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Spanish CDS: A telltale sign that the Big 3 credit rating agencies are behind the ball

|Includes: DNB, EWP, FMLCF, MCO, The Ibero-America Fund, Inc. (SNF), SPGI

Moody’s recently announced that they were putting the Kingdom of Spain’s sovereign credit rating on downgrade watch the day after Spanish CDS hit a record high of 275 bps. Now the question for investors is does that announcement even matter. Investors who had been watching the CDS markets could have told you that was coming a long time ago.

As the last remaining major credit rating agency that still awards Spain the highest triple-A rating, a downgrade would normally have resulted in Spain facing significantly higher credit costs in terms of higher yields on its bonds but with CDS having traded at sequentially wider levels for a while now, the impact of an announcement like that in today’s day and age is probably more muted. In fact, according to some calculations, the current level of Spanish CDS implies a default probability of around 20% or below-investment grade (i.e. below BBB-).  Such a dichotomy between ratings and CDS levels has been seen before and CreditLime recently highlighted the opposite case in Turkey.

Spain’s Credit Rating Changes

CreditLime took a look at the recent history of Spain’s credit rating changes to reveal the following changes from both the major American credit rating agencies as well as a few foreign-based agencies that make available their publicly announced ratings.

  • January 20, 2009 – S&P downgrade from AAA to AA+
  • April 28, 2010 – S&P downgrade from AA+ to AA
  • May 7, 2010 – R&I downgrade from AAA to AA+
  • May 28, 2010 – Fitch downgrade from AAA to AA+
  • June 23, 2010 – CTRISKS downgrade from CT2A to CT1A
  • June 30, 2010 – Moody’s downgrade watch from Aaa to Aa1 or Aa2
  • July, 2010 – no announcement but JCR still maintains AAA

From the list, we can see S&P was clearly the most conservative of all the agencies in being the first to act - as early as a year ahead of everyone else, but what is more shocking is probably that Moody’s is not just last among the major agencies but behind the ball compared to a few lesser known agencies (see below for more info) in Japan and China with the exception of JCR – who last affirmedits Spanish AAA in May 2008. Could some of the foreign agencies be doing a better job in assessing credit? What exactly does it take to make a rating agency come to the realization that things are in fact better (or in this case worse) than they may appear in an old credit rating? and more importantly, does the market even care? Only time will really tell.

Disclosure: long all stocks