:20:00.000-08:002013-12-09T10:27:50.736-08:00It's Finally Happened - Moody's Downgrades the UK<br />
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<span style="font-family: Times, Times New Roman, serif;">Moody's finally <a href="http://www.moodys.com/research/Moodys-downgrades-UKs-government-bond-rating-to-Aa1-from-Aaa--PR_266844" target="_blank">confirmed</a> market rumours this evening and downgraded the UK's government bond rating from AAA to AA1. It cited several factors, including the sluggish growth outlook for medium-long term, anticipating that weak growth will last into the second half of the decade, posing challenges for the government's fiscal consolidation programme. The consequences of this include the government's "high and rising debt burden" which reduces the capacity for shock absorption on the government's balance sheets. Importantly, because of the extended time frame of the fiscal consolidation plans, taking them into the next parliament, the level of risk involved has increased. Now, instead of peaking in 2014, Moody's expects the UK's gross general debt to GDP to peak in 2016 at 96 per cent, which is up from just over 90 per cent now.</span></div>
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<span style="font-family: Times, Times New Roman, serif;">Despite these problems, Moody's stresses that the UK still retains high creditworthiness, due to its competitive, well-diversified economy, previous and future fiscal consolidation and robust institutional structure. It's favourable debt structures, bond maturity lengths, and the resulting reduced interest rate risk on UK debt are all additional factors in the UK's favour. Moody's seems to believe that the government's fiscal consolidation plan will, in time, be fulfilled, given the UK's underlying economic strengths. The ratings agency does mention that the UK's exposure to the Eurozone is an issue that may become more urgent depending on how the crisis in that area progresses, however the contagion is stated to be mitigated by the UK's independent monetary policy and the status of sterling as a global reserve currency.</span></div>
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<span style="font-family: Times, Times New Roman, serif;">Moody's had changed the outlook from stable to negative in February 2012, however today's downgrade shifts the outlook back to stable. Speaking this evening in response to the downgrade, UK Chancellor of the Exchequer George Osborne took the news as a "stark reminder" of the troubles being faced by Britain, and vowed to "redouble" his efforts to reduce the deficit and maintain historically low interest rates for families. Interestingly, the downgrade comes less than a month ahead of the Chancellor's budget on March 20th in which he will outline fiscal policy for the coming months. </span></div>
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<span style="font-family: Times, Times New Roman, serif;">But will the downgrade actually make any real difference? </span></div>
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<span style="font-family: Times, Times New Roman, serif;"><br /></span></div>
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<span style="font-family: Times, Times New Roman, serif;">The short answer to this is, well, economically no, but politically, maybe. For a start, bond markets are usually a couple of months ahead of ratings agencies when it comes to anticipating difficulties and slow growth prospects, and sterling has fallen significantly against the dollar over the past few months. This has the advantage of making exports cheaper, helping the UK economy, but it tends to signal that all is not well for economic outlooks (regardless of rumours of currency wars). More to the point, rumours have been circulating for some weeks - some even publicly - that the UK is on the verge of a downgrade. The announcement tonight by Moody's should not have surprised anyone. Will bond yields increase dramatically when the markets open on Monday morning? Unlikely. And considering the role call of countries who have been downgraded over the past few years, the UK is simply the latest to join the list.</span></div>
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<span style="font-family: Times, Times New Roman, serif;">But the political issue is slightly trickier. Like other political leaders across the western world, Osborne staked a good deal of political capital on maintaining the AAA rating. I <a href="http://creditratingagency.blogspot.co.uk/2012/02/taking-stand-nation-states-reclaiming.html" target="_blank">recently posted</a> about the French reaction to their downgrade from AAA. But it's loss in the UK may prove to be a double-edged sword. While it may force reappraisal of fiscal policy, it might also give the Chancellor some room to breathe and reassess his options.</span></div>
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<span style="font-family: Times, Times New Roman, serif;">Undoubtedly it marks a recognition by a CRA that the deficit reduction plan is not working as successfully as planned, and that plans for growth haven't produced the desired results. Fiscal policy to get Britain moving after the recession focused around shifting from domestic consumption to an export-oriented base. But as nearly 40 per cent of UK exports are destined for Europe, the ongoing recessions there are less than encouraging. You simply cannot build growth by exporting to contracting economies. The good news is that the markets still appear to have faith in the political and economic ambitions of the UK government. Bond yields remain persistently low, despite some warning of a collapse in the bond markets as seen by Greece. The economic reputation of the UK remains intact, but questions are likely to be asked over the coming days about the political will to stick to austerity, especially given the backlash against pure austerity in other parts of the world, notably Japan and France. It will be interesting to see, therefore, if the Chancellor's "plan A" will be "tweaked" slightly to take account of the latest developments, and shift slightly away from austerity towards growth.</span></div>
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Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-53440007435217524602013-02-04T17:51:00.000-08:002013-12-09T10:28:06.388-08:00S&P confirms Justice Department is to bring civil action<!--[if gte mso 9]><xml>
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<span style="font-family: Times, Times New Roman, serif;">The credit rating agency Standard & Poor’s has just
confirmed that the US Justice Department will bring a civil action
against it claiming that model used to rate mortgage-backed securities was
inadequate. The Justice Department claims that inflated ratings of securities
directly contributed to the housing bubble and in turn the financial crash.</span></div>
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<span style="font-family: Times, Times New Roman, serif;"><span style="text-indent: 0cm;">Commentators have been pondering the question of why S&P is the only agency to face a law suit, and why now. Many have been swift to point to the fact that S&P has been the only CRA to date to <a href="http://www.bbc.co.uk/news/world-us-canada-14428930" target="_blank">downgrade the US</a>, lowering the rating to AA+ with a negative outlook in August 2011. Whether this theory holds any water, I suspect we will never know, however if this is successful it is almost certain that other suits will follow (if parties don't settle first). </span>On news of the action, shares in S&P’s parent company,
McGraw Hill, fell 13.8%, the largest one day fall since the stock market crash
of 1987. Shares in Moody’s were also down 10.7%, as investors anticipate a
ripple effect throughout the ratings industry if the action is brought. </span></div>
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<div class="MsoNoteLevel1CxSpMiddle" style="margin-left: 0cm; mso-add-space: auto; text-indent: 0cm;">
<span style="font-family: Times, Times New Roman, serif;">The case could signal a change of approach to the rating
agencies, which have so far remained untouchable, shielding themselves (in the
US at least) by the First Amendment to the Constitution under which ratings are
deemed to be “opinions”, protected as free speech. However, the civil action
threatened by the Justice Department has a lower burden of proof than previous
criminal prosecutions.</span></div>
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<span style="font-family: Times, Times New Roman, serif;"><br /></span></div>
<div class="MsoNoteLevel1CxSpMiddle" style="margin-left: 0cm; mso-add-space: auto; text-indent: 0cm;">
<span style="font-family: Times, Times New Roman, serif;">Negotiations between the US Justice Department and the CRA
broke down when the Department demanded a settlement of $1 billion from the
agency. S&P state the action is “without legal merit and unjustified”, and
in a <a href="http://img.en25.com/Web/StandardPoorsRatings/S%26P_Release.pdf" target="_blank">statement</a> lists the steps taken by the agency to enhance systems, governance, analytics
and methodologies since 2007. The <a href="http://ratings.standardandpoors.com/changes/186199872.html" target="_blank">page of the agency’s website</a> explaining
changes brought in by the company also highlights a handy link to a
plain-English explanation of what ratings are, and what they are not, in case there was any doubt still. <span style="text-indent: 0cm;">The statement by the agency stresses that ratings were
provided in good faith by S&P in the "unprecedented" housing market of 2007. It points out that collateralized debt obligations (CDOs) and residential
mortgage-backed securities (RMBSs) that were awarded AAA ratings also received similar
ratings from rival firms.</span></span></div>
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<span style="font-family: Times, Times New Roman, serif;">It states that the Department of Justice’s plan to use the
Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) of 1989
would be unprecedented, and would have no legal merit.</span></div>
<div class="MsoNoteLevel1CxSpMiddle" style="margin-left: 0cm; mso-add-space: auto; text-indent: 0cm;">
<!--[if !supportLists]--><!--[endif]--><span style="font-family: Times, Times New Roman, serif;">Consequently, despite the fact
that the agency “deeply regrets” that it failed to anticipate the extent of the
downturn in the market, it claims that this was not foreseeable, and that when
doubts were raised, the agency took immediate action to reassess the relevant ratings.
