Developed Markets Sovereign Rating Model for Q3 2015

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In our Q3 DM Sovereign Ratinn Model, we assess relative sovereign risk in 30 Developed Markets (DM). In this round, Malta has been added to our model.

INTRODUCTION

We have produced this ratings model to assist investors in assessing relative sovereign risk over a wide range of Developed Markets (DM), 30 in all. We have added Malta to our model this round. 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, 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 agencies.

DEVELOPED MARKETS RATINGS SUMMARY

There were 10 DM rating actions that have been recorded since our last update in May. They were split almost evenly between positive (6) and negative (4) actions. However, netting Greece out, we instead saw 5 positive actions and 1 negative action. In the previous period, 4 actions were positive and 8 were negative. Here too, Greece accounted for 6 of the 8 negative actions. Netting Greece out gives a more positive view on DM ratings for this year – 9 positive moves and 3 negative moves.

With regards to Greece for this reporting period, all three agencies downgraded it. S&P first cut it from CCC to CCC-, followed by Fitch’s cut from CCC to CC and Moody’s cut from Caa2 to Caa3. However, S&P has so far been the only one to upgrade Greece after the recent crisis, moving it from CCC- to CCC+ this month with a stable outlook.

The other negative action this reporting period was taken by Moody’s. It moved the outlook on Finland’s Aaa rating from stable to negative, citing a worsening fiscal outlook and a rising debt load that stem from a prolonged period of slow growth.

On the positive side, S&P was the most upbeat of the agencies and provided all but one of the positive actions. Besides the upgrade on Greece, S&P moved the outlook on the Netherland’s AA+ rating from stable to positive. S&P then upgraded Ireland from A to A+ with a stable outlook, and then moved the outlook on Slovenia’s A- rating from stable to positive. S&P also upgraded Iceland from BBB- to BBB with stable outlook. Moody’s provided the only other positive action, upgrading Iceland from Baa3 to Baa2 with stable outlook.

Source: BBH, Bloomberg

DEVELOPED MARKETS RATINGS OUTLOOK

The stronger AAA credits (mostly the dollar bloc, the Scandies, and the northern eurozone) easily maintained their position this round. For this group, model scores were generally flat or improved, as Switzerland and Norway were the only ones to see deteriorating scores. On the other hand, Sweden, Luxembourg, the Netherlands, and Germany saw their scores improve the most. None moved by enough to signal an imminent rating change in either direction, and we believe all are correctly rated at this time.

Within the AA credits, Estonia, Belgium, and France saw their scores improve. France’s implied rating of AA-/Aa3/AA- still suggests downgrade risks to its AA/Aa1/AA actual ratings. Implied ratings for Estonia suggest upgrade potential. For Belgium, no rating actions are signaled. Iceland’s implied rating of AA-/Aa3/AA- underscores upgrade potential. The UK’s score improved slightly, but it still appears correctly rated at AA+/Aa1/AA+. We introduce Malta into our model as a AA+/Aa1/AA+ credit, which suggests upgrade potential to actual ratings of BBB+/A3/A.

Within the A credits, the story was mixed. Japan saw its score worsen slightly but its implied rating was steady at A+/A1/A+. While we did not agree with Fitch’s one notch downgrade to A, we think that S&P’s AA- rating is too high. Ireland’s implied rating of A+/A1/A+ signals upgrade potential to Moody’s Baa1 and Fitch’s A-. Implied ratings for Slovakia, Latvia, and Lithuania suggest modest upgrade potential. We see strong upgrade potential for Italy, as actual ratings of BBB-/Baa2/BBB+ are well below our implied rating of A-/A3/A-.

Within the BBB credits, the story was mixed too. Spain saw a slightly worse score but its implied rating of BBB+/Baa1/BBB+ suggests upgrade potential for S&P’s BBB and Moody’s Baa2. Slovenia’s implied rating of BBB/Baa2/BBB suggests some modest downgrade risk, while Portugal’s implied rating rose a notch to BBB/Baa2/BBB and suggests upgrade potential to actual ratings of BB/Ba1/BB+.

Within the BB credits, the implied ratings for both Cyprus and Greece improved slightly. Greece deserves a special mention. The nation has undertaken a massive adjustment that has seen actual and structural budget deficits as well as the current account balance improve significantly. We believe these improvements have been enough to move Greece into low BB territory. If a credible debt trajectory can be established that significantly lowers the long-term default risk, we think that current ratings will be upgraded closer to our model rating. Cyprus faces upgrade potential, as its implied rating of BB/Ba2/BB is above current ratings of B+/B3/B-.

CONCLUSIONS

Despite steady implied ratings, it is clear from the scores that fundamentals are taking divergent paths for many countries across the DM universe. Many are improving, but some are deteriorating. We continue to believe that our model helps to identify the winners and the losers within this divergence trend.