In the crisis, the credit rating agencies have not all reacted in the same way. An analysis of the three main rating agencies actions since the end of February, shows that Standard & Poor’s (S&P) has been much quicker than Moody’s and Fitch in revising down their views – REPORT
In the space of just one month, S&P reviewed* almost 20% of the corporates in its European and US portfolios. Practically, S&P downgraded the credit ratings of 35% of them, whilst a further 40% were placed on a negative watch. By contrast, Moody’s and Fitch have published far fewer negative reviews (by a factor of 3), and half as many downgrades, for a broadly similar exercise.
Acting with urgency
The rating agencies do not want to repeat their mistakes from the 2008 financial crisis. Too slow to spot the increasing risks in the debt markets, they intervened too late and distributed downgrades of several notches en masse, which plunged the financial system into deep distress. Heavily criticized at the time for this destabilizing effect, it resulted in them being regulated, especially in Europe.
In the context of the current macroeconomic shock of unprecedented magnitude, the speed with which S&P has acted does raise questions. The Debt Advisory team at Redbridge noticed that, in its eagerness to act, S&P had a large number of rating committees re-examine the situation, whilst acknowledging that most companies will have neither the time to finalise their own analysis of the situation, nor provide them with precise information on the short-to-medium-term impact of the coronavirus crisis on their business or their liquidity position. Agencies such as Moody’s and Fitch, appear to take a much more cautious approach to their analysis and are first trying to refine their views on the sectoral impacts of the crisis. S&P, on the other hand, has taken the decision to rule very quickly on the specific ratings of many issuers across multiple sectors.
Unless S&P knows much more than the rest of the market, their decisions seem premature. The situation is changing from day to day and there are a number of important elements to consider to form an accurate analysis.
A sophisticated analysis needs to be undertaken
Our view is that it should be possible to evaluate the credit risks for the most impacted issuers, whose financial position is clearly under pressure. But for the vast majority, multiple external parameters will be decisive in exiting the crisis: the possibility of resorting to furlough, an economic rescue plan aimed at stimulating consumption in the post-crisis period, actions by central banks to provide companies with all the necessary liquidity, concerted actions by oil-producing countries to restore calm to the markets, nationalisation of companies or buyouts by protection funds, intervention by shareholders to reinject capital into distressed companies, etc All these factors will play a role.
In the face of all these complexities, it is legitimate to question the value of hastily handed down judgments by agencies. What do they bring to investors that they do not already know? That the hotel industry and airlines will be some of the sectors most heavily impacted by the health crisis? The markets seem to have already factored in these risks.
Adverse threshold effects
On the other hand, a rating decision that is too hasty can have damaging consequences for a company’s liquidity. There are detrimental threshold effects all along the rating scale. For the strongest issuers, losing their short-term A2/P2 rating will make it more difficult for them to obtain financing on the debt markets (bonds, commercial paper) as their debt will no longer be eligible for the ECB’s repurchase programme. Going below a long-term BBB- rating means the defensive bond funds and life insurers will be forced to eject the paper from their portfolios. Finally, losing a B- rating means an exit from CDO/CLO conduits and places the issuer’s debt in the hands of so-called vulture funds.
CFOs – What should be done in this context?
How should the finance teams react once they have been approached by their rating agency? The situation is delicate. Giving too much information, too early, without having detailed answers from the executive board, could lead to a premature downgrading of their credit rating. At the same time, not responding to the requests could equally have a similar impact.
In this context, it is essential for the finance team to be transparent about the full range of measures taken by management in response to the crisis in order to avoid a potentially damaging impact on the company’s access to financing. At the same time, the financial communication should not be dictated to by the agencies.
In this situation, our best advice is to work on cash flow forecasts for various scenarios and only communicate this type of information to the agencies only once it has been extensively validated by the executive management team.
For the most credit worthy issuers, who currently issue unrated securities, it might be pragmatic to consider obtaining a rating in order to preserve their access to the market; the sales teams of some agencies have already identified this.
*Scope of the study : Analysis of rating decisions based on the portfolios of 2,610 companies (S&P – Capital IQ) and 1,935 companies (Moody’s) respectively in France, Italy, Luxembourg, Switzerland, the United Kingdom and the United States, all sectors combined, between 21 February 2020 and 25 March 2020. The analysis of Fitch Ratings’ rating actions is based on data published by the agency on 27 March 2020 and covering a portfolio of 1,171 companies in EMEA, the United States