</span></div>
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<span style="font-family: Times, Times New Roman, serif;">The proposed action has reignited debate over the best ways to
effectively regulate CRAs. Due to their position as gatekeepers to the markets,
both for private issuers and sovereign states, agencies hold a great deal of
power within the markets. Owing to the current way in which ratings are
requested, paid for and issued, numerous conflicts of interest have been
highlighted, many of which have been discussed in earlier posts. The possibility cited above of a previous downgrade being the reason for the current action stresses even further the inter-dependency of nation states and CRAs when dealing with access to international markets and international regulation. The fact that this action could represent any kind of "pay back" on the part of the US Department of Justice and Securities and Exchange Commission (SEC) is a frightening prospect. Issues that are this important for the security and stability of the economy must remain above the "tit for tat" of politics and retribution. </span></div>
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<div class="MsoNoteLevel1CxSpLast" style="margin-left: 0cm; mso-add-space: auto; text-indent: 0cm;">
<span style="font-family: Times, Times New Roman, serif;">Since the financial crash, CRAs have responded by separating braches of their operations and
repeating that ratings are assigned in good faith. Regardless of regulation, however, the issue remains that the job of assessing risk and assigning a rating to a debt has to be performed. It provides a quick source of information that remains vital to the markets, despite claims by the agencies that investors should rely on their own research rather than simply a rating. As CRAs
have come to occupy such positions of power within the markets, it seems likely
they will continue to fulfil this role. Questions of effective regulation that deal with conflicts of interest, therefore,
will continue to occupy policy makers, market leaders and academics for some
time to come.</span></div>
<!--EndFragment-->Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-12217701406827694792013-01-14T01:02:00.000-08:002013-01-14T01:02:36.048-08:00The Politics of Ratings, and the Politics of Avoiding Ratings<br />
<span style="font-family: inherit; font-size: 14px; font-weight: normal;">A while back I wrote a </span><a href="http://creditratingagency.blogspot.co.uk/2012/02/taking-stand-nation-states-reclaiming.html" style="font-family: inherit; font-size: 14px; font-weight: normal;" target="_blank">post</a><span style="font-family: inherit; font-size: 14px; font-weight: normal;"> about the muddling of finance and politics. The Eurozone crisis had seen France stripped of its AAA rating, and the move hadn't been taken well in France or the rest of the Eurozone. In particular, there was a significant, and very public, "answer back" from the French government and central bank, claiming that the UK should be downgraded first.</span><span style="font-family: inherit; font-size: 14px; font-weight: normal;"> </span><br />
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<span style="font-family: inherit;">These downgrades, along with those of Italy and Greece, had been notable for the significant political rhetoric behind the ratings. As was plainly cited at the time, the lack of political leadership and consensus was one of the main factors behind the downgrades, making the CRAs political commentators as well as risk assessors. This has never been denied by the CRAs. In their sovereign rating methodologies, each of the Big Three provide for political risk factors to be included in the assessment, along with "other factors" that the analyst might deem relevant. (Standard & Poor's sovereign rating methodology can be found <a href="http://www.standardandpoors.com/spf/ratings/How_We_Rate_Sovereigns_3_13_12.pdf" target="_blank">here</a>, and Moody's methodology is <a href="http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_109490" target="_blank">here</a>. Interestingly, Moody's is currently <a href="http://www.moodys.com/research/Moodys-seeks-market-feedback-on-proposed-refinements-to-sovereign-rating--PR_262487" target="_blank">seeking feedback</a> to proposed "refinements" of its sovereign rating methodology. More on this in a later post).</span></div>
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<span style="font-family: inherit;">The problem now, though, is that the US is facing the same. The fiscal cliff negotiations that played out in the final minutes of 2012 displayed to the world how divided the US legislature really is when it comes to solving the fiscal problems facing the US. Maybe "problems" is an understatement? </span></div>
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<span style="font-family: inherit;">In August 2011, Standard & Poor's downgraded the US one notch from AAA to AA+. This was the first downgrade in US history and stunned Washington. S&P cited - unsurprisingly - the large debt burden, but also the political stalemate that made tough decisions to tackle the deficit nigh on impossible. It seems that Moody's and Fitch, however, are looking very closely at their top ratings in the US. Fitch, speaking during the negotiations, reminded us that failure to raise the debt ceiling would exacerbate uncertainty over US fiscal policy and send the US into an unnecessary recession. It stated that this could erode medium-term growth potential and financial stability, leading to an increased likelihood that the US would lose its AAA status. </span><span style="font-family: inherit;">Moody's, taking a similar line, has also expressed concern about the lack of political consensus to come up with a credible long term debt reduction plan. It stated that the current AAA rating will only be confirmed if current negotiations lead to a long term strategy that reduces debt to GDP ratio.</span><span style="font-family: inherit;"> </span></div>
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<span style="font-family: inherit;">The political aspect of downgrades of Berlusconi's Italy centred on the lack of credibility of the leader. But in the US, the political agenda is not the issue, so much as the lack of ability to reach a suitable agreement. Politics may not be the issue, but it got in the way of finding a solution to the real, underlying problem. The fiscal cliff may have been avoided, but the issues surrounding debt levels remain. It is estimated that without action, the US debt will reach $25 trillion by 2022. Moody's statement that only a reduction in the deficit will lower the likelihood of a downgrade seems rather trite considering the figures. For now, the country remains on "negative outlook".</span></div>
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Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-55041539854915066412012-06-25T11:40:00.000-07:002013-12-09T10:28:46.687-08:00Cyprus Downgraded<span class="Apple-style-span" style="font-family: Rockwell; font-size: small; font-weight: normal;"><br /></span>
<span class="Apple-style-span" style="font-family: Times, Times New Roman, serif; font-weight: normal;">Today, Fitch Inc downgraded Cyprus to junk status - as the country officially the EU for a bail out. Cyprus had been relying on Russia for funds, but has been forced to approach Europe for €1.8billion, approximately equivalent to 10% of that country's GDP, and making it the fifth EU member state to request funds. Cyprus, which is the EU's third smallest economy, cited exposure to Greek debts, and the need to recapitalise Cyprus Popular Bank.</span><br />
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<span class="Apple-style-span" style="font-family: Times, 'Times New Roman', serif; font-size: small;">The bailout request comes ahead of Cyprus assuming the Presidency of the EU in the second half of 2012. It follows Spain's request for €100billion, finalised on June 9th. This will be jointly met by the EFSF and the ESM, creating a headache for lenders and future investors as only one of the funds has preferred investor status. However markets have judged neither fund as containing sufficient money to solve Eurozone woes, with blame increasingly falling at Germany's door for failure to take action.</span></div>
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<span class="Apple-style-span" style="font-family: Times, 'Times New Roman', serif; font-size: small;">Moody's recently downgraded Spain's sovereign debt to one notch above junk status, and has kept the rating on review for further possible downgrade, although Moody's assigns the lowest rating to that country. It's banks have so far held on to ratings at least one notch above this, due to profitable overseas businesses.</span></div>
