Friday, 3 April 2020

Two of the “Big Three” Affirm the US Sovereign Credit Rating

In continuing the new approach of providing small updates on the credit rating industry here in financial regulation matters, today’s brief post assesses the recent announcements by both Fitch and S&P regarding the sovereign rating of the United States.


Just before last week’s downgrading of the UK’s credit rating, as we covered here Fitch had, on the 26th March, affirmed the US’ credit rating as AAA, with a stable outlook. Despite warning that the coronavirus pandemic was inflicting an unprecedented shock on the market, Fitch believes that both a. the country is deploying adequate resources (financially, at least) as part of its $2T stimulus package, and that b. as long as the pandemic clears before 2021, the agency expects the drop in GDP to reverse sharply and bounce back. All of the agency’s analysis is caveated by the development and potential continuation of the pandemic, naturally. Yesterday S&P followed suit, affirming the US credit rating as AA+, with a stable outlook. S&P expect continued political disputes to affect the economic progression of the country but, like Fitch, sees the recent stimulus package as positive in terms of dealing with the economic impact of the pandemic. S&P also envisage a strong 2021, pandemic depending. However, both agencies seemingly agree that the debt and fiscal deficits are likely to continue to worsen, as we know they will, but that this will have a negative effect for quite some time moving forward.

Thursday, 2 April 2020

State Intervention Sees HSBC Threaten to Leave the UK

The COVID-19 pandemic has created a global scene that is producing some incredible reactions. One of which is the level of state-backed intervention that is occurring in the UK and US, with the respective Conservative and Republican governments announcing record financial packages. However, as part of that intervention, we are starting to see elements of state intervention in private business that is not being received well by the market. In this post, we shall examine the Bank of England’s decision, as part of its role as the British regulatory framework’s top supervisor, to apply pressure to banks to cancel dividends. For HSBC, and its structure, this has proven to be a particular issue.

It was reported recently that a number of the UK’s largest banks had received pressure from the Prudential Regulation Authority, the regulatory arm of the Bank of England, to halt their dividends ‘after they were warned against paying out billions of pounds to shareholders during the coronavirus pandemic’. Amongst the group were Lloyds, RBS, Barclays, HSBC, Santander, and Standard Chartered (Nationwide, the building society, was also included), who all had also agreed to cancel any plans for share buybacks. In a somewhat unusual display of authority, the PRA sent a ‘formal request’ to the companies, although it went further by declaring that is was ‘ready to consider use of our supervisory powers’ if the banks did not comply with the request. Barclays, for one, had responded by stating that whilst it was a difficult decision to cancel dividends, they thought it ‘is right and prudent, for the many businesses and people that we support, to take these steps’. However, the sentiment was not shared across the group.

On the 14th April, HSBC was due to pay a dividend of $4.2 billion. For HSBC, more than four-fifths of its profits comes from Asia and, in Hong Kong specifically, a large proportion of that dividend was due to be paid to retail investors who ‘rely on dividends for a significant part of their income’. It has been suggested that a number of the banks’ Boards were waiting for the regulator to impose this move, in line with EU freezes witnessed last week, to protect them from shareholder criticism, but for HSBC the effect has been immediate. For the first time since records began in 1946, the dividend freeze has resulted in shares in the bank falling by nearly 10% in both London and Hong Kong trading, wiping nearly £8 billion from its valuation. Fitch Ratings, yesterday, changed the bank’s outlook to Negative. This has spurred the HSBC Board to consider a number of elements. The Financial Times, citing an ‘executive’, suggest that the HSBC Board are annoyed that the decision sends out a message that the bank is in a weak position, when in fact they are not. Yet, despite official communication that says the Bank fully understands the decisions of the PRA, and that there are no discussions ‘to review HSBC’s global headquarters and no plans to reopen the issue’, this has not stopped speculation. Originally based in Hong Kong from when it was founded in 1865 as the Hongkong and Shanghai Banking Corporation by Thomas Sutherland, to 1993 when it moved to the UK to aid its takeover of Midland Bank, the bank is now placed in a delicate position of being between two very different social structures. The anger that is supposedly spurring such discussions regarding re-domiciling elsewhere will inevitably be countered by the reason HSBC moved to London in the first place – to escape the clutches of the Chinese Government. If they were to move back to Hong Kong, that issue would re-emerge. There is apparently anger because ‘for the regulators at the Bank of England to put a gun to the head of the board of directors is terrible’, but this sense of freedom to whatever it wants would certainly be curtailed in a similar, if not more extreme fashion in Hong Kong. It is more likely that this supposed outburst is the bank’s attempt to exert its influence over the regulator as, in the coming post-Brexit and now post-COVID-19 arena, the UK will need the City of London to be as strong as possible, with losing HSBC to Hong Kong representing, prospectively, a massive blow. Yet, it is likely that the PRA both know and anticipated this. For its position, it cannot become a victim of extortion every time it seeks to implement a regulatory endeavour that does infringes, at any level, upon the freedoms of the banks.


