how reliable are sovereign debt ratings?
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Norbert Gaillard, Ph.D.'s presentation at February 29th Debt Ratings Agencies ConferenceTRANSCRIPT
How Reliable Are Sovereign
Debt Ratings?
Norbert Gaillard, Ph.D.
Independent Consultant
Debt Ratings Agencies: Their Role in the Global
Debt Capital Markets – Past, Present and Future
February 29, 2012
Global Interdependence Center
CFA Society of Philadelphia
Conference held at the FED of Philadelphia
Stability of Sovereign Ratings,
Quality and Accuracy of Sovereign Ratings.
2
How Can We Assess Reliability?
Difficulty in anticipating the debt crisis,
Pro-cyclicality of sovereign ratings.
3
Quick Look at the Past: the Wave of Sovereign
Defaults in the 1930s 1/2
Fitch
UP
Moody’s
UP
Poor’s
UP
Standard
Stat. UP
Fitch
DN
Moody’s
DN
Poor’s
DN
Standard
Stat. DN
1925 20.75 9.80 2.13 9.09 41.51 0.00 4.26 4.55
1926 25.00 9.23 1.47 1.54 1.56 4.62 0.00 1.54
1927 17.91 2.74 2.74 0.00 0.00 1.37 0.00 0.00
1928 4.94 3.80 12.50 2.74 0.00 1.27 0.00 1.37
1929 16.67 4.35 0.00 5.88 4.17 3.26 0.96 1.18
1930 23.76 0.00 0.00 1.89 0.00 3.88 4.85 4.72
1931 0.00 0.99 1.98 3.81 60.00 10.89 32.67 30.48
1932 0.00 0.97 0.95 0.00 93.07 84.47 49.52 50.47
1933 2.88 0.00 0.00 0.00 17.31 38.83 21.15 33.01
1934 18.63 2.94 3.96 20.59 6.86 26.47 23.76 9.80
1935 21.65 8.82 21.05 13.40 2.06 3.92 11.58 10.31
1936 16.48 0.00 0.00 11.46 3.30 0.00 7.53 1.04
1937 15.29 0.00 2.20 0.00 12.94 6.45 6.59 7.53
1938 5.63 1.18 0.00 4.82 7.04 0.00 15.12 6.02
1939 1.52 0.00 0.00 17.44 0.00 2.33 23.26 20.93
Source: Gaillard (2011).
Very low default rates for the Double-A and Triple-A
categories,
Five-year default rates for the Single-A category reached
19%-25%.
4
Quick Look at the Past: the Wave of Sovereign
Defaults in the 1930s 2/2
European countries Date of default
Greece 1932
Bulgaria 1932
Yugoslavia 1932
Romania 1933
Germany 1934
Hungary 1934
Poland 1936
Austria 1938
Lat. Am. countries Date of default
Bolivia 1931
Brazil 1931
Peru 1931
Chile 1931
Dominican Rep. 1931
Panama 1932
Salvador 1932
Colombia 1933
Cuba 1933
Guatemala 1933
Uruguay 1933
Costa Rica 1936
5
Pro-cyclicality of sovereign ratings:
Fitch
UP
Moody’s
UP
S&P
UP
Fitch
DN
Moody’s
DN
S&P
DN
Fitch
Ratio
UP/DN
Moody’s
Ratio
UP/DN
S&P
Ratio
UP/DN
2001 12 9 17 17 7 18 0.71 1.29 0.94
2002 16 27 16 10 6 14 1.60 4.50 1.14
2003 23 19 21 9 8 12 2.56 2.38 1.75
2004 24 7 29 2 3 10 12.00 2.33 2.90
2005 19 12 24 8 4 7 2.38 3.00 3.43
2006 13 20 21 2 1 7 6.50 20.00 3.00
2007 12 17 25 3 1 5 4.00 17.00 5.00
2008 10 8 11 17 9 29 0.59 0.89 0.38
2009 3 11 3 18 17 25 0.17 0.65 0.12
2010 15 15 22 9 9 15 1.67 1.67 1.47
Source: Gaillard (2011).
Comparing the Rating Changes of the Three CRAs,
1 January 2001 – 1 January 2011
6
Comparing the Performances of the Three CRAs,
1 January 2001 – 1 January 2011
One of the contributions of A Century of Sovereign
Ratings (2011).
Examination of a unique sample composed of 747 annual
observations for 84 sovereign issuers rated simultaneously
by Fitch, Moody’s, and S&P from 1 January 2001 to 1
January 2011.
Comparing the quality and the accuracy of ratings
assigned by the different credit raters.