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Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-63151483482334185012012-02-13T15:42:00.000-08:002013-12-09T10:29:17.902-08:00Moody's revises UK and French ratings to "Negative Outlook"<span style="font-family: Times, Times New Roman, serif;">UK sovereign bonds have today been given a "negative outlook" by rating agency Moody's, along with those of France and Austria. All three countries are still rated AAA by Moody's, even though France had <a href="http://creditratingagency.blogspot.com/2012/02/14th-january-au-revoir-aaa.html" target="_blank">lost the triple A rating</a> assigned by Standard & Poor's in January 2012.</span><br />
<span style="font-family: Times, Times New Roman, serif;"><br /></span>
<span style="font-family: Times, Times New Roman, serif;">Spain was downgraded to A3 from A1 with a negative outlook, Italy was downgraded to A3 from A2 with a negative outlook and Portugal was downgraded to Ba3 from Ba2 with a negative outlook, according to Moody's criteria. The agnecy also cut Slovakia’s, Slovenia’s and Malta’s ratings.</span><br />
<span style="font-family: Times, Times New Roman, serif;"><br /></span>
<span style="font-family: Times, Times New Roman, serif;">It should be noted that "negative outlook" is not quite as drastic as "negative watch", implying only a one in three chance of losing the top rating over the next 12 to 18 months.</span>Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-72153380993563170072012-02-05T09:34:00.000-08:002012-02-05T09:34:01.267-08:00Taking a Stand - Nation States Reclaiming Sovereignty, or Political Posturing?Arguments that sovereignty has shifted from the nation state (in its post-Westphalian glory) to "the markets" are not new. The sovereignty of the markets and their ability to shape government policy and borrowing are well documented. What is less frequently noted is the role played by the "gatekeepers", or "<a href="http://finance.eller.arizona.edu/lam/fixi/creditmod/Portnoy.pdf" style="color: black;" target="_blank">gateopeners"</a> to the markets. This is a term popularized by <a href="http://www.law.columbia.edu/fac/John_Coffee%20Jr.">Professor John C. Coffee</a> to describe those actors who regulate entry to - and exit from - the market. Credit rating agencies are prime examples of gatekeepers. While most issues and financial products require at least two ratings, government oversight of the markets in the form of ratings-based regulation further entrenched, and legitimised the role of the CRAs. As such, it is not a great stretch to argue that sovereignty has shifted from the nation state (perhaps via the markets) into the hands of gatekeepers to the markets. This has been the de facto situation for several years, and went largely unnoticed - or at least largely unchallenged.<br />
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It is also easy to argue that the sovereign debt rating is not simply a requirement for market access, but a political statement and quantifier of the strength and direction of government of a particular state. Yet recent comments by the French finance minister, Francois Barron, regarding the 'political' intentions of threatened downgrades question whether politics may be attempting to re-appropriate the discourse which has become the preserve of markets over the past decades. In December 2011, while France was threatened with the loss of its AAA rating, he stated on the French radio station Europe 1 that the French economy was in a better shape than the UK's. He was speaking after the French Prime Minister Francois Fillon and the French Central Bank Chief Christian Noyer both pointed to comparative weakness in the UK economy and outlook. Mr. Noyer went on to say that the U.K. should be downgraded before France.<br />
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In an interview with the French paper Le Telegramme, Mr. Noyer stated "A downgrade doesn't seem justified to me when you look at the economic fundamentals." He went on to say "Or else a downgrade should come first for the UK, which has a greater deficit, as much debt, more inflation, and less growth than us, and collapsing credit." He finished by stating that "Our British friends have a higher deficit and more debt, and I would say that the ratings agencies have not yet noted that." <br />
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These claims have been echoed by a senior lawmaker in Angela Merkel's party. Michael Fuchs, a CDU lawmaker and deputy parliamentary floor leader, is quoted as saying "It isn't fair that Standard & Poor's concerns itself for example with France and Austria, but why don't they do it with England." He went on to state that "It's simply not fair to leave England its AAA rating with a stable [outlook], while other countries get a downgrade, this is not right." <br />
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In other interesting developments, Italian prosecutors have announced that they are investigating Standard & Poor's recent downgrade of Italy, in particular whether crimes of market manipulation and illicit use of privileged information were committed when S&P's reports were released in May, June and July 2011, prompting a sell-off of Italian assets. The probe has been extended to include the January downgrade, however Standard & Poor's rigorously denies the claims.<br />
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As noted in a <a href="http://creditratingagency.blogspot.com/2012/02/14th-january-au-revoir-aaa.html">previous post</a>, the UK is at much less risk of default than the Eurozone states for the simple reason that the Bank of England has signaled its willingness to print more money. However the interesting point here is whether these statements reflect a willingness on the part of governments to engage with credit rating agencies on a political and to reclaim the political debate. In other words, are governments now willing to play the agencies at their own game?<br />
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Sovereign rating methodologies - now publicized on Standard and Poor's and Moody's websites in a transparency drive - has always comprised an element of political assessment. The downgrades of Italy that eventually prompted Berlusconi's political demise were perhaps the most overt in their political reflections, however the assessment is present in any sovereign bond rating. What Eurozone leaders don't seem to realize is the effect their lack of political will is directly impacting on their ratings. Were Chancellor Merkel to seize the proverbial bull by the horns, arguably we would not be seeing the rounds of ratings downgrades that we are. European integration in the 1970s and 1908s stalled, and was referred to as a period of "eurosclerosis". Europe is once again seized with indecision, and is paying the price.Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-44206697714093274122012-02-05T08:56:00.000-08:002012-02-05T08:56:29.071-08:0014th January - 'Au revoir' AAAOn the 14th January, France finally - and officially - lost its AAA credit rating. Had Sarkozy not made such a fuss about the importance of retaining it last year, it might not have been such a big deal. As it is, reports speak of Eurozone doom and little else. In total, nine countries in the Eurozone were downgraded; Italy, Spain, Cyprus and Portugal were cut two notches, with the latter two given "junk" ratings. Austria, Slovakia, Slovenia and Malta were the other countries downgraded. Germany kept its AAA rating.<br />
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But what do the downgrades mean? The sovereign debt rating is an instrument designed to gauge the likelihood of a state being able to repay its debts. There are several considerations that come into play here, discussed in another post. But here's where France and the UK differ - if the UK runs into problems repaying debts, the Bank of England can print more money and off we all go. The government has shown that it is not afraid to turn to quantitative easing, and this is an important reason why the UK - even with current debt levels - is much less likely to default that France, regardless of the devaluation that occurs. Germany has repeatedly blocked moves to allow the European Central Bank to print Euros, so France only has a finite supply. Considering Germany's experience with hyper-inflation in the 1920s, this is understandable, but leaves the Eurozone in a difficult situation. <br />
