Sovereign Credit Ratings Should Be Scrutinized, OECD SaysJohn Detrixhe
Investors should “scrutinize” sovereign-credit ratings, according to the Organisation for Economic Co-operation and Development, which changed its standards for what it considers “safe assets.”
“Since the track-record of ‘sovereign-risk pricing’ is not very impressive, suggested market measures of this risk (including ratings) should be treated with great caution,” the Paris-based OECD said today in a report. “Downgrades and their implications for the supply of ‘safe sovereign assets’ should not be taken at face value but more carefully scrutinized.”
The intergovernmental group last year assigned sovereign bonds of Greece and Portugal, which received European Union-led bailouts, the same country-risk classification as Germany and the U.S. The organization no longer reviews or classifies those countries. About two-thirds of OECD’s members are EU nations.
“In view of the conflicting signals” of market measures of sovereign risk and ratings, a government borrower ranked AA or higher by one of the major rating companies is considered “safe,” the OECD said. The standard relaxes the group’s previous “2 out of 3 rule.”
Moody’s Investors Service, Standard & Poor’s and Fitch Ratings are the three-biggest ranking companies, supplying 96 percent of all grades in the $42 trillion debt market in 2011, according to a November SEC report.
Studies signaling that market-based measures of credit worthiness, such as credit-default swaps, respond to changes in credit quality before rankings has spurred suggestions policy makers, investors and debt managers should use swaps spreads for determining risk rather than credit ratings, the OECD said. Those measurements however must also be treated “great caution.”
Credit swaps protecting against a borrower’s default typically fall as investors’ perceptions of creditworthiness rise and increase as they deteriorate. The contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.
Swaps tied to the U.S. are priced at 42 basis points, compared with 41 basis points for Germany and 82 basis points for France, according to CMA data compiled by Bloomberg. Those linked to Portugal are at about 400 basis points.
Treasuries rallied after S&P stripped the U.S. of its top ranking on Aug. 5, 2011, with yields touching a record low 1.379 percent in July 2012. U.S. government debt gained 9.8 percent in 2011, the most in three years, according to Bank of America Merrill Lynch index data.
Moody’s cut France’s country’s top rating on Nov. 19 by one level. S&P lowered the rating by one step to AA+ from AAA on Jan. 13, 2012. Yields on the nation’s 10-year bonds have climbed nine basis points, or 0.09 percentage point, since the Moody’s downgrade.
“Many sovereigns experienced lower bond yields in the wake of the downgrade,” the OECD said. “These conflicting signals are raising fundamental questions about the information value of sovereign credit risk ratings.”
Yields on sovereign securities moved in the opposite direction from what ratings suggested in 53 percent of 32 upgrades, downgrades and changes in credit outlook last year, according to data compiled by Bloomberg published in December. Investors ignored 56 percent of Moody’s rating and outlook changes and 50 percent of those by S&P. That’s worse than the longer-term average of 47 percent, based on more than 300 changes since 1974.