7
Fitch average cumulative default rates,
1 January 2001 – 1 January 2011 In % Year 1 Year 2 Year 3 Year 4 Year 5
AAA 0.00 0.00 0.00 0.00 0.00
AA+ 0.00 0.00 0.00 0.00 0.00
AA 0.00 0.00 0.00 0.00 0.00
AA– 0.00 0.00 0.00 0.00 0.00
A+ 0.00 0.00 0.00 0.00 0.00
A 0.00 0.00 0.00 0.00 0.00
A– 0.00 0.00 0.00 0.00 0.00
BBB+ 0.00 0.00 0.00 0.00 0.00
BBB 0.00 0.00 0.00 0.00 0.00
BBB– 0.00 2.50 5.65 5.65 5.65
BB+ 0.00 0.00 0.00 0.00 0.00
BB 2.78 2.78 2.78 2.78 2.78
BB– 0.00 0.00 0.00 4.17 9.21
B+ 4.00 4.00 8.80 13.87 13.87
B 3.23 10.39 14.29 14.29 14.29
B– 4.17 17.23 21.37 25.74 25.74
CCC+ 33.33 33.33 33.33 33.33 55.56
CCC 66.67 66. 67 66.67 66.67 66.67
CCC– N.R. N.R. N.R. N.R. N.R.
CC N.R. N.R. N.R. N.R. N.R.
C N.R. N.R. N.R. N.R. N.R.
Source: Gaillard (2011).
8
Moody’s average cumulative default rates,
1 January 2001 – 1 January 2011
In % Year 1 Year 2 Year 3 Year 4 Year 5
Aaa 0.00 0.00 0.00 0.00 0.00
Aa1 0.00 0.00 0.00 0.00 0.00
Aa2 0.00 0.00 0.00 0.00 0.00
Aa3 0.00 0.00 0.00 0.00 0.00
A1 0.00 0.00 0.00 0.00 0.00
A2 0.00 0.00 0.00 0.00 0.00
A3 0.00 0.00 0.00 0.00 0.00
Baa1 0.00 0.00 0.00 0.00 0.00
Baa2 0.00 0.00 0.00 0.00 0.00
Baa3 0.00 2.08 4.36 4.36 4.36
Ba1 0.00 0.00 0.00 0.00 0.00
Ba2 0.00 0.00 0.00 0.00 0.00
Ba3 0.00 0.00 0.00 0.00 0.00
B1 2.00 4.08 6.48 9.32 9.32
B2 3.57 7.76 7.76 12.62 17.47
B3 11.11 14.53 18.25 18.25 18.25
Caa1 12.50 37.50 46.43 54.08 54.08
Caa2 33.33 33.33 33.33 33.33 66.67
Caa3 0.00 0.00 0.00 0.00 0.00
Source: Gaillard (2011).
9
S&P average cumulative default rates,
1 January 2001 – 1 January 2011
In % Year 1 Year 2 Year 3 Year 4 Year 5
AAA 0.00 0.00 0.00 0.00 0.00
AA+ 0.00 0.00 0.00 0.00 0.00
AA 0.00 0.00 0.00 0.00 0.00
AA– 0.00 0.00 0.00 0.00 0.00
A+ 0.00 0.00 0.00 0.00 0.00
A 0.00 0.00 0.00 0.00 0.00
A– 0.00 0.00 0.00 0.00 0.00
BBB+ 0.00 0.00 0.00 0.00 0.00
BBB 0.00 0.00 0.00 0.00 0.00
BBB– 0.00 2.94 6.41 6.41 6.41
BB+ 0.00 0.00 0.00 0.00 0.00
BB 0.00 0.00 0.00 0.00 0.00
BB– 2.63 2.63 2.63 2.63 2.63
B+ 0.00 0.00 0.00 0.00 0.00
B 3.57 7.28 11.31 19.76 24.48
B– 7.41 14.81 14.81 14.81 14.81
CCC+ 0.00 14.29 38.78 47.52 56.27
CCC 66.67 83.33 83.33 83.33 83.33
CCC– N.R. N.R. N.R. N.R. N.R.
CC 100.00 100.00 100.00 100.00 100.00
Source: Gaillard (2011).
10
One-year cumulative accuracy profiles,
1 January 2001 – 1 January 2011
Source: Gaillard (2011).
11
Accuracy ratios
One-year accuracy
ratio
Three-year
accuracy ratio
Five-year accuracy
ratio
Fitch 0.890 0.819 0.817
Moody’s 0.915 0.835 0.852
S&P 0.914 0.847 0.852
1 January 2001 – 1 January 2011
1 January 1987 – 1 January 2011
One-year accuracy
ratio
Three-year
accuracy ratio
Five-year accuracy
ratio
Moody’s 0.935 0.840 0.787
S&P 0.950 0.823 0.761
Sources: Author’s computations.
Source: Gaillard (2011).
Source: Gaillard (2011).
12
We Have to Mitigate These Results
1/ There have been few sovereign defaults since the 1990s,
2/ Sovereign Ratings turn out to be less pro-cyclical than
market-based indicators.
Sources: Author’s computations.
