The world of Aaa debt just got a lot more interesting

It seems that no one has a pleasant word today for Moody’s, except maybe investors in Icelandic bank bonds. The ratings agency went on a triple-A spree yesterday, bringing pretty much every Icelandic bank up to Aaa status. Landsbanki was upgraded from A2: an incredible 5-notch upgrade.

John Glover at Bloomberg:

Moody’s Investors Service was blasted by Royal Bank of Scotland Group Plc, Dresdner Kleinwort and Societe Generale SA for new criteria that rank Iceland’s three biggest banks as better credits than ABN Amro Bank NV…

Last year, Kaupthing’s 23 billion euros ($30 billion) of bonds lost as much as 11 percent in value after Fitch Ratings cut the country’s credit outlook on concern economic growth and levels of borrowing were unsustainable.

“The market will be stupefied,” Tom Jenkins, an analyst at Royal Bank of Scotland in London, said in an interview after publishing a note titled “Moody’s Lose The Plot Completely” earlier today. “Creating Aaa rated banks across the board essentially means that there is no risk in investing in financials, and that buying a senior Kaupthing bond, for example, is effectively risk-free. It isn’t.”

The yield on Kaupthing’s 150 million euros of 5.9 percent bonds with no set maturity fell by a record 22 basis points to 155 basis points over German government bonds, the lowest in a year, according to Royal Bank of Scotland. The spread on ABN Amro’s 1 billion euros of 4.25 percent notes due 2016 is 27 basis points.

Alex Chambers, at Euromoney, pulls even fewer punches:

Most bank analysts are up in arms, while investors are dumbfounded. Here’s just one typical reaction: “We believe that the capital markets should ignore Moody’s entirely… Nothing has changed except that Moody’s credibility is lower and lower by the week” said BNP Paribas analysts in a note to investors this morning…

Moody’s ratings were once a great shortcut to good analysis, now they risk being seen merely as a detour.

Moody’s stock certainly took a beating in the wake of the upgrades, falling more than 5%, knocking roughly $1 billion off the company’s valuation. Ouch.

It is possible to see where Moody’s is coming from here. No major European bank has defaulted in living memory, which hardly squares with all those single-A credit ratings. It’s silly to pretend that banks won’t get bailed out in a crisis when in fact they always do. But on the other hand, Moody’s prides itself on including some kind of market risk in its ratings, and clearly, with Kaupthing debt trading at 155bp over, there’s a lot of risk priced in there.

The problem is that if you’re a CDO investing in triple-A securities, suddenly your world has been turned upside-down overnight. Should you just dump everything and invest in Icelandic bank debt? What’s going to happen to all those triple-A indices?

My take on all this is that if Moody’s had just stopped one notch short of Aaa and rated the Icelandic banks Aa1, then much of the uproar could have been prevented. But triple-A is a magical and special rating, and people get very offended when it’s handed out willy-nilly.

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14 Responses to The world of Aaa debt just got a lot more interesting

  1. Tom says:

    The problem I hear with the rating agencies is not inappropriate ratings but confusion. All these new ratings make poor bond traders very confused!

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