F&C Questions Impact of Rating Agencies

(January 20, 2012)  —  Downgrading a country’s debt has little impact for investors or issuers, a paper by F&C Investments has concluded a week after rating agency Standard and Poor’s took action on several European nations.

The act of reducing a county’s status is often a reaction to what has been happening to its debt in the wider market already, F&C’s Liability Driven Investments bulletin reported.

It said: “Ratings agencies were slow to react at the onset of the credit crunch; so to an extent whilst credit ratings are meant to be forward looking they may, in certain cases, be lagging indicators, whereas a more sensitive market implied measures such as credit spreads may have reacted earlier and reflected a change in the perceived creditworthiness.”

A week ago, S&P downgraded a series of Eurozone countries including France, which lost its triple A rating, which should have pushed their sovereign debt yields up due to their more risky status. In fact there was little immediate reaction on bond markets, and in some cases the yield on bonds issued by the effected countries actually went down, signalling more confidence and appetite from investors. This was also the case when S&P withdrew the United States’ AAA rating last summer.

The F&C paper said: “In the case of countries like Italy, spreads on their government debt relative to Euro denominated swaps, which is a measure of Italian sovereign credit risk, had already started to widen at the beginning of 2011 even though Italy was not formally downgraded by Moody’s until September 2011 from Aa2 to A2.”

The asset manager’s paper added that over the longer term external factors played a larger part in the movements of the bond’s yield than the removal of a top rating.

Fears of institutional investors dropping the securities following a downgrade were also overblown, according to the paper. It said that while some funds may have to sell out of bonds that no longer were of an acceptable the grade to its terms and other investors needed higher grade bonds to use as collateral, situations were usually adaptable.

The paper said: “Institutional investors often start selling sovereigns about to be downgraded much before the event such that the rating downgrade itself does not constitute a significant market event. Likewise, we have seen derivative clearing firms raise the margins required on sovereign debt in response to price volatility rather than ratings downgrade. Similarly, credit ratings restrictions are not always set in stone and often common sense prevails. For example, the European Central Bank historically has only accepted investment grade sovereigns as collateral for capital raising purposes.”

However, earlier this week, market monitor Data Explorers said demand for high quality sovereign bonds to use as collateral had pushed the level of AAA-rated European countries’ bonds out on loan to record levels.