DM Sovereign Rating Model For Q2 2019

We have produced this ratings model to assist investors in assessing relative sovereign risk over a wide range of Developed Markets (DM), 33 in all. We have decided to adhere to MSCI methodology and have moved Hong Kong, Israel, and Singapore from EM to DM.

Scores directly reflect a country’s creditworthiness and its underlying ability to service sovereign debt obligations. Each country’s score is determined through a weighted compilation of fifteen economic and political indicators, which include debt/GDP, current account/GDP, GDP growth, actual and structural budget balance, per capita GDP, political risk, banking sector strength, and inflation.

These scores translate into a BBH implied rating that is meant to reflect the accepted rating methodology used by the major rating agencies.

 

DEVELOPED MARKETS RATINGS SUMMARY

There were three DM rating actions recorded since our last update. Each agency was responsible for one rating move. S&P upgraded Portugal by a notch to BBB with stable outlook. Moody’s upgraded Greece two notches to B1 with stable outlook. Lastly, Fitch moved the outlook on the UK’s Aa2 rating to Rating Watch Negative.

 

DEVELOPED MARKETS RATINGS OUTLOOK

Within the AAA credits, scores were mixed. The stronger AAA credits (mostly northern eurozone, Asia, and the Scandies) easily maintained their implied ratings. Of note, the US improved modestly and moved back (barely) into AAA territory. It has been going back and forth between AAA and AA+ for several quarters and still bears watching. If the tax cuts lead to further fiscal deterioration, we think it would likely push the US deep enough into AA territory to trigger downgrades for the US.

Within the AA credits, most scores improved. Slovenia’s implied rating rose a notch to AA/Aa2/AA, reversing last quarter’s drop and suggesting greater upgrade potential for actual ratings of A+/Baa1/A-. Israel entered our model universe at AA-/Aa3/AA- last quarter but improved this round to AA/Aa2/AA. This suggests stronger upgrade potential for actual ratings of AA-/A1/A+. Lastly, Estonia’s implied rating jumped two notches to AA/Aa2/AA, suggesting upgrade potential for actual ratings of AA-/A1/AA-.

Within the A credits, most scores were steady to higher. However, none improved enough to change their implied rating. Of the countries in this group, Portugal stands out for having the greatest upgrade potential.

Within the BBB credits, most scores improved. Italy was the outlier and saw its implied rating drop a notch to BBB-/Baa3/BBB-, reversing last quarter’s rise.  We see rising downgrade risks for Italy.

Within the BB credits, Greece’s score improved modestly. Its implied rating of BB-/Ba3/BB- still suggests upgrade potential to S&P’s B+ and Moody’s B3 ratings. Fitch’s BB- appears to remain on target.

 

CONCLUSIONS

DM sovereign ratings remain largely intact. Many scores improved this quarter, but this improvement will be hard to sustain in the face of slower global growth in 2019. We continue to believe that our model helps investors identify dislocations and potential divergences in the agency ratings.