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Moreover, considering France was one of the main backers of the EFSF, the loss of a French AAA rating clearly had implications for the future of the fund. Two days later Standard & Poor's downgraded the EFSF from AAA to AA+. The loss of AAA ratings effectively reduced the fund's AAA rated guarantees from €440 billion to €260 billion. Approximately €40 billion of this will go to bailing out the Irish Republic and Greece, while €100 billion had been ear-marked for a second Greek bailout. Due mainly to procrastination and posturing on the part of Eurozone leaders, this latter has now risen to an expected €145 billion, however Greece is currently under huge pressure to implement further austerity reforms before this second bailout will be agreed.Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-54664802928051363382011-11-30T09:16:00.000-08:002011-11-30T09:16:39.389-08:00The Lawsuits Keep ComingThe case against Standard and Poor's finally got underway on October 7th in Australia. Thirteen towns were sold AAA-rated Constant Proportion Debt Obligations (CPDO's - also known as "Rembrandts" by the Australian firm Local Government Financial Services in 2006. According to Standard and Poor's, who rated the synthetic derivatives, there was less than a 1% chance of failure. Within two years the products had crashed, resulting in losses of $15 million for the affected councils. Standard and Poor's has been charged on two fronts. Firstly, as the CPDOs were new products, they did not have sufficient information to accurately rate them. Secondly, they are charged with bowing to pressure from the issuing bank, ABN Amro, to issue a favourable rating.<br />
In responses, Standard and Poor's has rehearsed familiar arguments, stating that "rating is an art, not a science", and reminding us of recent US judgments declaring ratings no more than "predictive opinions". See previous posts on the <a href="http://creditratingagency.blogspot.com/2011/09/standard-and-poors-moodys-and-fitch-win.html">Ohio case here</a>.<br />
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These may be revisited, however, as on September 30th a judge sitting in Albuqureque denied rating companies' requests to have claims brought against them dismissed. The case is being brought against all three big ratings agencies (Moody's, Standard and Poor's and Fitch) by Maryland-National Capital Park & Planning Commission Employees’ Retirement and the Midwest Operating Engineers Pension Trust Fund. They are representing investors who lost $5 billion in Thornburg Mortgage Home Loans Inc. mortgage- backed securities which were rated AAA.<br />
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Developments will be posted here.Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-3634505183925593422011-11-14T15:21:00.000-08:002011-11-14T15:34:25.747-08:00S&P Revised Bank Ratings Criteria and BICRA MethodologiesStandard & Poor's has just released revised bank ratings criteria. The new criteria aims to provide greater insight into how banks are rated, and claims that the new approach is more 'intuitive'. It builds on existing methodology but aims to simplify and incorporate what has been learned over the past few years throughout the financial crisis. According to Standard & Poor's, the stresses of the crisis have forced banking to reinvent itself. There has been, and continues to be, a potential shift in the balance of power between banks in the west and those in BRICs nations, and while recovery in the former is not a foregone conclusion, neither is sustained growth in the latter. Moreover, there has also be a shift in business volumes away from the formal banking sector towards the shadow banking sector. This is somewhat due to heavier regulation of banks following the crisis and the more stringent capital and liquidity requirements. Restrictions on higher risk activities have also forced these operations elsewhere, meaning that profit margins on regulated banking activities are likely to be reduced over coming years. Moreover, government support for banks is also less certain, with moves by many governments to support certain activities, sectors, and institutions, or in some cases to make it clear to the markets that no institution is too big to fail. The new criteria are designed to reflect the changes that are taking place, and keep pace with current market practice. <br />
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The new criteria also aim to establish a greater degree of global consistency across the ratings frameworks and - interestingly - in so doing to sustain market confidence in the ratings. <br />
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The revised BICRA (Banking Industry Country Risk Assessment and Assumptions) methodology results from consultations carried out throughout 2010 following a request for comment back in January 2010. According to the feedback from this request, Standard & Poor's report that one of the most often cited complaints was a lack of clarity about the criteria and how it was applied. Consequently, Standard & Poor's appears to be on something akin to a PR drive at the moment to publicize and more importantly explain how the methodology works.<br />
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So what is new?<br />
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The criteria take a revised approach to investment banking, with elements allowing for a greater differentiation of risk. This can now be taken into account with the business profile. Credit risks of banks operating in different business lines are also more clearly differentiated, meaning that risks pertaining to a specific sector can be more accurately expressed.<br />
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Secondly, criticism was levelled in replies to the 2010 request for comments that no account was taken of stronger liquidity of institutions in funding analysis. Under the revised criteria, "funding and liquidity" is a discreet factor. Now, when this is above average (strong liquidity and above-average funding), the standalone credit profile can be raised by one notch.<br />
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Thirdly, criticism was also directed at the practice of using capital standards globally. Under this system, the RAC (risk adjusted capital) ratio of banks operating in higher risk countries would be assessed in the same way as banks operating in lower risk countries. However, the capital standards one would expect to be achieved by a bank operating in a high risk country would, on average, be less. Under the revised criteria, country profiles are taken into account, and therefore for a bank operating in a higher risk country with a standalone credit risk anchor of BB or B-, slightly lower RAC ratios (moderate amounts of capital) falling just short of the usual 5-7% will not automatically see a rating reduced by one notch, as was previously the case. Risk adjusted capital frameworks (bank capital methodology) remain unchanged.<br />
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Finally, the BICRA methodology, while retaining its original structure, has been tightened somewhat. The criteria has been integrated more sovereign analysis in an attempt to make ratings more consistent. The BICRA methodology itself is designed to allow for evaluations and comparisons between global banking systems, with the system being given a BICRA score between 1 and 10, with 1 comprising the lowest risk groups and 10 the highest. A BICRA analysis for a country includes both rated and unrated financial institutions that take deposits and/or extend credit within a particular country. The new methodology takes a macroeconomic approach, looking at the entire financial system of a country and considering the relationship between the banking system and financial system as a whole, including the impact of non-bank market participants. The macroeconomic approach also assesses the influence of government supervision and regulation of the banking sector, including emergency support mechanisms, although note that targeted government intervention for systemically significant institutions is reflected through ratings uplift rather than BICRA.<br />
The methodology remains divided into the two main areas of economic risk and industry risk, which are each further subdivided into three. Standard & Poor's claim that this will not only make the analysis easier for the user to assess, but will make bank ratings more consistent with their sovereign counterparts. Each factor is assessed for an economic and industrial score for each country - the BICRA score. The rating methodology for banks uses the economic and industrial profiles produced by the BICRA analysis to give an anchor which then acts as the starting point for determining the bank's stand alone credit profile (SACP). Following this, factors such as support from a government or parent group are considered before an overall rating is assigned.<br />
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The guidance notes go on to state that the creditworthiness of a sovereign and its banking sector are closely related, and that many of the factors underlying a sovereign rating are relevant in determining a BICRA score. Also, the sovereign rating methodology is applied in assessing sub-factor such as "economic resilience" and "economic imbalances". The methodology also recognizes that the influence of a sovereign's creditworthiness on the related BICRA is more pronounced when the sovereign's creditworthiness deteriorates.<br />