Keywords – banks, HSBC, Hong Kong, China, UK, @finregmatters

Wednesday, 1 April 2020

EU asks for information on how Credit Ratings are used

In doing something slightly different for financial regulation matters, this post is just a small update for those connected or interested in the credit rating industry. The EU, on the 30th March, has published a call for comments on the availability and use of credit rating information and related data. As stated on the ESMA’s website, ‘the purpose of this call for evidence is to gather information on the specific uses of credit ratings as well as how the users of credit ratings are currently accessing this information’. This reflects an alteration in regulatory direction that a number of entities have been calling for – instead of just focusing on the rating agencies and mis-regulating because of a lack of scope, a greater focus needs to be placed on the users of credit ratings. This call for information is the EU’s attempt to start that process. I am reminded of my own journey in which the scholarly literature is massively negative regarding the credit rating industry and its usefulness, but in having spoken to a number of practitioners, there were more people than I had anticipated who found the ratings useful in their business practices – this is, of course, not to say that this sentiment is universally shared amongst practitioners. Yet, regulatory speaking, this is a positive move from the EU and, arguably, should have happened much sooner. It seems to be a direct reaction to the phenomenon we are witnessing at the moment; a lot of regulatory capital was expended on reducing regulatory reliance, and the use of credit rating subsequently increased, rather than decrease had many had expected.

The call is currently open and will remain open until the 3rd August 2020. ESMA have stated that ‘input is welcomed from all interested stakeholders, including users of credit ratings such as public authorities and financial market participants, credit rating agencies, as well as distributors of credit rating data’. The aim of the endeavour is to consider options that will improve access to and use of credit ratings, and also whether there is scope to improve the usability of the information provided for on rating agencies’ websites – the sentiment to this can be seen to be somewhat of an antithesis to the sentiment that was promoted when ending regulatory reliance was at the forefront of global regulatory efforts.


Saturday, 28 March 2020

Rating Agencies Take Aim at Sovereign Debt Ratings

In this short post today, we will look at the news recently regarding the rating agencies’ declarations regarding two countries’ sovereign debt ratings, what underpins them, and what may be next for countries facing up to the COVID-19 pandemic, amongst a number of other impactful factors.

The first news came from South Africa. As was to be expected on account of the other two rating agencies downgrading South Africa to ‘junk status’, Moody’s finally took the leap and cut South Africa’s rating to Ba1, from Baa3, with the outlook remaining negative. In providing details as to why Moody’s finally followed S&P and Fitch in downgrading South Africa to junk status, albeit 3 years later, the agency stated that the key driver underpinning the downgrade was ‘the continuing deterioration in fiscal strength and structurally very weak growth, which Moody’s does not expect current policy settings to address effectively’ (sign-in required). The agency then went on to detail the reasoning for the negative outlook it ascribed, stating that the country’s access to funding will be negatively impacted by market conditions, thus making the prospect of recovery that much harder. This negative view on the country’s progression is shared by many onlookers and experts, with economists warning of further upheaval as South Africa’s GDP is predicted to continue to fall. For its part, the Government of South Africa has admitted that the downgrade comes at the worst possible time and that it, along with the COVID-19 pandemic, ‘will truly test South African financial markets’. It is highly likely that the South African economy will experience more hardship in the near future.

