Credit Raters Who Didn’t Predict Iceland Crisis Miss Rebound

Wednesday, 06 Jul 2011 12:54 PM

 

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The credit rating companies that were too slow in predicting Iceland’s economic collapse in 2008 may be underestimating the strength of its resurrection.

Fitch Ratings said in May it may take two years for the island to shed its junk status, while Moody’s Investors Service and Standard & Poor’s give Iceland their lowest investment grades. That hasn’t deterred investors from trying to buy twice the amount offered in last month’s $1 billion bond sale as the island returned to global capital markets less than three years after its banks defaulted on $85 billion in debt.

“When you look at how successful that auction was, it’s clear that investors are now crunching the numbers themselves and that the credit grades from the rating agencies are less relevant,” Valdimar Armann, an economist at Reykjavik-based asset manager Gamma, said in a July 4 interview.

Iceland’s experience shows the rating companies may be overcompensating after failing to identify some of the risks that led to the global financial crisis, said Armann. While Moody’s kept a Aaa rating on Iceland until five months before its banks collapsed, reluctance to raise the island’s credit grade now is blocking the country’s access to a broader investor base. Debt derivatives show the low ratings may be unwarranted as credit default swaps on Iceland indicate it’s less likely to default than euro member Spain.

“If things turn out better than expected, the rating can move up,” said Paul Rawkins, a senior director at Fitch in London, in a phone interview. Still, there are “uncertainties that need to be taken into account,” he said.

‘No Discrepancy’

Moody’s head of media relations for Europe, the Middle East and Africa, Dan Piels, said the company’s ratings “reflect a multitude of factors, only one of which is access to international bond markets,” in an e-mailed reply to questions. “There is no discrepancy in the ratings of Iceland and eurozone members.”

S&P director of communications in Europe, Mark Tierney, said the company “constantly” monitors developments in Iceland, in an e-mail. S&P last week announced a new sovereign ratings methodology “as part of a series of transparency initiatives we are undertaking to help investors better understand the meaning of our ratings,” he said.

Raters Criticized

The rating companies have been criticized by European officials for exacerbating market turmoil by announcing downgrades as policy makers struggle to end the debt crisis. European Central Bank Governing council member Yves Mersch said in March he’s heard of “increasing uneasiness” in Europe about “surprising movements” by the main rating companies.

Moody’s yesterday slashed Portugal’s rating four levels to junk, citing concern that the country faces unsustainable market borrowing costs. The announcement sent the yield on Portugal’s 10-year government note up 72 basis points today to 11.74 percent. Yields on government debt sold by Italy, Spain and Ireland also surged.

Rating cuts in Europe have had “significant” spillover effects in the region, revealing a potential to stoke instability, the International Monetary Fund said in a March report. Cuts to levels near the lowest investment grade for “relatively large economies” have hurt other countries sharing the euro, the IMF said.

European officials are trying to involve private investors in a new Greek bailout without raters labeling the arrangement a default. Greece needs more aid after last year’s 110 billion- euro ($160 billion) rescue proved insufficient.

Bank Creditors

Iceland, which averted a sovereign default by refusing to bail out bank bondholders, will see economic growth of 2.2 percent this year and 2.9 percent in 2012 as its budget deficit narrows to 1.4 percent of gross domestic product, the Organization for Economic Cooperation and Development estimates. The 17-member euro region will grow 2 percent this year and next, the OECD said May 25.

Iceland’s “current economic conditions call for a better investment grade in the near future,” Economy Minister Arni Pall Arnarson said in an interview.

CDS on Iceland’s debt have eased 14 percent this year. Contracts on five-year debt were 229 basis points last week, compared with 257 basis points for Spain, the fourth-largest euro member.

“The credit ratings impact the size of the potential investor base,” said Ingvar Ragnarsson, head of funding and debt management at Iceland’s Finance Ministry. “Access to a larger, more diversified investor base can help reduce funding costs.”

Fitch Was First

While Iceland kept an investment grade until its collapse, Fitch was first to warn of risks in 2006, citing “soaring net external indebtedness.” By contrast, Moody’s said April 2006 that talk “of risks that may accompany increased leverage in the economy” has “recently been exaggerated.”

Iceland in 2008 got a $4.6 billion bailout led by the IMF. It has made “impressive progress in implementing” that program, Julie Kozack, head of the fund’s mission to the nation, said last month.

By lobbying Moody’s and S&P in April, Iceland avoided a downgrade to junk after voters rejected a $5.6 billion accord with the U.K. and Netherlands to cover depositor claims from failed Landsbanki Islands hf.

“We pressed them hard to examine the facts,” said Arnarson.

Moody’s and S&P affirmed their ratings at the lowest investment grade, keeping a negative outlook. Fitch raised its outlook on Iceland to stable. That may be too little too late, according to Armann.

“Rating companies have become less relevant for investors,” he said. “They were behind the curve.”

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