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In a <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1933952">paper</a> written last year I suggested that greater amounts of end-user due diligence could be encouraged to relieve some of the excess reliance on market 'opinions' produced by credit rating agencies. The revision of analyses to enable users of ratings to more readily understand the methodology certainly goes some way towards increasing the transparency of the methods used and analysis undertaken by the agency and should be applauded. However we should be careful. The methodology is certainly more accessible, and Standard & Poor's are clearly aware that greater transparency of process is necessary for market trust and maintaining reputational capital. But we are still none the wiser as to the quality of information that goes in to the algorithms, or indeed what institutional and economic assumptions these latter are based on. <br />
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The new criteria are due to be applied in November/December 2011, and Standard & Poor's claims that the impact of the new methodologies will be less than previously feared, with 90% of new rating anticipated to remain within one notch of their previous rating. The agency claims that around 10% of A1 ratings will fall to A2 as a result of the revisions. <br />
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All criteria documents can be accessed <a href="http://www.standardandpoors.com/AI4FI">online</a>, and each has a straightforward explanation of the function and purpose of the criteria.Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-4685457185129762722011-11-11T13:00:00.000-08:002011-11-11T13:00:46.225-08:00France downgraded due to "technical error"Standard and Poor's mistakenly downgraded France yesterday due to a "technical error". This was at the expense of France, who, along with the rest of Europe, are still incandescent over the episode. It appears that a message was sent out to some subscribers stating that France's sovereign rating had been downgraded. However less than two hours later the agency withdrew the statement and reconfirm the country's AAA/A-1+ rating. The erroneous announcement caused a surge in French 10-year bond yields by up to 28 basis points, up to 3.456 per cent, although these fell again following the retraction.<br />
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Last month, Moody's stated that France was - financially speaking - the weakest economy in Europe to still cling on to its AAA credit rating, and put it on a three-month review period (<a href="http://creditratingagency.blogspot.com/2011/10/and-downgrades-continue.html">see earlier post here</a>). French bank exposure to Greek and Italian debt means that this situation has not changed.<br />
The technical error prompted French Finance Minister Francois Baroin to ask market regulators in France and Europe to investigate the "causes and potential consequences" of Standard and Poor's actions. France's stock market regulator, AMF, subsequently opened an investigation into the incident. France's fiscal policy is premised on its AAA rating, and Nikolas Sarkozy has effectively pinned his re-election hopes on retaining the rating. A second package of austerity measures in three months was announced this week by the French prime minister, Francois Fillon.<br />
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A downgrade for France would almost certainly entail a downgrade of the EFSF, which could pose big problems for the rest of Europe. However, considering that the Fund is unlikely to be able to cover significant bail out for larger European economies a modest increase in interest rates is unlikely to derail its use for smaller loans. However, the unhappy incident does prompt questions about the internal controls and screening mechanisms in place in the big three ratings agencies, not least how it could take nearly two hours for the CRA to realize its error. <br />
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While there is no press release or statement on Standard and Poor's website regarding the mistake, reactions in Europe indicate that the matter is not likely to die down soon. Speaking today, Michael Barnier, European commissioner for the internal market stated how serious the error had been. He emphasized that it was imperative that market players exercise discipline and a special sense of responsibility. Mr. Barnier is due to unveil a new regulatory regime for credit rating agencies on Tuesday.<br />
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In other developments, the Isle of Man was downgraded one notch to AA+ from its AAA credit rating by Standard and Poor's today. The agency cited reasons that the economy was small, undiversified and focused on financial services, all of which left it vulnerable to market shocks. The agency stated that by diversifying the economy of the crown dependency, the Isle of Man could regain its AAA rating.Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-9200160578567465802011-10-26T10:37:00.000-07:002011-10-26T10:37:44.719-07:00The Mystery of the Triple A rating and the Reincarnation of the CDOSpeaking last month, Christine Lagarde stated that if banks could raise sufficient funds on the open markets to meet their liabilities and Basel III requirements within the certified time (between 7 and 9% of capital to risk-weighted assets) then governments should step in and lend to the banks. No-one, it would seem, wants this outcome. The banks retaliated with claims that they were not in need of a second "bail out", and there aren't many taxpayers who would be happy with another round of bank bailouts.<br />
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But it's not just banks. At the end of last year, Ireland needed a bailout. Greece and Portugal swiftly followed, and now Italy and Spain have joined the list of those 'giving cause for concern'. The European Financial Stability Facility was set up following the Irish bailout as a means of dealing with the problem. At the time, no-one expected, and likely intended, for the fund to be used. It was intended merely as a 'back up' plan that would encourage the market to lend to Ireland. But this never happened, and now - unable to fulfil the government guarantees of banks - Ireland cannot raise money on the markets. Estimated interest rates of 7% on Irish government bonds being unsustainable, Ireland had to look elsewhere, and the EFSF was the remaining option.<br />
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The EFSF, it is anticipated, will borrow €750 trillion from the markets and will lend to countries in need.The means of the EFSF are combined with loans of up to € 60 billion coming from the European Financial Stabilisation Mechanism (EFSM), i.e. funds raised by the European Commission and guaranteed by the EU budget, and up to € 250 billion from the International Monetary Fund. In other words, the fund is a special purpose vehicle (SPV) set up to lend money to countries that can't issue bonds on the markets. Investors who won't lend to Ireland and Spain because of their poor economic situations are being asked to lend to the EFSF, which will in turn lend ot Ireland and Spain. The core countries of the Eurozone have agreed to guarantee the fund, though, so each are liable for the defaults of others. Germany, France and Italy are the largest contributors, making Germany, France and Italy liable in large part for the debts of countries who borrow from that fund. So far so good.<br />
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All of the big three ratings agencies were asked to assign the fund a triple A rating - the highest possible, and each agreed. This was justified on the basis that those countries guaranteeing the loans could afford to honour their guarantees. But the fund is essentially supplying loans to people who can't borrow anywhere else because it is unlikely they'll be able to pay the loan back. It's also guaranteed by countries who aren't solvent either (Ireland, Greece, Portugal, Spain and Italy are all guarantors too). Put this way, the triple A rating assigned seems surprisingly optimistic - reminiscent almost of the CDOs that came to symbolise the worst of the sub-prime mortgage crisis.<br />
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Of course, the CRAs have defended their actions, citing Germany's surplus and the structure of guarantees involved. Indeed, Scott Mather, Pimco fund manager, has stated that if the EFSF just loans to Ireland then the fund appears to be a fairly safe bet. The problem comes if and when more countries need to borrow from the fund. By guaranteeing Ireland's loan from the EFSF, Spain, for example, will have to set aside assets to cover the guarantee, leaving less room for manoeuvre should anything go wrong, and making it more likely to need to borrow from the fund itself. The more countries that borrow, the fewer guarantors there are, and the rating assigned will drop. In the worst case scenario, Germany, and to a lesser extent France, will be left lending to the rest of Europe, and most likely writing off a significant part of any loan. This - as we are all well aware - is well after the point at which politics steps in and marks the end of the single currency experiment - and is the worse case scenario.<br />