The second country to have its rating changed recently by one of the Big Three is the UK, with Fitch cutting its sovereign rating to AA-, the same as Belgium and the Czech Republic. It is also putting the UK on a negative outlook as it predicts that a further cut could follow. In detailing why it took this action, Fitch stated that ‘a significant weakening of the UK’s public finances caused by the impact of the COVID-19 outbreak and a fiscal loosening stance that was instigated before the scale of the crisis became apparent’ was at fault. Furthermore, the negative outlook was based upon the agency’s view that ‘reversing the deterioration in the fiscal metrics beyond 2020 will not be a political priority for the UK government. Moreover, uncertainty around the future trade relationship with the EU could constrain the strength of the post-crisis economic recovery’. The UK Treasury has recently stated that its borrowing is the right course of action to protect the economy, but given the downgrade comes only a few short months after a recent improved assessment by Fitch, the volatility will be worrying for all concerned. With health experts suggesting the UK’s measures to fight the COVID-19 pandemic could extend into months, the economic impact of such measures will only add pressure to this downward movement for the country’s sovereign rating.

In other news regarding sovereign debt ratings, Mexico saw its rating cut by S&P to BBB from BBB+, with the agency declaring that the pandemic, alongside the shocks to the price of oil, were determining factors in its decision. In a similar vein, Oman saw its rating from S&P lowered even further into junk territory, on account of the country’s dependence on oil revenue. Fitch recently cut Ecuador’s rating to CC because its fuel-dependent economy is struggling, alongside its decision to recently renegotiate some of its commercial responsibilities. Elsewhere, analysts have suggested that Germany’s prized AAA rating may come under threat as its increased spending in reaction to the pandemic takes hold. With Nigeria and Angola all experiencing downgrades recently because of their dependence on oil price movements, whilst Russia and Saudi Arabia only just escaped downgrades from S&P. With Russia’s banking system being sized up for downgrades by both S&P and Moody’s however, the volatile climate looks set to be represented in the sovereign bond market also. The sovereign debt analysts at all the rating agencies will be working hard to keep abreast of the ever-changing conditions, with many more rating decisions likely to be forthcoming. Analysts are predicted downgrades globally by much bigger delineations than we are currently seeing, and the current trend makes that difficult to argue with.


Keywords – ratings, sovereign debt, downgrades, COVID-19, business, @finregmatters

Thursday, 26 March 2020

SoftBank Challenge Moody’s and Raise Questions over Rating Timeliness

The giant Japanese conglomerate SoftBank, a holding company that holds shares in Sprint, Alibaba, Uber, and many others, was recently downgraded by Moody’s dragging it further into ‘junk’ status. However, it has decided to take aim at this decision and has suggested that Moody’s has ‘biased and mistaken views’. Is this retaliation to Moody’s justified, or is it a company, and a CEO, under increasing pressure as its debts continue to build?

SoftBank, founded in 1981 by Masayoshi Son (now CEO), went public in 1994 and was valued at $3 billion. Since then, it has gone on to become one of the world’s largest public companies, and Japan’s second largest behind Toyota. However, recently there have been concerns from the market that the company was exposing itself to too much debt, with the Financial Times reporting that SoftBank currently has $55 billion in net debt. It was on this basis, supposedly, that Moody’s took its recent decision to downgrade SoftBank’s credit rating by two notches, from Ba1 to Ba3. In order to reduce this debt burden, SoftBank have been planning to sell a number of its shares in the companies it holds stakes in, and increase the scale of a share buyback. It plans to sell a total of $41 billion of its shares, which the FT recently labelled as am ‘emergency’ asset sale to stem the collapse in its share price as a result of the Covid-19 pandemic. It had not been confirmed which shares would be liquidated, but analysts have suggested that its shares in Alibaba, totalling nearly $140 billion, would be a prime source of such liquidation (Son was an early investor in Alibaba).

