independent

Thursday 17 April 2014

What you need to know about the credit rating

Q & A

Q: A ratings upgrade from Moody's has been hotly anticipated, why is it such a big deal?

A: Ireland has left the bailout and successfully returned to borrowing on the markets, so this is certainly not a make or break issue. The markets already price Irish bonds better than those of higher rated Spain and Italy, but the Government has been pushing very publicly for an upgrade, as it will help rehabilitate "brand Ireland" with investors.

Q: So, other than face-saving for ministers, it really makes no difference?

A: Ratings do matter, particularly over the longer term. Many investors use credit ratings as a guide to investment risk. That is especially true for money managers who oversee the likes of large insurance funds and pension pots, or the savings accounts of countries.

Some of the richest funds in the world, located in Asia and the Middle East, are specifically barred under their own rules from investing in anything that does not have a higher grade rating from all three of the main agencies.

A Moody's upgrade opens up those markets, and that might prove important in helping us to ride out any new shocks in Europe down the line.

There are three main rating agencies and two -- Standard & Poor's and Fitch -- class Irish government debt as a safer "investment grade" bet. Moody's cut its Irish rating to sub investment grade -- or junk -- in 2011 though and keeping it there has proved a thorn in the side of efforts to put the crisis behind us.

Q: So what exactly is a credit rating?

A: Credit ratings are really just opinions about the riskiness of various investments -- including the debts of governments.

The main credit rating agencies all produce standardised A-B-C-D tables designed to make it easy to compare the credit worthiness of various companies or states.

These tables work a bit like traffic lights. Higher ratings, the A and higher B grades, are a green light to buy. A low D rating -- for default -- is a red light.

Before the crisis, most euro area countries had top "AAA" ratings but there are fewer and fewer of those. Generally speaking, the lower your rating the higher the interest rate you are charged -- but its not a fixed relationship.

Q: Are these ratings official?

A: Not really. Rating agencies are private companies and no one is obliged to take them seriously. That said, they are deeply embedded in the financial system.

Recent moves by European policymakers to regulate the sector have ironically tended to boost their importance.

Q: How so?

A: The Moody's action last night is a good example. In the past we would not have known when to expect rating action, as it is called, so there was a lot less anticipation about when or if Moody's or Fitch was poised to make a change.

New rules that kicked in at the start of this year mean agencies have had to produce a calendar to say when they would be updating each country's rating, so it now becomes an event in the markets.

Q: Who has the best rating?

A: AAA ratings are now few and far between. Germany still gets top marks from all of the agencies but the US, France and the UK have suffered downgrades over the past two years -- with no real ill effects, it has to be said.

Irish Independent

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