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It is worth noting a couple of final points. The AAA rating for the fund was necessary because the investment it is seeking to attract is mainly funds. Pension funds and other investors who usually look for low(er) risk vehicles that are investing the life savings of teachers, postal workers, etc. Ireland had its first bail out nearly one year ago. It followed IMF advice and introduced strict austerity measures. The economy has shrunk by 20%, unemployment is in the high teens and debt to GDP ratio has soared to over 100%. IMF advice hasn't solved anyone's problems, yet it is still being offered as the solution, in the form of a second bailout package. Greece is in the same situation. It is estimated that Greek debt will rise form €270 billion to €340 billion in four years time. This is predicated on the assumption that Greece follows IMF advice by introducing strict austerity measures. The problem is that Greece can't afford to service its current debt levels, let alone increased levels. Massive write offs are the only way that Greece is going to be able to default 'gently', although it does bring the wisdom and the function of the EFSF into question even further.<br />
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For more on this see <a href="http://www.npr.org/blogs/money/2011/08/30/140066004/the-tuesday-podcast-to-solve-debt-problem-europe-borrows-more-money">NPR's Planet Money</a> podcast on the issue. An FAQ factsheet on the EFSF is available <a href="http://www.efsf.europa.eu/attachments/faq_en.pdf">here</a>.Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-3930719703267991802011-10-24T12:09:00.000-07:002011-10-24T12:09:38.235-07:00... and the downgrades continueAnd so the banking crises and the sovereign debt crises rumble on, with endless meetings in Brussels that have so far achieved stupendously little given the time already devoted. We are being reassured that progress is taking place, so perhaps just a little longer...<br />
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In the meantime several more European downgrades have been occupying the rating agencies. On the 18th October Moody's cut Spain's sovereign credit rating, making it the last of the big three rating agencies to take such action, lowering the rating from Aa2 to A1. A couple of weeks before, Fitch had cut Spain's sovereign rating to A minus from double A, followed closely by a similar move by Standard and Poor's. Considering Spain's sovereign rating was triple A status until September last year, recent downgrades mark the latest turn in a significant drop. Moody's cited reasons of political uncertainty (further elections could see the conservative People's Party make huge gains in elections on November 20th), unrealistic deficit reduction plans (from 9.2 per cent of GDP last year to 4.4 per cent in 2012) with equally unrealistic growth figures (forecasts of 1.8 per cent growth have been estimated by Moody's to be closer to 1 per cent). Further reasons cited include the government debts of Spain's 17 autonomous regions, and the willingness of these to curb their spending.<br />
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Moody's have also downgraded both Belgium and Italy, the latter following a similar move by Standard and Poor's last month. Standard and Poor's have also downgraded three large Italian banks although it confirmed the ratings of 18 large banks - including the largest by assets. 21 regional banks were also downgraded. However concerns have been raised by the head of Italy's banking association and chairman of Monte dei Paschi, Giuseppe Mussari, that EU bank recapitalisation plans being discussed in Brussels could do more harm than good in Italy by forcing banks to hold 'unnecessary' amounts of capital and exacerbating the sovereign debt crisis. Italy's 10-year bond yield rose 7 basis points to 5.867 per cent on Tuesday, the highest close since before the European Central Bank began buying Italian bonds on August 8 to try keep down borrowing costs.<br />
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As negotiations to bail out Greece and the Euro with it continue in Brussels, Moody's has announced that it may change the outlook on France's triple A rating from stable to negative in the next three months. As is customary in such situations, a downgrade is neither forthcoming or imminent, but the mere prospect of such sends shivers through the markets and French banks' shares fell following the announcement. Moody's praised France's 'very high economic strength', its 'ample capacity to absorb shocks' and its 'favourable public debt maturity', along with political efforts aimed at fiscal consolidation. However, the global financial and economic crisis had, according to the rating agency, led to a deterioration in French 'government debt metrics'.<br />
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The agency stated that France's finances were now among the weakest of those countries which still had a triple A rating. France's public finances are not only looking vulnerable but French banks are heavily indebted to Greece. Standard and Poor's last week downgraded BNP Paribas by one notch from double A to double A minus citing exposure to Greek debt. What's more, major consequences could follow for France if Greece defaults on its liabilities and markets react poorly, or if there are any further defaults. Add in the fact that France has been gradually becoming less competitive for businesses over the past years - in contrast to neighbouring Germany - and it becomes easy to understand why Sarkozy might be worried. Moody's isn't alone, however, as Standard and Poor's included France in the role call of countries likely to see further downgrades in the case of a double dip recession - alongside Spain, Italy, Ireland and Portugal. France's public debt is approaching 90 per cent of GDP and so a downgrade could prove extremely painful, even though this figure is set to fall as France's budgetary deficit is brought down from 5.7% currently to 3% in 2013. These figures are - as most Eurozone projections - based on optimistic growth forecasts. France anticipates 1.75% over the next year. Most commentators doubt this will materialize, either making deficit reduction a longer-term goal, or necessitating further austerity measures in the run up to the election next year. <br />
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France is already committed to €158.5bn ($217bn) in guarantees for the new eurozone rescue fund, the European financial stability facility, which is equivalent to 8.5 per cent of GDP. It has also just agreed to guarantees for the failing Franco-Belgian bank Dexia. Now these don't matter much unless and until one of these fails, at which point the government is bound to step in. But it does mean that France has much less room for manoeuvre on its balance sheets than it did three years ago, leaving it vulnerable to further financial shocks. It is also limited in the resources it can supply to the European Financial Stability Fund (EFSF), and Germany's peas for a greater Greek write-off followed by French re-leveraging of banks is, as a consequence, increasingly difficult. Politically, at least, Sarkozy has hailed the AAA rating as 'untouchable', and while rating agencies take political direction into account, it will no doubt take more than a statement of intent to preserve France's rating.Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-24622478568733064652011-10-07T02:52:00.000-07:002011-10-07T02:52:05.817-07:00UK financial firms downgraded by Moody'sThe credit rating agency Moody's has downgraded the senior debt and deposit ratings of twelve UK financial firms, including RBS (down two notches from AA3 to A2), Lloyds TSB (down one notch from AA3 to A1), Nationwide and Santander UK. Nine Portuguese banks were also subjected to the same. While the agency stated that it did not believe that conditions had deteriorated, it attributed the downgrades to the belief that the UK government was less likely to bail out any of the institutions should they get into difficulties.<br />
The removal of implicit government support for the banking sector was welcomed by Lloyds as necessary for the sector in the UK at least to stand on its own once again, however the news prompted falls in all the share prices, including for Barclays whose share price fell in accordance with the other banks despite the fact that it was not downgraded.<br />
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The Chancellor George Osborne stated that British banks were among some of the best capitalized in the world, and that the government were taking steps to address the "too big to fail" problem. Of course, detail is scant, and heralding capitalization levels and stress test successes should be taken, one feels, with a Dexia-sized pinch of salt. Moody's split the downgrades into three categories - those institutions still with a high likelihood of government support, a moderate level, and a low level of support. Unsurprisingly, the large banks including RBS and Lloyds fell into the first category, while the smaller institutions were split between the second and third.<br />
