Just as your risk of a dodgy bailout is determined by your size so too, perchance, is your risk of an odd ratings action. On Tuesday Slovenia’s credit rating was junked by Moody’s, forcing it to call off a planned US dollar debt sale.
Those we have talked to are pretty baffled by this one. Not only does the timing seem strange but the critiques leveled are questionable (more on that below) particularly when you take into account the depth of the cut from Baa2 to Ba1.
As Citi said, this decision has no impact on the eligibility of Slovenian bonds for repo operations since S&P and Fitch rate Slovenia A-, which is the rating threshold consistent with no additional haircuts. What’s more, considering the demand demonstrated before Slovenia’s bond sale was postponed, alongside the kind of investors gunning for this debt, and you’d guess it will still go ahead. Which would say something about the rater’s clout at the moment.
Maybe we are being too mean to Moody’s. The fault for the postponement might lie on the Slovenian side or this might have just been an unavoidable coincidence — it was going to happen and the information had to be released.
Pimco’s Myles Bradshaw tends to fall on the less-charitable side of this one (our emphasis):
The tightening in peripheral sovereign spreads to Bunds suggests investors are moving down the eurozone sovereign credit curve, while the flattening of the Bund curve shows that near-”zero” interest rates are encouraging investors to capture higher yields by moving out along the yield curve. Some of this probably reflects rising expectations of an ECB (European Central Bank) rate cut this Thursday and possible further unconventional action in the months ahead. How much economic impact such ECB action will have is debatable. But by suppressing financial volatility, it likely increases the perceived attractiveness of carry trades and the investor “hunt for yield”.
Small as well as large eurozone sovereigns have benefited from this liquidity But Moody’s downgrade of Slovenia (by two notches, to Ba1) on Tuesday night reminded us that being a small non-systemic entity in the eurozone can be a hazardous occupation. Last months’s Cypriot bailout highlighted how eurozone policymakers can be very unpredictable … But the Moody’s downgrade of Slovenia shows that rating agencies are also becoming affected. It is a useful reminder that investors should look to a broad and deep pool of credit analysts rather than relying on rating agencies alone.
A key factor behind Moody’s downgrade of Slovenia was an uncertain funding environment. The fact that Slovenia had that same day built a rumoured book of as much as $11 billion for a 5-year and 10-year new sovereign debt issue suggests that Moody’s assessment of this risk was dated at best. For context, annual Slovenian bond funding needs are in the order of $3 billion (excluding bank recapitalisations), and Slovenia has already prefunded itself for 2013. In terms of fundamentals, Moody’s estimated that bank recap costs of 8% to 11% of GDP could result in the government-debt-to-GDP level stabilising above 75% of GDP in 2013. This is well below the average 2012 level of sovereign debt in the eurozone: 93% of GDP. Moody’s also noted that Slovenian government debt levels were unlikely to reach unsustainable levels.
Exactly why Moody’s downgraded Slovenia just as it was about to raise funds that would have reduced the odds of an ESM application considerably is a mystery. A charitable interpretation is that this is one of the many unintended consequences from bailing in Cypriot depositors. The message that eurozone politicians sent in the case of Cyprus was that small sovereigns applying to the ESM face and unpredictable policy response. This higher level of political risk in turn argues for a structurally lower rating for small versus systemic sovereigns. In any event, it means that investors must truly understand the balance sheets they are investing in rather than relying on a rating agency’s letter.
Basically good advice.
Related links:
A Slovenia Q&A – FT Alphaville
But you start to follow the money… Barnejek’s Blog