(Photo courtesy of Movietome.com)
This week has been quite crazy on the financial front. We saw another global stock market rout last Tuesday after an intra-meeting Fed rate cut that sparked renewed fears of a US recession. At least 24 hours after, we saw global markets recover, and at weeks end yesterday, several, almost unbelievable news.
On Wednesday, we had HSBC’s visiting economist Fred Neumann saying he was not even changing his economic forecast for the Philippines despite all the talk about an impending US recession. Early on Friday, Moodys Investor Service upgraded the outlook for the Philippines to positive from stable. A few hours after, the Government Service Insurance System signed an investment agreement with two global investment banks to invest $1 billion of its funds overseas–initially. All these while markets were still cautiously recovering from the sell-offs on Tuesday.
Here’s something that can help non-financial people understand sovereign credit ratings.
When Moodys, Standard and Poors and Fitch Ratings announce something, the market is all ears. In the late 1990s, they were severely criticized for failing to spot the debt excesses of Asia’s economies. When that criticism fizzled out, markets went right back at tracking what credit rating agencies had to say.
What these firms do in a nutshell is analyze the financials of countries and corporations that issue bonds. They give out ratings that are widely assumed to be independent and objective. These debt ratings influence returns on bond investments directly, and equities investments indirectly. I saw analysts from these firms descend on government officials like Men In Black, and we financial beat reporters shadowed them like little mice. One government official told me then that credit rating agencies charge quite a hefty sum of money to analyze and give out ratings.
Here are the ratings and what they mean, in English:
Aaa/AAA – debt that belong in this category are the crème of the crop. They are considered to have the highest credit quality, meaning there is almost no chance they won’t be able to pay their debt. For investors holding instruments with this rating, that means your money is very safe.
Aa/AA – “Double A” debt is still considered to be very safe investments, but with modest risk that may change from time to time because of economic conditions.
A/A – At this level, there’s already some risk associated with ability to pay but at very low levels.
Baa/BBB – Already a little bit risky and speculative, but considered still suitable for institutional investors. Risk of not being paid is higher when the economy goes under stress.
Ba/BBB – Risky and speculative. Overall quality may move up and down frequently.
B/B – there is real risk that obligations will not be paid. Investors have to watch debt in this category closely, because the quality fluctuates widely.
Caa/CCC – bonds are in poor standing. Some are in default. Others are in danger of default.
Ca/CC – highly speculative, often in default. That means, you as bondholder, wouldn’t get paid if the borrower defaults on its obligations.
C/C – with almost no chance of ever getting a better rating.
Sometimes, you see ratings like Ba1 or Ba2. Ratings agencies use numerical “modifiers” to further refine its ratings. Also remember not to confuse credit upgrade with an upgrade in outlook. Moody’s decision yesterday, for example, was to upgrade the outlook from stable to positive, which means there is a possibility Moody’s would upgrade the country’s credit rating within 12 months if the economy shows further improvement.
A dose of financial market irony: The Philippines is considered three notches below investment grade or a very speculative investment in global markets. In Philippine markets, government bonds are considered the safest. 
Why would institutional investors buy Philippine government bonds, then? Debt instruments below investment grade offer higher returns compared with bonds with A-class credit ratings. When you hear bankers saying “investors ask for a higher premium because of the higher risk,” that merely means “you have to pay me more interest because I’m not even sure if you can pay me back!”
Here’s a summary of credit ratings from different ratings issuers, courtesy of The Bond Market Association (now the Securities Industry and Financial Markets Association and Blaha.com.