Yet, for Moody’s, this was an ‘aggressive financial policy’ that was to form the basis of the downgrade. The rating agency suggested that the company’s value would be reduced significantly if it liquidated even parts of its stake in Alibaba, and also Sprint. Motoki Yanase, a Moody’s senior credit officer, said that ‘asset sales will be challenging in the current financial market downturn, with valuations falling and a flight to safety’. SoftBank have in turn stated that the downgrade ‘deviates substantially’ from Moody’s stated rating criteria and, as such, creates ‘substantial misunderstanding among investors who rely on ratings in making investment decisions’. As part of its official statement, SoftBank has asked Moody’s to withdraw the rating. Whilst analysts have suggested that removing the rating will likely not make much difference to the company, as it will still incur higher borrowing and refinancing costs, the unusual move is still very much a notable one. Yet, Moody’s competitors do not share their view, with S&P declaring that although it recently cut its outlook on SoftBank to negative, the planned share sales had the ‘potential to ease the downward pressure on its credit quality’. SoftBank, predictably, agree with this, stating that Moody’s rating was based on ‘excessively pessimistic assumptions regarding the market environment and misunderstanding that SBG will quickly liquidate assets without any thorough consideration’. Some analysts have fallen in line with this argument (albeit reluctantly it seems), with an analyst from CreditSights being quoted by the FT as saying ‘as much as we hate to pick sides, we do not follow Moody’s rationale here… we would go as far to say Moody’s are using the [SoftBank Group] asset sale announcement as an excuse to re-rate a credit which was overdue a downgrade’.

This brings forth an interesting issue. On one side we have Moody’s downgrading, and on the other we have its main rival and other analysts suggesting that either a. the share sale may work, and b. that the Moody’s downgrade is potentially behind the curve. There are two issues which shed more light on this. SoftBank still has an investment-grade rating from JCR, a Japanese rating agency and, as a result, is issuing significant amounts of debt into the Japanese domestic credit market. However, its position is becoming increasingly precarious but not, crucially, because of its debt exposure (though it is, of course, all interrelated and an important factor). It has been noted that one of the company’s biggest issues is that its bets on particular industries have put it directly in the crosshairs of the Covid-19 pandemic and the world that it is creating. Its ownership of companies like Uber and WeWork are coming under increasing pressure in the current climate, and the stability of the company’s $100 billion ‘Vision Fund’ is worrying investors (the fund invests in emerging technologies among other things). The company is heavily invested in industries that rely on the concept of ‘sharing’ like Uber (taxiing and shared-ride services), WeWork (co-working spaces), and Chinese company Didi Chuxing (ride-sharing). These sharing-economy industries are suffering badly at the moment and this should be one of the key aspects affecting its creditworthiness. In its rating rationale (available here [though sign-in is required]) Moody’s state that ‘it is unclear why SBG is undertaking such a dramatic recapitalisation during a time of severe stock and market volatility’. Perhaps, the exposure to industries that are capitulating in the current climate is just one, albeit a major factor in the need to reduce its debt burden so rapidly. This will, of course, be known by Moody’s, so the question can be raised as to why that factor is not included within its rationale, with the agency instead going with ‘it is unclear’ why the company are taking such apparently drastic measures. The more transparency that can be articulated via rating rationales the better, and this is a common request of the rating industry. It is likely why analysts are suggesting that Moody’s is using this stock liquidation as an excuse to downgrade when they should have done this a while ago. We spoke yesterday of the glaringly-obvious importance of ESG-consideration in the rating process in the light of the current climate, and this rating downgrade perhaps alludes to that sentiment further. A very helpful comment on social media with regards to yesterday’s post said that nobody could have foreseen the Covid-19 pandemic coming, which is absolutely true. However, moving forward, the experience can be utilised (whilst it is also worth stating that the outbreak began around the turn of the year in China, which may have raised some alarm bells, even if just on a very conservative basis). That the globalised world can be ground to a halt because of the spread of disease must now be hardwired into the rating process when an agency considers ESG in its processes, and factored in accordingly. A company which is heavily invested in the sharing economy should, with the benefit of hindsight, have this factored into their creditworthiness assessment moving forward and, perhaps, indefinitely so. The title of the post is with regards to timeliness affecting the opinion that onlookers have of rating agencies, but perhaps the key here for Moody’s is to be incredibly articulate and open with its rating rationale, even it just declares that it has attempted to connect the dots in order to come to a rating decision; stating that it is ‘unclear’ why a company is taking a certain decision will only ever lead to accusations that harm the authority of a rating agency, rather than promote it (whether rightly or wrongly).


