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Euromoney Country Risk

Credit rating agencies' shortcomings laid bare by ECR eurozone periphery trends

Experts taking part in Euromoney’s Country Risk Survey were ahead of the game in predicting the increased default risk plaguing peripheral, eurozone sovereigns in the wake of the 2008 crisis, and repeatedly so across a range of issuers.

Now that risk sentiment among experts is rebounding, ECR trends are once again signalling the importance of the fluid crowd-sourcing approach to sovereign risk compared with the step-wise changes favoured by the rating agencies.

ECR data previously illustrated the failure of the agencies to accurately signal the high-risk situation that developed in the wake of eurozone sovereigns harbouring massive debts exacerbated by assuming responsibility for banking failures.

Downgrades to six eurozone sovereigns by Fitch in October 2011 – including Italy (which up to that point had been stable at AA-) and Spain (hitherto unchanged at AA+) – were long overdue, according to ECR’s survey data.


Italy’s score plummeted 15 points over the 12 months preceding the rating action, while Spain dropped no fewer than 20 points, highlighting how ECR experts took a decidedly more pessimistic tone before Fitch was eventually prodded into action.

At that point Fitch still gave A-ratings to both countries, which were only later revised down to triple-B in June 2012 for Spain, and to the same level for Italy in March 2013.

Moody’s and S&P moved a little earlier, but neither sounded the alarm bells as quickly as those rung by Euromoney’s sagely clique. Scores for Greece, Ireland and Portugal followed similar trends.

ECR pointing upwards

So what should we make of current trends?

A turning point in the eurozone crisis was reached toward the end of 2013 when scores began to reverse for all peripheral countries, bar Cyprus, as economists and other experts took a more favourable view of the tail-risks affecting euro participants.


Portugal, 3.4 points higher since 2013, has gained from its nascent economic recovery and from the fact the government has declared it will soon exit its €78 billion bailout programme without ongoing emergency support.

Ireland, too, has seen its score climb 3.6 points since its wobbles toward the end of 2012, gaining impetus from being the first of the bankrupt nations to successfully complete its bailout programme.

And with its improving macro-fundamentals, Spain is now three points higher since this time last year.

The risks remain heightened of course. Prospects for Italy and Greece, with their more intricate political problems and enormous debt loads, are less certain.

Moreover, scores for every eurozone member except fiscally-astute Estonia are still heavily marked down on their levels in 2010, led by Greece, currently 37.6 points adrift in ECR’s highest-risk category, Cyprus (25.5), Italy (20.8) and Slovenia and Spain (roughly 19 points each).

Agencies confused

The problem is that the ratings agencies have no method for signalling these shifts in sentiment.

Of all the raters Fitch is at least more consistent, giving a BBB+ rating to Ireland, which has climbed five-places in ECR’s global rankings since 2013 (to 38th out of 186 countries), and to Spain (up nine places to 47th) and Italy (six places to 49th).

Portugal a little lower in 52nd place, but 12 places higher since 2013, is rated BB+ (positive). However, Cyprus (65th) and Greece (118th) are both rated B- in spite of their distinguishing characteristics.

Scores for 15 political, economic and structural factors (in addition to debt data, credit ratings and access to capital) highlight these various strengths and weaknesses in ECR’s survey.


Moody’s and S&P meanwhile seem to disagree.

Ireland, rated Baa3 (positive), is lower than Baa2-rated Spain or Italy according to Moody’s, contrary to their ECR rankings, while S&P has Spain lower than Italy and Portugal. Remarkably those two are still on review for a downgrade.

New kid on the block

The emergence of DBRS into the sovereign ratings market in 2010 has so far not augured well for improving the poor record of the credit-rating process.

The USP of DBRS’ sovereign rating is predicated on its long-term stability “through the cycle”. Its methodology  considers fundamental strengths affecting longer-term creditworthiness, including the quality of policymaking, economic diversification and political stability among other variables. As such, normal cyclicality in economic factors has less impact, leading to fewer changes in the ratings and accordingly less volatility than other credit rating agencies.

However, some would argue that even a stopped clock is always right twice a day and the idea that DBRS should avoid volatility in ratings actions seems counter-intuitive for the purpose of detecting subtle movements in daily bond prices and CDS spreads.

An economist predicting 3% growth every year is determining a trend, but that isn’t particularly helpful to an investor needing to know if a recession is coming. A double-A may eventually return to double-A, but investors require reliable information now to determine creditworthiness.

DBRS would counter that its approach relies more on structural changes in credit fundamentals than the normal cyclical swings in the economy.

It may have a point, and may be contributing something new, though Moody’s purports something similar and, in any event, ECR incorporates several of these long-term factors into its own survey.

However, DBRS did not assign any ratings to Greece and Cyprus until last year (placing both on triple-C) and its methodology backtracks to a less rigid interpretation allowing for excessive downturns, suggesting a lack of faith in its convictions.

Norbert Gaillard, author of A century of sovereign ratings, argues:

“DBRS may face a major problem if there is a political, economic or financial crisis in Italy, Portugal or Spain.”

Under such circumstances, with DBRS presumably obliged to downgrade massively, Gaillard would have doubts about the process, similar to his conclusions about Moody’s in 2008-10 (Credit rating agencies and the eurozone crisis: what is the value of sovereign ratings?) Only ECR score changes react with sufficient rapidity.

Moreover, the latest downgrades by DBRS to Ireland, Portugal and Spain coincide with historic highs in two-year bond yields.

Gaillard says this is puzzling because “it might suggest that DBRS adjusts its ratings when they diverge too significantly from two-year bond yields, thus taking market indicators into account in times of higher risk aversion, but disregarding them when bond yields decline.”

DBRS hasn’t altered its views for the past year, or even longer in some cases. That implies its analysts can detect medium-to-long term determinants of creditworthiness.

Only time will tell if its strategy proves worthwhile. In the meantime investors can gauge changing risk-sentiment from ECR’s survey score trend.

This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.

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