Moody’s (MCO) is going on a rampage regarding the sovereign debt of the eurozone periphery. They are now reviewing Portugal and Spain for a potential ratings downgrade. That means they are threatening Greece with junk status and also warning that cuts to Portugal may come as well. Spain’s rating outlook remains stable and Ireland is not mentioned.
In their most recent note alerting the market of these actions, Moody’s has defended themselves despite the wide perception that the ratings agencies are perennially behind the curve on downgrades.
Our ratings and market spreads have occasionally come to reflect considerable differences of opinion. A similar divergence occurred at the height of the banking crisis in late 2008, when our bank ratings were in the Aa-A range while spreads suggested quasi-default situations – before returning to levels more consistent with our ratings. Also, for several years, our single-A rating for Greece appeared to some to be "behind the curve" because it was much lower than market prices suggested and apparently ignored the market’s favourable momentum. Unlike market spreads, Moody’s credit opinions on governments do not change very often because the fundamental drivers of sovereign creditworthiness rarely change precipitously in direction or degree. However, because market spreads are often volatile and affected by momentum-driven trades, our ratings may at times be perceived to be behind an imagined curve.
Brown Brothers Harriman’s Win Thin disagrees. He notes that BBH’s models suggest the agencies are, indeed, behind the curve. He writes:
Just so markets don’t get too carried away, Moody’s decided to issue some negative comments regarding the peripheral countries. The agency warned that it may cut Greece to junk in the next four weeks, but added that a move to Baa range “is most likely.” Greece is currently rated A3 (equivalent to A-) and so a move to junk would be a minimum of 4 notches. Not unheard of in this crisis, but certainly aggressive. Recall Fitch cut Greece three notches to junk BB+ back on April 27. Moody’s added that Portugal would probably be cut to Aa3, but added that A1 was possible compared to current rating of Aa2 (equivalent to AA). Lastly, it said that no action on Ireland’s Aa1 rating (equivalent to AA+) was expected. So, Moody’s is basically saying that its ratings are still way out of whack with the current reality and/or the peripheral countries are likely to remain under downwards rating pressure despite the EU/IMF plan just announced. Haven’t seen any comments from the other agencies. And we note that Moody’s is most out of line with our internal ratings model on the peripheral countries and that Fitch and S&P are more in line than Moody’s. If borrowing costs can be kept down, then downgrade pressures should ease. But don’t expect any quick turnarounds by the rating agencies to the upside.
Needless to say, the potential downgrades are very much in line with the themes from my last post about national solvency. The report is below.