| Most of the S&P rating downgrades had been expected |
| 14.01.12 17:10 | |
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Most of the S&P rating downgrades had been expected and priced into the market to a large extent, even in fact before the early December S&P announcement. This has been the case to a certain extent recently, as markets have typically moved in anticipation of rating actions and the actual announcements have had limited impact (eg, on Belgium or Spain recently). There are no direct implications in terms of ECB collateral eligibility or index inclusions as such, although there might be some impact for some investors from France and Austria losing their AAA, Italy moving to BBB+ or, less likely, Portugal now being rated below investment grade by all three agencies. While many investors are using weighted average ratings, or have moved to name by name investments already, we suspect these moves may restrict the investor base for these issuers only at the margin compared to what it is now. It is clear that a number of these flows have already happened, and there is frankly no way to estimate how much this is likely to weigh going forward. We would also note that in the case of France and Austria, the other rating agencies have not indicated imminent moves, and therefore the overall impact might indeed be more limited. Similarly, there might be some impact on the repo market (where a number of counterparties would accept only AAA collateral), but in a context where GC repo on Germany (and other AAA investors) is close to 0%, the extra premium likely to be demanded on French collateral is likely to be limited (French GC has traded about 5bp above Germany recently, Belgium trades around 2-25bp over). In our view, more than the move on France and Austria, which are relatively symbolic and to a large extent reflected in prices already, the Italian downgrade might be key going forward: Italy is at BBB+ now by S&P, but is on watch negative by Fitch (at A+) and on negative outlook by Moody's (at A2), and therefore some further downgrades are likely. In terms of impact, we would note that if Italy sees a two-notch downgrade from Moody's or a three-notch downgrade from Fitch, it would fall from Barclays linker indices. This may have implications in terms of long-term investor base erosion. In contrast to the situation in mid 2011, the bulk of foreign investors are probably now underweight Italy vs their benchmarks (with the liquidations having been absorbed by domestic investors, and more importantly, the ECB). But given the size of the Italian bond market (roughly 20% of the euro area bond market), it is likely that foreign investors still own a lot of Italian bonds in absolute terms. Hence, they may continue to reduce their holdings going forward, by not fully rolling their maturing bonds. This will require domestic investors, and more importantly, the ECB to remain active (which we believe they will). Impact on other entities Following Friday's sovereign downgrades, in the coming days we expect a litany of other rating downgrades of related entities (eg, agencies, banks, etc): these entities have typically been put on watch negative already. An important one in that respect will be the rating of the EFSF (although clearly not the biggest issuer by outstanding bonds - the impact on CADES might be bigger). While a downgrade of the EFSF by S&P is not automatic, as certain credit enhancements could be put in place (eg, cash payments), these are likely to be costly, given the French and Austrian loss of AAA. As such, in practice, it is possible that the EFSF ratings are downgraded as well. The ESM, due to be introduced in mid-2012, is likely to be less rating sensitive, since it will depend on upfront paid up capital, rather than guarantees. source: BarCap |
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