How Does the Ratings Agencies Work?

We recently had the privilege to listen to Standard & Poor’s  director of Financial Institutions in South Africa, Matthew Pirnie.  S&P is one of the 3 ratings agencies that determine the investment grade of a country. The other two agencies being Fitch and Moody’s.

He tried to explain as simple as possible how they calculate their ratings and what the factors are that they consider and what is the outlook for South Africa.
Below follow a summary of his presentation:

Why is there ratings?
The Ratings is for the bond holders. So that they can compare each other.

Not criticizing the country or the corporate, but to tell the investor what the probability is that he will get his money back (don’t default).

The higher the default rate the bigger the interest the investor should receive (higher risk, higher reward)

The Rating is not Investment advice, a recommendation or a way of defining between “good” or “bad”

Junk Status

Is a term made up by the media. They call it speculative Grade and if you are not “junk” you are Investment Grade

Drivers for the ratings

  1. Institutional Assessment – Governance of a Country
    The removal of Pravin Gordhan did not help the case for South Africa
    Treasury is still stong especially if compared to other emerging markets
    S&P Assessment of South Africa: Neutral
  2. Economic Assessment
    You get Rich economies and Poor economies.
    Poor economies is expected to grow faster than Rich economes because of lower base it comes from
    South Africa is a poor economy but the growth is also slow
    S&P Assessment of South Africa: Weak
  3. External Assesment
    Liquidity of Bonds and availability
    S&P Assessment of South Africa: Neutral
  4. Fiscal Flexibility and Debt Burden
    There is not a lot of room left to generate more debt for the government.
    A Big worry is the state owned enterprises.
    SAA got bailout of R 5 billion which is small change compared to Eskom’s Debt, if government will need to buyout.
    At this stage the potential debt that can come on the government books from Eskom is R 243 billion
    S&P Assessment of South Africa: Weak
  5. Monetary Assessment
    Financial Institutions and Treasury still strong and uncorrupted in South Africa
    S&P Assessment of South Africa: Strong

SA Ratings Factors


Summary

S&P Outlook Remains Negative on Ratings Downgrade

Political Risks remain elevated this year which could detract from economic growth, enhancing priorities and slow the pace of fiscal consolidations. These factors have an influence on the consumer and investors confidence

S&P would lower the ratings if:

  • GDP Growth or fiscal consolidation do not improve in line with their current expectations
  • Net Government Debt and contingent liabilities exceed their current expectations

S&P could revise the outlook to stable if:

  • Political Risk Reduce
  • Economic growth or fiscal outcomes strengthen compared with our base case projections

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