13
10-year
CDS
(in bps)
Fitch
actual
rating
CDS–
Fitch IR
Moody’s
actual
rating
CDS–
Moody’s
IR
S&P
actual
rating
CDS–
S&P IR
DEU 50.2 AAA AAA Aaa Aaa AAA AAA
FRA 59.0 AAA AAA Aaa Aaa AAA AAA
FIN 65.5 AAA AAA Aaa Aaa AAA AAA
BEL 83.9 AA+ AAA Aa1 Aaa AA+ AA+
NLD 93.5 AAA AA Aaa Aa2 AAA AA
PRT 100.4 AA AA Aa2 Aa2 AA– AA
ESP 104.6 AAA AA Aaa Aa2 AAA AA
SVN 117.2 AA AA Aa2 Aa2 AA AA
AUT 135.0 AAA AA Aaa Aa2 AAA AA–
ITA 161.1 AA– AA– Aa2 Aa2 A+ AA–
SVK 165.0 A+ AA– A1 Aa2 A+ AA–
IRL 185.0 AAA A+ Aaa A1 AAA A
GRC 239.5 A A– A1 A1 A A–
Sovereign ratings vs. CDS-IRs, 1 January 2009
Source: Norbert GAILLARD, A Century of Sovereign Ratings, Springer, New York, October 2011.
Note: CDS-IRs (CDS-Implied Ratings) result from the transformation of CDSs into credit ratings.
14
Sovereign ratings vs. CDS-IRs, 1 January 2010
Source: Norbert GAILLARD, A Century of Sovereign Ratings, Springer, New York, October 2011.
Note: SG denotes “Speculative Grade”.
10-year
CDS
(in bps)
Fitch
actual
rating
CDS–
Fitch IR
Moody’s
actual
rating
CDS–
Moody’s
IR
S&P
actual
rating
CDS–
S&P IR
DEU 31.1 AAA AAA Aaa Aaa AAA AAA
FIN 34.5 AAA AAA Aaa Aaa AAA AAA
NLD 38.9 AAA AAA Aaa Aaa AAA AAA
FRA 39.9 AAA AAA Aaa Aaa AAA AAA
BEL 60.8 AA+ AA+ Aa1 Aaa AA+ AA+
SVN 80.8 AA AA Aa2 Aa1 AA AA
AUT 88.6 AAA AA Aaa Aa1 AAA AA
SVK 89.0 A+ AA A1 Aa1 A+ AA
PRT 98.5 AA AA Aa2 Aa1 A+ AA
ITA 115.8 AA– A Aa2 A1 A+ A
ESP 119.6 AAA A Aaa A1 AA+ A
IRL 160.4 AA– BBB+ Aa1 A3 AA BBB+
GRC 279.4 BBB+ SG A2 SG BBB+ SG
15
Sovereign ratings vs. CDS-IRs, 17 May 2010
Source: Norbert GAILLARD, A Century of Sovereign Ratings, Springer, New York, October 2011.
Note: SG denotes “Speculative Grade”.
10-year
CDS
(in bps)
Fitch
actual
rating
CDS–
Fitch IR
Moody’s
actual
rating
CDS–
Moody’s
IR
S&P
actual
rating
CDS–
S&P IR
FIN 35.12 AAA AAA Aaa Aaa AAA AAA
NLD 51.22 AAA AAA Aaa Aaa AAA AAA
DEU 52.96 AAA AAA Aaa Aaa AAA AAA
AUT 70.64 AAA AA+ Aaa Aaa AAA AA+
FRA 79.34 AAA AA+ Aaa Aaa AAA AA+
SVN 82.04 AA AA+ Aa2 Aa1 AA AA+
SVK 93.17 A+ AA A1 Aa2 A+ AA+
BEL 104.63 AA+ AA Aa1 Aa2 AA+ AA–
ITA 136.28 AA– A– Aa2 A1 A+ A–
ESP 180.74 AAA BBB Aaa A3 AA BBB+
IRL 195.05 AA– BBB– Aa1 Baa2 AA BBB
PRT 246.10 AA– SG Aa2 SG A– SG
GRC 544.89 BBB– SG A3 SG BB+ SG
16
Are the Traditional Determinants of Sovereign
Ratings Still Relevant?
Five traditional determinants (Cantor & Packer 1996): GDP per capita,
CPI,
FC debt/revenues,
Development indicator,
Default history.
These determinants have been the same since the
1920s (Gaillard 2011).
Two more determinants for emerging and developing
countries: Foreign exchange reserves (Afonso, Gomes and Rother 2011),
Workers’ remittances (Avendano, Gaillard and Nieto 2011).
17
Conclusions
Greater transparency of sovereign rating methodologies
since 2008 but paradox: the default of Greece is about to
lead to the biggest “misrating” since the mid-1980s…
WHY? Belief in the “euro umbrella”,
GDP per capita and income levels have been overestimated,
Debt sustainability has been overestimated (Greece and Italy),
Insufficient focus on tax systems (Greece),
Lack of analysis in terms of competitiveness (Greece, Portugal,
and Spain).
→ “Welfare states” are not sustainable in Southern
European countries.