Comments on: Moody’s view of sovereign ratings

By: BoringCanadian

BoringCanadian — Tue, 16 Aug 2011 21:14:40 +0000

The test of whether S&P considers their notching of sub-debt to be a PD or LGD issue would be in how they treated it in the default statistics. If they count the default against the rating of the senior debt (even though it remained current), that suggests that the senior debt reflects the PD and notching the sub-debt was due to lower expected recovery. On the other hand, if they count the default against the rating of the sub-debt, then that suggests that they believed they were rating the PD of the sub-debt itself. I don’t see enough disclosure in their 2010 report to be sure which approach they chose.

By: FelixSalmon

FelixSalmon — Tue, 16 Aug 2011 20:31:52 +0000

@Greycap — I never mind snark. But Anglo Irish senior debt didn’t *recover* 100%, there was never an event of default in the first place. And yes, @Danny_Black, the sub debt did see an event of default. Ask the people who wrote CDS.

By: Danny_Black

Danny_Black — Tue, 16 Aug 2011 18:09:57 +0000

You can’t default on sub debt and not on senior debt. What you can do is either negotiate hard with the sub holders on the basis they will get more with the new deal or if you are the government you can just ignore the rule of law or change it. AIB didn’t “default” on it’s sub debt, it “renegotiated” it. There is a difference.

By: BoringCanadian

BoringCanadian — Tue, 16 Aug 2011 17:02:37 +0000

FWIW – Each of Levey’s 3 reasons why Moody’s and S&P ratings effectively mean the same thing, despite the supposed difference in approaches, is bang on. Default on sub-debt but not on senior debt can happen, but it is the exception rather than the rule. In practice, few market participants can be bothered to differentiate between the ratings assigned by the agencies, and the historical default statistics published by the agencies confirms that they are close enough that the difference isn’t worth worrying about.

By: genauer

genauer — Tue, 16 Aug 2011 16:31:43 +0000

I think Lewey has summed it in not only the way it is, but has to be. Has anybody here ever tried to come up with her own credit ratings, for corporations, ETFs, countries ?
I did, and you end up with very similar ways. It is kind of generic. But in the end there always has to be a certain judgement, and not just some official numbers, especially if you dont trust them, but cannot say so in public. If you look at Greece, Portugal, Ireland, S&P was the more agressive in downgrading, what, from my perspective represents their more independent positioning. But ultimately none of them can stay too far away from CDS and interest spread numbers (especially in Euroland)without getting ridiculous. Just like federal bank rate announcements. Rating the US AAA or AA also depends on things you can not say in public, and whether you were horrified of the discussion or, with some knowledge of the US history, just enjoyed the show.

By: johndelaney

johndelaney — Tue, 16 Aug 2011 14:35:15 +0000

Without going into the question of likelihood, I think there’s another reason why a default on subordinated debt could have a more severe impact on a financial institution than a default on senior debt: if the debt is truly subordinated and therefore puts these “tier-2″ holders in a position similar to that of equity holders, regulators often allow tier-2 issues to count toward a financial institution’s capital requirements. So, if a senior default weren’t already apocalyptic enough, a t-2 default could mean that an institution also fails to meet its capital requirements. Not good!

By: Greycap

Greycap — Tue, 16 Aug 2011 13:05:57 +0000

“isn’t that exactly what we saw at Anglo Irish Bank?”

There have been many examples of 100% recovery in history. In fact, considering only nominal amounts, recoveries are sometimes over 100%. One way this can happen is that interest can be accrued on delayed settlement. Another (which applies more to loans than bonds) is that restructuring can result in more onerous covenants on the borrower; covenants that can trigger various payouts if breached. These covenants have positive economic value which boosts effective recovery.

(It is normal to report nominal recovered amounts; something to bear in mind when examining recovery statistics. The record I have seen is 100% recovery … after 20 years!)

But I digress. The issue is that while *realized* recoveries may be 100% or more, a rating is supposed to indicate *expectations* of recovery. An expectation of 100% corresponds to zero recovery risk. I challenge you to produce a historical example of a market expectation of 100% recovery. Especially since you are the guy who always says there is no such thing as a risk-free asset!

Finally, I can see that my comments were both hyperbolic and snarky; I apologize. But you did wind me up!

By: Danny_Black

Danny_Black — Tue, 16 Aug 2011 11:53:58 +0000

aquacalc, if you think Dagong is serious you should rush out and buy chinese bank debt and local government debt. China just spent 10% of GDP bailing them out. Let us know how that works out for you, maybe you’ll do as well as the geniuses who bought chinese companies that reversed onto US and Canadian exchanges.

Apparently everyone DOESN’T know the difference between sub debt and other debt. You and the “financial engineer” Mike Konzal apparently didnt know the difference with first and second mortgages. Also sov debt is completely different from corporate debt. For one thing, if the US gov defaults no one is going to be selling off the white house, as the debt is backed by the faith and credit of country. The resolution process is different too – ie no international chapter 11 or bankruptcy court.

By: aquacalc

aquacalc — Tue, 16 Aug 2011 11:23:09 +0000

The view from the head of Dagong, the Chinese rating agency, in a short interview translated in the English version of Der Spiegel:

http://www.spiegel.de/international/worl d/0,1518,780502,00.html

By: nixonfan

nixonfan — Mon, 15 Aug 2011 22:22:51 +0000

David is a friend and former colleague. After the East Asian crisis and then Enron/WorldCom, investors wanted rating methodologies that were “transparent and replicable”. As a result, today Moody’s publishes somewhat prescriptive methodologies for all major sectors. While these are not binding on the rating committee, they provide clear signals about what matters and what doesn’t. This is good for investors and issuers who used to have to guess about criteria. It also introduces a greater degree of intellectual rigor, because it prevents dancing around the data. Do the methodologies produce rating outcomes that are consistent with expected loss? That question is answered by Moody’s default studies and rating performance metrics. S&P had clear sectoral criteria and specific criteria for the US. They followed those criteria. You may not agree, but at least they are not playing games.

By: Greycap

Greycap — Mon, 15 Aug 2011 20:35:38 +0000

Now do you grasp Levey’s point? Say a company issues two bonds, one “senior” and one “subordinated.” The meaning of this is that in the event the company defaults, the claim of the first is senior to that of the second, and is paid first. The default probability of the two bonds is identical but the expected recovery in event of default is not. So if they have different ratings, the ratings can only be explained by recovery.

This case is extremely common, in contrast to your “main case”, which arguably has never existed in the history of the world and will never exist until the end of time.

By: Greycap

Greycap — Mon, 15 Aug 2011 20:26:11 +0000

“Subordinated debt is more likely to default — that’s what subordinated means.”

No it doesn’t. Subordinated means “subordinated”: lower in claims priority than other debt in the event the issuer defaults. So it has lower recovery, not lower default probability.

By: Foppe

Foppe — Mon, 15 Aug 2011 20:16:36 +0000

I fear that this is exactly the reason why S&P started coming out with weirdly precise deficit-cutting targets — the “chop $4 trillion over ten years, or we’ll downgrade”

Yes, and I'm sure it that the weirdly large size (along with the fact that there is no economic-'theoretical' reason whatsoever to assume that massive government spending cuts will create economic health rather than a "double dip") has nothing to do with the fact that S&P is owned by McGraw-Hill, and that the CEO of that firm is also the head of the Business Roundtable..