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While most UK banks have exposure to Irish sovereign debt, they are not exposed to other Eurozone countries in the same way as some of the European banks. There's more on this point, along with discussion of some interesting calculations carried out by French bank Natixis <a href="http://www.bbc.co.uk/news/business-15212476">here</a>.Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-54612747843308472592011-10-07T02:27:00.000-07:002011-10-07T02:27:36.224-07:00New Zealand soverign debt downgradedStandard and Poor's and Fitch both downgraded New Zealand's sovereign debt a few days ago. The ratings agencies cited increased government spending after the earthquake along with high levels of household and agricultural debt. Fitch also stated that New Zealand's high level of external debt was 'an outlier' among comparable developed nations.<br />
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The Standard and Poor's rating was cut from AA+ to AA, however Moody's rating remains unchanged at AAA. New Zealand's debt to GDP ratio has fallen over the past year following government efforts from 86% to 70%, and while most commentators agree that several years ago the country would have escaped attention from the CRAs, the sovereign debt crisis has prompted a more cautious approach.Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-54292047082127370182011-10-05T02:20:00.000-07:002011-10-05T02:20:49.362-07:00Moody's downgrade Italian bondsMoody's, the credit rating agency, has been busy. The agency cut Italy's government bond ratings yesterday, this time by three notches to A2. <a href="http://www.moodys.com/research/Moodys-downgrades-Italys-government-bond-ratings-to-A2-with-a--PR_227333">Reasons cited</a> include long-term funding risks for states in the Eurozone and high levels of public debt. While this is the first downgrade of Italian bonds for many years, the move parallels recent activity by Standard and Poor's who recently downgraded Italian sovereign debt to single A. The ratings from the two CRAs now equate with each other, and both have a negative outlook, meaning that further downgrades could follow. While the downgrade from Standard and Poor's comprised a thinly veiled warning about the political leadership of the country, that of Moody's appears to focus less heavily on the antics of Berlusconi and more on the Eurozone banking and sovereign crises.<br />
Many large French and German banks are heavily exposed to Italy, and the downward revision of that country's sovereign debt will only fuel fears that the sovereign debt crisis in Europe is morphing into a second banking crisis.<br />
Also on Tuesday, Moody's placed the ratings of seven Hungarian banks (OTP Bank NyRt, OTP Mortgage Bank, K&H Bank, Budapest Bank, FHB Mortgage Bank, Erste Bank Hungary and MKB Bank) on review for possible downgrade. The move follows the approval of a law in that country that would allow foreign currency mortgage borrowers to repay their loans in full at exchange rates falling well short of current market rates. Moody's cites that this will add potential stress to a banking system "already under significant pressure". Around 80% of Hungarian banks are owned by foreign banks.<br />
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This morning, Moody's has also placed on review for downgrade the standalone bank financial strength ratings (BFSRs), the long-term deposit and senior debt ratings and the short-term ratings of Dexia Group. The liquidity position of the Group, along with wider concerns about the state of the market is cited as reasons. Further details are available <a href="http://www.moodys.com/research/Moodys-reviews-ratings-of-Dexias-main-operating-entities-for-downgrade--PR_227154">here</a>.Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-65669112686605317632011-10-02T12:06:00.000-07:002011-10-02T12:06:06.423-07:00SEC Staff Report on Credit Rating AgenciesThis <a href="http://www.sec.gov/news/press/2011/2011-199.htm">Report</a> brings to the fore many of the issues that commentators have been citing for a long time about problems inherent in the ratings market. This (long) post summarizes the Report and discusses briefly the findings, but future posts will most likely draw more on this Report and what it is likely to mean for US and EU regulation in the future.<br />
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Staff of the SEC have issued a report on the ten Nationally Recognized Statistical Rating Organizations (NRSROs) registered in the United States. These include the "big three" of Standard and Poor's, Moody's and Fitch, and the report - required by the Dodd-Frank Act - makes for some interesting reading. The Dodd-Frank Wall Street Reform and Consumer Protection Act 2010 requires the SEC to examine each NRSRO annually and report on findings. The aim of the increased oversight was to ensure compliance with the new reporting, disclosure and examination requirements as set out in Dodd-Frank. The CRAs, which were criticized for issues of inaccurate ratings relating to mortgage-backed securities leading up to the financial crisis, still have "apparent failures" in following their own methodologies and procedures, the report found. <br />
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One CRA, which is not identified (more on this later), apparently allowed some "dissemination" of a pending rating before it's public release. The report also notes apparent failures in some instances to make timely and accurate disclosures, to establish effective internal control structures for the rating process and to adequately manage conflicts of interest. The Report itself splits the ten CRAs into two groups, the first comprising the "big three" (Standard and Poor's, Moody's and Fitch), and the seven smaller CRAs operating as NRSROs. The Report notes that the larger CRAs are mainly financed along the lines of the issuer-pay model. While some of the smaller agencies have traditionally kept to subscriber-pay models, these are now beginning to explore more issue-pay models, in particular with respect to the rating of asset-backed securities.<br />
The report also notes that since the <a href="http://www.sec.gov/news/studies/2008/craexamination070808.pdf">2008 Public Report</a>, the larger agencies have taken steps to address the concerns raised. That report had examined operations relating to ratings given to certain Residential Mortgage-Backed Securities (RMBS) and Collateralized Debt Obligations (CDOs) and had highlighted concerns about the sufficiency of resources devoted to ratings and surveillance, the adequacy of disclosures, documentation of the rating process and management of conflicts of interest. The 2011 report states: "Each of the three larger NRSROs appears to have devoted notable resources and effort to responding to the concerns and recommendations outlined in the 2008 Public Report". Further detail on this point is notably absent, although conclusions can be drawn from the number and breadth of concerns raised in the Report.<br />
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The Report's essential findings also show that one larger CRA failed to follow its methodology for certain asset-backed securities, applying the wrong methodology to one class of securities which have now been put on review. This was reported to the Staff during the period of the review, causing concerns to be raised about the speed with which the error had come to light, been disclosed, and then remedied. This, according to the Report, led the Staff to express concerns about the extent to which lack of resources - a criticism of the 2008 Report - remains a factor, making the lack of detail about the extra resources put in place by the "big three" even more frustrating. The CRA in question apparently has greater resources devoted to the surveillance of ratings of asset-backed securities, yet the error still took months to come to light. The Report questions if this means that the CRA is following its own published criteria for the review of asset-backed securities ratings. Interestingly, the Report cites market share as one of the possible factors that led to a delay in discovering and disclosing the error and further delays in taking remedial action.<br />
The Report further found that one of the smaller NRSROs was slow to disclose changes to its rating methodology for certain asset-backed securities and how those changes would apply to its ratings, and slow to apply those changes to outstanding ratings of affected asset-backed securities.<br />
