The BP downgrade cycle

June 16, 2010
Quote of the day comes from Fitch's Jeffrey Woodruff, in the wake of downgrading BP by a whopping six notches, to BBB from AA:

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Quote of the day comes from Fitch’s Jeffrey Woodruff, in the wake of downgrading BP by a whopping six notches, to BBB from AA:

“We think the CDS market is overdone hence our decision to shift rating to BBB,” said Jeffrey Woodruff, senior director in Fitch’s EMEA Energy team and lead analyst for BP.

Inevitably, partly as a result of the downgrade, BP’s CDS gapped out: it seems that rising CDS spreads cause ratings downgrades, and ratings downgrades cause rising CDS spreads, in exactly the kind of death spiral that we all remember far too vividly from a couple of years ago.

In this case, however, I don’t think there’s much systemic risk. Real-money investors are buying BP cash bonds (Pimco’s just snapped up $100 million or so at double-digit interest rates), and BP has solved a lot of potential cashflow problems by suspending its dividend. I think we can leave the ratings agencies and the CDS markets to do whatever it is they feel they need to do: there’s no sign that the nervousness in the CDS market — or even the tone-deafness of BP’s chairman — is doing any damage to BP’s $100 billion market capitalization.

On the other hand, nervousness in the credit market is unpredictably contagious: it can have no effect for months, and then suddenly spill over into stocks and even the broad real economy if everybody starts getting worried about the banking sector again. That could, conceivably, happen if Obama signs a tough financial-reform bill.

Meanwhile, I’d love to hear from any investors in BP what and whether they think about the ethics of their investment. Does there come a point where a moral investor should avoid certain companies entirely? I, for one, wouldn’t feel comfortable buying shares in BP at any price. It just feels, well, slimy.


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