Keywords – Moody’s, CRAs, SoftBank, Covid-19, business, @finregmatters

Wednesday, 25 March 2020

The Wave of Credit Downgrades Rises on the Horizon

A number of financial media outlets, including Forbes, the Wall Street Journal, and the Financial Times are all reporting that a wave of downgrades is soon to be upon us because of the effects of the Covid-19 pandemic. In this post, we will take a look at those who have been downgraded, those likely to be downgraded, and also the wider effect of these downgrades. Also, it will be worth asking why so many downgrades are on the horizon because, as one journalist recently wrote (Cezary Podkul of the WSJ), ‘a bond rated AAA is supposed to keep that grade, even in tough times like these’. This is the theoretical foundation of the credit rating differentiation, so why so many downgrades?

On the 17th March, Forbes reported that ExxonMobil had been downgraded by S&P, to AA from AA+. On the same day, S&P took aim at Boeing, downgrading the beleaguered aircraft manufacturer’s rating by two notches, from AA- to BBB (just two notches above ‘junk status’. There are, perhaps, other reasons for these particular downgrades. Boeing is undergoing one of the most difficult periods in its history (as we have discussed before here in Financial Regulation Matters) and, as ExxonMobil’s CEO Darren Woods stated immediately after the downgrade, the company is aiming to reduce its capital and operating expenses as a result of the tumultuous climate, something S&P cited as being one of the reasons for the downgrade. However, there are a number of other high-profile companies being downgraded which onlookers are suggesting is just the start of a larger wave. Lufthansa was recently downgraded to junk status by Moody’s, S&P cut Lufthansa and British Airways’ parent company IAG to one notch above junk, whilst cruise ship operators Royal Caribbean and Carnival have been placed on a negative outlook credit watch by S&P. We already know that Kraft-Heinz has been downgraded to junk, whilst Macy’s suffered the same fate not so long ago. S&P recently said that default rates in the US were surging past 10%, up from 3.5% just last month. The effect of this is that a number of other companies may be caught in the general downturn, leading to further downgrades. The result of this, as one commentator mentioned, is that it may be the case that there will be too much ‘junk’ debt flooding the marketplace and not enough investors with the appetite or capability to absorb it.

The downturn has continued to affect sectors. The insurance sector is experiencing some losses (the Philadelphia Contribution Group was recently downgraded by AM Best). In the troubled CMBS market, S&P recently stripped a AAA grade from a $215 million bond backed by mortgages on the Destiny USA mall. Cezary Podkul and Gunjan Banerji of the WSJ discuss how a number of bonds attached to industries like shopping malls, hotels, airlines, and even local governments are all in line for downgrades, with the rating agencies stating that ‘the global recession is here and now’ and that there has been a ‘severe and extensive credit shock across many sectors, regions and markets’. A further casualty has been Delta Airlines, who have seen their credit status reduced to junk status by S&P. Yet, even though these companies on the brink have been downgraded, a number of AAA rated entities and bonds are being downgraded, which Podkul and Banerji quite rightly note should not be the case, with AAA-rated entities being regarded as safe as Treasury bonds. The sentiment is that such potential shocks should have already been factored into a rating, rather than waiting for them and then reacting via downgrades. According to their article, there are more than 100 downgrades that have been related to the Covid-19 pandemic, and many more are planned. So, how much responsibility should we lay at the feet of the rating agencies?

The unfortunate conclusion is that a number of onlookers who have suggested the rating agencies have very little informational value to add to the marketplace, and are merely reactionary in nature, will be validated by these recent events. The key question is, perhaps, whether we should expect the agencies to foresee a crisis like the one currently enveloping the world, or at the very least whether they should factor in the potential of a crisis of this magnitude happening. Is the Covid-19 a so-called ‘black swan event’? If we accept that this is a black swan event, then the position of credit rating agencies is a difficult one. However, if we suggest that the concerted move into considering ESG-related issues fundamentally within the credit rating production process should have impacted the development of top-rated ratings so much that shocks like these are considered, then the position of the agencies is less precarious. That sentiment would suggest that the rate of downgrades should have been reduced because environmental and/or social elements should have been considered more. Maybe not. Yet, the subjectivity of the ‘E’ and ‘S’ elements, as compared to the ‘G’ element, is now perhaps being revealed to be a major issue with the concerted incorporation of ESG-related information. They are really important elements of the impacts upon businesses, as we are now seeing, and their incorporation is vital. But, finding an agreed-upon understanding of what ESG means, and how it impacts upon creditworthiness, appears to be a fundamental issue. What is clear is that work needs to be done on this issue, on behalf of the agencies, and it needs to be done very quickly. Another raft of downgrades has the potential to affect the authority of the rating agencies, although a number of people would suggest they are somewhat immune to such pressures anyway.


