ratings

Deja vu? No, ratings agency Standard and Poors has cut Portugal’s credit rating for the second time in less than a week, this time one notch to BBB-, leaving the rating with a negative outlook. Last week the agency cut by two notches – the most it could reasonably cut, given an explicit indication that they would be “unlikely” to cut by more. The agency left the rating on negative creditwatch, but that is usually interpreted to mean a further cut is likely in three months, not three days.

Greek ratings, meanwhile, have been cut deeper into junk territory with a two notch downgrade to BB-. The rating remains on negative creditwatch meaning a further cut is likely if there is no improvement; typically, that would be within three months, but in the current climate, who knows?

In both cases, the downgrades have been prompted by the structure of the permanent eurozone rescue fund, the ESM, which was confirmed at the end of last week by eurozone leaders. Two things in particular. One is the issue of subordination 

The ESM term sheet claims its first casualty. As predicted, Standard and Poors rating agency has downgraded Portugal by two notches to BBB, leaving the rating on creditwatch negative, meaning another downgrade is likely within three months if there is no improvement in the country’s financial prospects. A further downgrade could place Portugal’s rating below investment grade: S&P’s rating is now just two notches above junk. But by then, the country will have passed or failed two significant tests: refinancing its debt in the markets in April and June.

S&P’s move is likely to be more significant than recent downgrades by Moody’s and Fitch. That’s because, first, S&P is leading the rating descent, having downgraded Portugal to its current Moody’s/Fitch level of A- in May of last year. (Moody’s and Fitch have only just downgraded to this level.) Second, the downgrade is significant because of timing. With a key vote on Portugal’s austerity package yet to pass and the PM stepping down, fiscal discipline will be further delayed. (This is one reason given by S&P for the move.) More than that, general elections are expected in a few months, and it would be very tempting for a new government to restructure its debt, laying the blame with its predecessors. Similar temptations must be present in Ireland.

Fitch has just downgraded Portugal two notches to A-, placing the rating on credit watch down, meaning that further downgrades are likely. It’s not great news for the Iberian nation, which faces increasing pressure for a bail-out as yields rise and domestic politics worsen. But the bigger ratings news is yet to happen and it is likely to come from Standard and Poors.

Fitch’s downgrade just brings its Portuguese government rating in line with those of its peers: all three main agencies now hold equivalent ratings. Moody’s downgraded Portugal two notches to A3 (=A-) about a week ago, leaving the rating with a negative outlook. S&P was quicker off the mark, lowering its rating in April 2010 and placing the rating on watch down on November 30. 

The cost of rehabilitating the Spanish banking sector is partly behind Moody’s decision to downgrade Spanish government debt from Aa1 to Aa2 today. The rating has been left with a negative outlook, meaning a further downgrade is likely within two years if there is no improvement. Moody’s also completed its review of Greek debt with a three notch downgrade earlier this week. It seems the agency has saved the most sensitive review – that of Portugal – till last; it is due out before March 21 but is more likely to appear next week.

Moody’s decision completes a set of Spanish downgrades by all three main ratings agencies in recent weeks. S&P downgraded to AA (equivalent to Moody’s Aa2) on February 1, and Fitch downgraded to AA+ (equivalent to Moody’s Aa1) on March 4. Reasons given: 

Bad day for Portugal. S&P has cut to junk the credit ratings of four state-owned utilities, saying the country’s sovereign debt troubles could limit the timeliness or sufficiency of help on offer from the government:

Government support for distressed state-owned companies was “increasingly constrained by difficult financial conditions”. This was also reflected in the “weak access” of Portuguese banks to external funding, S&P said. 

Do the markets know something we don’t?

S&P cut Ireland’s credit rating by one notch today, taking it to A- (still several notches above Moody’s and Fitch, at equivalent peggings of Baa1 or BBB+ respectively). Yet markets continue to relax, with the Irish ten-year cost of debt falling 20 basis points today, a fifth of one percent; at 5.45pm they were 8.8 per cent.

The cost of debt for Spain, Portugal, Italy, Belgium and Greece have all fallen, too. Greek yields are below 11 per cent for the first time since early November.

Gary Jenkins, head of fixed income for Evolution Securities, says: “It is interesting that while the story [that the EFSF mandate will be widened to allow debt buybacks] has been doing the rounds for three weeks now, yesterday was the first day since then that we have witnessed yields moves of such a magnitude, which does make one wonder if there has not been a leak ahead of the European leaders’ summit on Friday.” 

Lisbon might soon have more difficulty accessing debt through the markets, precisely because Moody’s is worried that it will. With rather circular reasoning, Moody’s said it was placing Portugal’s A1 rating on downgrade review because of “concerns about Portugal’s ability to access the capital markets at a sustainable price”. Yields will no doubt rise further on the news.

Moody’s is also worried about the effect of bank support on the government’s debt, as well as the impact of austerity measures. The rating looks perilous, then, since Moody’s fears will rise whether Portugal cuts or spends. 

It jumped last but – not to be outdone – Moody’s has slashed five notches off its Ireland rating, taking it to Baa1 (which is equivalent to Fitch’s BBB+ and about three notches above junk). They’ve also slapped a negative outlook on it, meaning a further downgrade is likely in the next two years if there is no improvement. A multi-notch downgrade was likely – the ratings agency said so itself – though it has come relatively late in the game, after similar cuts by S&P and Fitch.

S&P now offers Ireland the highest rating at A, two notches above Fitch and Moody’s. Under the original ECB collateral requirements of A-, this would mean Ireland’s bonds could still be used – just – as collateral at the central bank. As it is, the “temporary” lowering of collateral requirements to BBB- is still in force, so Ireland need not worry. (As with Greece, the ECB would probably make an exception for Ireland even if its ratings were cut below this level.) 

Hungary’s credit rating is just one notch above junk since rating agency Moody’s cut two notches and warned of further downgrades. Concerns about fiscal sustainability led Moody’s to cut to Baa3, now in line with S&P. Fitch remains one notch above its peers, but is expected to cut by the end of the year. The cut places Hungary’s rating just a notch above that of Greece.

Last week, Hungary raised its key interest rate 25bp to 5.5 per cent to combat rising inflation expectations. It was the first rise since October 2008, and was largely unexpected by the markets.

Moody’s isn’t going to get caught out this time. The ratings agency has said today that its review of Irish sovereign debt is likely to end in a multi-notch downgrade. If we take “multi” to mean three or more, the current Aa2 rating will probably end up below those of S&P and Fitch.

Curious timing. All three agencies have stayed mute about Ireland in recent weeks. S&P and Fitch are yet to say anything and Moody’s has waited for the announcement of the aid package.

Perhaps there were burnt fingers over Greece. In the Spring, S&P and Fitch downgraded Greece as market fears intensified, adding to the commotion and leaving Moody’s in a very awkward place (had they downgraded Greece, they might single-handedly have disqualified Greek assets from being accepted as collateral at the ECB).

Rating agencies were heavily criticised for aggravating matters in April and May,