'Tension-Raising' Low Sovereign Rating of Turkey

Some time has passed since I wrote an article about the severe errors in judgment on the part of credit rating agencies, specifically relating to Turkish sovereign debt.

One of the reasons why I decided to submit the Turkish sovereign ratings article to Seeking Alpha six months ago was that some analysts were coming out with wrong numbers and serious misinformation about Turkish economy at the time. Some claimed that Turkey needed to the tune of 150 billion dollars of external financing, numbers that had no basis in fact.

With such misinformation, contamination, exaggerated scaremongering as well general bias and stereotyping, there was no doubt in my mind not only about the ridiculosity of the rating agencies especially when it came to Turkey, but also about the mispricing of the Turkish sovereign debt and its concurrent undervaluation in the marketplace at the time.

I also remember jokingly referring to the cookie-cutter statements credit rating agencies made, as well as the ubiquitous negativity surrounding their dire evaluations relating to the Turkish economy (or its education system or its institutions in general), while trying to defend their investment thesis or grading recommendations.

After the article was published on Seeking Alpha, the Turkish sovereign debt and the position I had taken consistent with my thesis performed so well that it’s been a little spooky.

I don’t mean to blast having been ahead of the curve, but if you were lucky enough to read and take advantage of the article I submitted for general public consumption six months ago, you would have been rewarded handsomely, both in terms of the fallen Turkish sovereign yields and the currency I happened to “like” at the time (although I got lucky on the euro entry point).

I don’t blog on a consistent basis on Seeking Alpha. Yet I do think this is a good platform for folks like us to have their opinions read by much larger audiences.

I would not be submitting pieces to the Seeking Alpha platform if I happened to be in agreement with the mainstream opinion on a specific issue. I also would not be contributing if I felt that my take on an issue did not add to the marketplace of ideas in a meaningful fashion.

Thus I like to think that the article I wrote in the beginning of the year resonated with enough people to take a more careful (if not critical) look at the way the Turkish sovereign debt gets graded (or rather, gets defiled) by credit rating agencies.

Coincidental or not, some have become more vocal about their discontent. I would have liked to say that it was the “restless natives” that created the stir, but the international man of mystery in this case was Timothy Ash of the Royal Bank of Scotland. The former London-based Bear Stearns analyst worked in the fixed income division and published research on Emerging Europe (including Turkey) when I worked in the equity research division of the New York headquarters of the same firm.

There are so many examples you can find to point out the unfair treatment that Turkey gets by the credit rating agencies that I get overwhelmed even to name a few. Luckily, Timothy Ash has taken on an angle at this issue while comparing Latvia to Turkey. Latvia’s troubles far exceed the risks Turkey faces, yet Moody’s recently reaffirmed its investment grade rating of Baa3, which is, as Ash points out, “three notches above” that of Turkey.

Timothy Ash makes various comparisons based on actual data (refreshing to say the least) and rightfully points out the following: "With the market putting Latvia's five-year credit default swaps at 7 percent higher than that of the United States, and Turkey at only 2.55 percent higher than that of the U.S., someone is clearly wrong."

Someone is clearly wrong indeed.

In fact, the “right” thing that we should all be comforting ourselves with is the consistency with which the rating agencies have been “wrong” about Turkey.

My humble opinion is that investment ratings are not only lagging indicators, but they are also indicative of the cozy relationships that financial sector has with rating agencies. Investment ratings in general also happen to be indicative of the biases that the financial sector holds.

In fact, a Fitch representative, while trying to defend the investment rating of Turkey, has affirmed that their rating decisions reflect the “negative feelings” that economists of financial institutions (such as investment banks) have of the country’s economy “behind closed doors”.

Talk about confessing to your crime while trying to free yourself from the accusations. Rating agencies are not supposed to transfer any due diligence responsibility to Wall Street analysts of brokerage houses and / or investment banks.

Furthermore, “behind-closed-doors” conversations of analysts, where trading or investment banking business of one firm could be influenced by an investment grade or recommendation of another firm, are indicative of collusive behavior, and could trigger all kinds of breaches of the law including, but not limited to, market manipulation or insider trading.

The same article quotes that Timothy Ash had a strong reaction to the Fitch representative, as you can read below:

Speaking to the Hürriyet Daily News & Economic Review, Ash rejected Berker's criticism, saying analysts could not make any different assessment behind closed doors than they do in public. "There are rules from both the U.S. Securities and Exchange Commission and the Financial Services Authority in Britain that govern what we can say and write," he said.

Perhaps Mr. Ash does not participate in the “behind-closed-doors” meetings of this mystical Dead Poets Society of Economists, but my gut feeling is that the Fitch representative is telling the truth. In fact, it is entirely consistent with why rating agencies never even bother defending their investment grading decisions with solid facts and data, but rather resort to cookie-cutter statements. It’s that simple. No need to defend a verdict that has already been determined by the “secretive society”.

Let’s assume for argument’s sake that there are no ethical or legal concerns of having collusive behind-closed-doors meetings to determine an investment rating, which is a product monopolized by credit rating agencies, and coincidentally (as the Fitch representative affirms), by Wall Street itself…

Wait… Is my imagination running wild again? Or was it precisely what happened when ratings agencies stamped their AAA ratings on mortgage derivatives that were prepared by Wall Street analysts and investment bankers? Only this time the “behind-closed-doors” arrangements enabled Wall Street firms to sell those securities at a higher price to customers who believed they were actually buying “risk-free” securities…

I guess being part of the “club” has advantages when it comes to pushing your agenda and putting a stamp of approval on the investment products you wish to promote. It could also lead to stigmatizing investments that you are in disapproval of, as we can see in the Turkish sovereign bond case.

I happen to think that the marketplace is the best judge when it comes to valuing one’s investment opinions, to the extent that information hiding, manipulation as well as colluding do not contaminate markets and cause false valuations to occur.

Judging by the performance of the Turkish sovereign bonds as well as the credit default swaps, this “secretive society” of economists has erred significantly.

It is more acceptable for unsuspecting retirement funds or foreign banks to claim to have been tricked into buying AAA rated mortgage securities and take the position of the unassuming victim.

Yet it is indeed absurd for rating agencies to depend on secretive meetings of Skull And Bones Society of Economists for due diligence and then put the blame on them when these assessments prove to be wrong.

Disclosure: Long 2017 Turkish Sovereign Eurobonds denominated in Euros, long sovereign TL instruments (various durations).

Comments

[Slimsum:]

Good article and a "make you think" condemnation of the ratings agencies.

Jun 29 10:27 AM

[StealthInve...:]

Turkish economy is getting worse, political instability is escalating, foreign investors are leaving Turkish stock market. These are all bad signs. Highly speculative and risky market.
Not because the rating agencies said so, just look at the unemployment rate.

Jul 08 12:15 AM

[alallmd:]

A most insightful, well-written and informative article written by a beautiful person.
We need more writers with Suna's insight and caliber on this web-site.
What a delight !

A Lall

Jul 18 02:51 PM