Keywords – credit rating agencies, downgrades, ESG, @finregmatters

Monday, 23 March 2020

British Rail Services “Nationalised” in Response to Covid-19

In response to the global pandemic involving the transmission of the Covid-19 (Coronavirus) disease, a number of extraordinary measures are being put in place around the world. In the UK, the Conservative Government has taken a number of steps which, ideologically, go against their principles. Today, the latest in a line of extraordinary measures was taken when the Department for Transport stepped in to, essentially, nationalise the rail industry in the UK on an emergency basis. The developments and details of that extraordinary measure form this post.

Rail services, along with other modes of travel like aeroplanes and coaches, were quick to suffer the natural consequences of the worsening of the Covid-19 pandemic. A number of rail operators had already started to reduce their services before the British Prime Minister requested that non-essential travel be avoided, and this was accentuated by a further reduction in services in places like London (where up to 40 underground stations were closed last week). The Transport Secretary Grant Shapps stated last week that the aim was to reduce services, but to allow some services to continue so that keyworkers could still perform their duties, and so that freight services could continue delivering much needed supplies across the country. However, today, the Department for Transport spectacularly announced that the Government was taking emergency measures ‘to support and sustain necessary rail services as operators face significant drops in their income’.

Those significant measures centre around the headline-grabbing move to temporarily suspend the franchising system and ‘transfer all revenue and cost risk to the government for a limited period, initially 6 months’. What does this mean? Essentially, the Government has guaranteed the survival of all rail operators who choose to sign up to these measures. The sentiment is that all the operators will fall in line, as there is little chance of survival without doing so. Yet, there are a number of key elements to the decision. Although it has been suggested today that the franchising system ‘had long had its day’ before today’s announcement, the reality is that the rail system in the UK is, as from today, essentially nationalised and that marks a huge turnaround. Second, it is clear from the wording from the DfT that this is not a pre-determined system, and could go on longer than the 6 months cited. Those representing the rail industry supported the moves, whilst the Shadow Transport Secretary also welcomed the moves and suggested that these events will form part of the discussion on how the rail industry moves forward after the crisis. The Government have not just guaranteed the rail industry, but put in place measures for rail passengers to be refunded on all tickets, so as to remove any penalty for abiding by the promoted guidance – not all providers were willing to refund all tickets, like advance tickets. The Government has also placed a cap of 2% of the cost base of the franchise, which they suggest incentives operators to perform adequately but will see a reduction in the profits being extracted by the private companies. In the event that an operator takes the unlikely decision to reject this approach, the Government has said that they stand prepared to step in and rescue the operator and take it over.

So, there are a number of conclusions. Yes the Conservative government has essentially nationalised the rail industry, but this is not nationalisation. It is a response to an emergency which will not be repeated, so the suggestion from Labour that this decision will form part of any post-crisis discussion on the formulation of the rail industry are probably wide of the mark. Also, the argument that this decision will be more cost-effective for the taxpayer in the long-run is accurate. However, this leads to a much more important discussion about what capitalism has become, or perhaps what it has always been. The decision by the Government to nationalise rail operators, and guarantee that any operator who fails will be saved, fundamentally proves that the concept of ‘too-big-to-fail’ is pervasive in the modern society. It is highly likely that the airline industry will prove the same concept, as too might many other sectors. The question is whether these events will be remembered once the crisis is over, or whether it will be ‘business as usual’? Any sort of liberal economic theory now has to be understood in context, and arguably should always have been (as demonstrated by the Financial Crisis) – when push comes to shove, the market cannot support society alone. It is the ‘lender-of-last-resort’ principle that makes capitalism as we know it possible. It is for this reason that there are now claims surfacing, more than before, that this time ‘small people should get the bailouts’. For the time being, that is being promised (in a number of senses, although not universally) but whether or not the principles underlying those claims survive after the crisis has passed is another thing altogether and, most likely, will have a familiar conclusion.


Keywrods – Covid-19, rail, trains, economics, politics, business, @finregmatters