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It is the issues highlighted by the Report in relation to management of conflicts of interest that is perhaps the most illuminating. The Staff identified "troubling weaknesses" in two of the smaller NRSROs with regards to their securities ownership policies and procedures, and the implementation of these. It was found that a lack of adequate documentation made it impossible to verify that the procedures had been adhered to, and that one key employee in particular had violated the policy by failing to adhere to securities trading pre-approval requirements. Moreover, it would appear that this same key employee held securities related to a business sector for which he participated in criteria development, in clear violation of the policy. In other of the smaller NRSROs, the securities and ownership policies, including monitoring and enforcement were found to be "haphazard and inconsistent" and one instance was identified where a key analyst may have directly owned a security of a company that was subject to a rating action in which the analyst participated, contrary to Rule 17g-5(c)(2) Dodd-Frank. Even more surprising is that the Report states that the Staff made recommendations that each enhance its policies and procedures, including documentation and enforcement, and presumably hope to find progress in the next annual report. The Report does stress that employee securities ownership policies play a crucial role in preventing the misuse of material non-public information, before stating that this area will comprise a focus of future reviews.<br />
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Issues raised with regulation of conflict of interest continue with a focus on the larger NRSROs, two of which were found not to have specific policies or procedures in place for managing potential conflict of rating issuers that may be significant shareholders in the NRSRO itself or a parent company, a situation the Staff found could give rise to a conflict of interest. Indeed, the Report states that two of the larger agencies issue ratings for companies that "may be" significant shareholders of the NRSRO or the NRSRO parent company. The Report recommends that the agencies establish procedures for managing these conflicts of interest where they arise, and this may include complete separation of such functions within the firm, although the Report makes no suggestions. This conflict of interest parallels that of the subscriber-pay business model, which the Report highlights as providing potential for conflicts of interest in three smaller NRSRO which appear to have weaknesses with regard to their policies and procedures to manage this. According to the Staff, the subscriber-pay model is more likely to see the subscriber exert pressure on the NRSRO in order to obtain a more desirable outcome.<br />
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Two of the smaller NRSROs were also found to have weaknesses in policies and procedures concerning the disclosure and management of conflicts of interest associated with certain ancillary business. This latter is defined in the Report as "any services which an NRSRO may provide which are not core credit rating services". Again, detail here is scant, and the Report does not specify the services referred to, but it is likely that some of these were product design and financial advice. The financial crash highlighted the practice of CRAs effectively advising on the market, assisting in financial product design, and then assigning these a rating. While separation of such functions was present prior to the crash, standards have been tightened since.<br />
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The Report goes on to examine internal supervisory controls, and found that in three of the smaller NRSROs these are "weak", including one firm lacking any internal audit function and having limited compliance personnel. The Report also found that of three of the smaller and one of the larger NRSROs, "the procedures for disseminating a pending rating action appeared to allow for limited dissemination of a pending rating action in some instances prior to public dissemination".<br />
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The Report notes in Part C that disclosure by one smaller NRSRO regarding certain rating methodologies appears "weak", while public descriptions of its committee process and details about the number of analysts working on credit ratings appear to be "misleading". Overall disclosure could be improved, according to the Report. However, as no NRSRO is named in the Report, it is difficult to see how the market can react to these findings. Admittedly, with only three larger players, and a total of ten NRSROs in the US market, it may be unrealistic to call for complete transparency in the hopes that the markets will respond by punishing those CRAs with poor documentation procedures. Indeed, transparency is not the focus of Dodd-Frank. But the trend in the Report does appear to be to call for increased disclosure from the NRSROs themselves. It seems a missed opportunity for this to be the same in the Staff Reports. <br />
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Finally, the Report gives no guidance on how to solve the interminable, and by now infamous, question of conflicts of interest in the ratings industry. Whether the issuer is a shareholder in the NRSRO or not, whether the rating is funded on the issuer-pay or subscriber-pay model, and whether the NRSRO employee holds securities in the issuer (or pays into a pension which holds them) all give rise to potentially material conflicts of interest. The latter is perhaps the simplest to address, but answers to all three remain tricky - and the subject of a future post.<br />
The report notes that the staff made various recommendations to the NRSROs to address the staff’s concerns and that in some cases the NRSROs have already taken steps to address such concern, but the SEC believes that working with the CRAs without disclosing bad practices is the best way for these issues to be resolved. The report stresses that the "essential findings" set out are those of staff members who conducted the examinations, and do not constitute any expression of the Commission per se, nor do they constitute any "material regulatory deficiency", although they may form the base for such in the future.Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com0tag:blogger.com,1999:blog-6315611024887341924.post-18810807440483364012011-09-28T01:24:00.000-07:002011-09-28T01:24:26.776-07:00Standard and Poor's, Moody's and Fitch win dismissal of caseStandard and Poor's, Moody's Corp., and Fitch Inc., have won dismissal of a case brought against them in the Ohio courts by five public employee pension funds. The funds claimed that the ratings given to certain mortgage backed securities were faulty and caused them to lose money.<br />
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US District Judge James L. Graham, throwing the case out yesterday, agreed with previous case law that the opinions were mere "predictive opinions", and without specific intention to defraud by the ratings agencies, there was no liability. Former Ohio Attorney General Richard Cordray, who filed the suit in 2009, and who has since been replaced by current Ohio Attorney General Mike DeWine, claimed that the ratings assigned to the securities - all AAA or equivalent - were assigned because of payments made by the issuers. Further action by the current Attorney General has been promised.<br />
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As stated, the case confirms previous rulings in the US regarding the legal status of ratings, which are considered to be public opinion, protected under the First Amendment to the US Constitution. This was first clarified in 1999 in the Jefferson County case where a suit against Moody's was dismissed. The Jefferson County School District had sued Moody's, claiming that ratings assigned to bonds issued were unfair, causing financial distress to the County. Dismissing the case, the US Court of Appeals of the Tenth Circuit found the statements too vague to be "provably false".<br />
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In a similar case in Orange County, also in 1999, a Santa Ana judge also found that without proof of actual malice, Orange County would not be able to succeed in an action against Standard and Poor's. Orange County claimed that ratings ascribed by Standard and Poor's had been too high.<br />
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The result? Ratings assigned by CRA's are "public opinions" protected as such under the First Amendment to the Constitution, and therefore without proof of actual malice are not open to legal challenge. For a more detailed overview of the US case law see <a href="http://blogs.reuters.com/alison-frankel/tag/credit-rating/">this post</a>. For the time being, all suits brought against rating agencies have been in the US. It is, however, unlikely that any result in Europe would vary.Clare Williamshttp://www.blogger.com/profile/12684466640751702296noreply@blogger.com2