DM Sovereign Rating Model for Q3 2018

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.  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. We changed the methodology slightly last year to include Net International Investment Position (NIIP) and the national savings rate.

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 7 DM rating actions that were recorded since our last update, all positive save one. So far in 2018, there have been 16 positive actions and only 1 negative. For all of 2017, the total was 26 positive and 2 negative. In 2016, the count was 12 positive and 10 negative and so there is a clear and very strong improving trend within DM that has carried over into 2018.

Moody’s was the most upbeat with three positive moves since our last update. It upgraded Cyprus from Ba3 to Ba2 with stable outlook. Moody’s also moved the outlooks on Iceland’s A3 rating and France’s Aa2 rating from stable to positive. Moody’s also provided the sole negative move, putting Italy’s Baa2 rating on review for possible downgrade.

S&P was next with two positive moves since our last update. It upgraded Greece from B to B+ with stable outlook, and then later moved the outlook on that B+ rating from stable to positive.

Fitch made one positive move since our last update. It moved the outlook on Austria’s AA+ rating from stable to positive.

DEVELOPED MARKETS RATINGS OUTLOOK

The stronger AAA credits (mostly northern eurozone) easily maintained their standings this round. Most scores were steady or better. Switzerland, Canada, and Australia bucked the trend and saw minor deterioration in their scores. Ireland’s implied rating was steady at AAA/Aaa/AAA after rising a notch last quarter and still suggests strong upgrade potential for actual ratings of A+/A2/A+.

Within the AA credits, the scores were mixed. Of note, the US deteriorated modestly and moved back (barely) into AA+ territory. It has been going back and forth between these two categories for several quarters and bears watching. If the recent tax cuts lead to significant fiscal deterioration, it would likely trigger downgrades for the US. Japan’s implied rating improved to AA+/Aa1/AA+ and suggests stronger upgrade potential to actual ratings of A+/A1/A. The UK’s implied rating improved a notch for the second straight quarter to AA-/Aa3/AA-, suggesting diminished downgrade risk to actual ratings of AA/Aa2/AA. Estonia and Slovenia both hung on to last quarter’s move into AA territory and so enjoy continued upgrade potential.

Within the A credits, the scores were also mixed. Lithuania hung on to last quarter’s improvement in its implied rating to A+/A1/A+, while Portugal’s hung on to its improvement to A/A2/A. Both are enjoying upgrade potential. Slovakia’s implied rating was steady at A/A2/A after dropping a notch last quarter. This still suggests downgrade risks to S&P’s and Fitch’s A+ rating, while Moody’s A2 appears to be on target now.

Within the BBB credits, we saw movement in both directions. Cyprus saw its implied rating improve a notch to BBB/Baa2/BBB. This suggests greater upgrade potential for actual ratings of BB+/Ba2/BB+. On the other hand, both Spain and Italy saw their implied rating fall a notch to BBB+/Baa1/BBB+, dropping them back into BBB territory.

Within the BB credits, Greece’s score improved. This was enough to reverse last quarter’s drop and moved its implied ratings back to BB-/Ba3/BB-. This still suggests upgrade potential to actual ratings of B+/B3/B as all three seem too pessimistic.

CONCLUSIONS

Given the upward path this quarter for scores and implied ratings, it is clear that fundamentals are still mostly improving across the DM universe.  Most countries improved this past quarter, but some are still deteriorating. We continue to believe that our model helps to identify the winners and the losers within the ongoing divergence trend across most markets.