On the recent decision made by +Fitch Ratings to downgrade Malaysia's credit outlook to negative have made the Ringgit down to RM3.20 range against the greenback, so far. Bloomberg reported that the currency dropped to the three year low and 10-year bond yield climbed to the highest since January 2011.
Fitch said that the cut is primarily due to Malaysia's public finance especially after the general election. The budget deficit widened from 3.8 percent in 2011 to 4.7 percent of GDP in 2012. The increase of 0.9 percent is closely related to the spending on public wages ahead of the May election, according to Fitch.
You can re-visit my previous posting on how rating agencies could influence the credit-worthiness of one economy here 'The story of ratings agency' and my slides...
S&P and other credit agencies, although reaffirmed their outlook, are playing wait-and-see game. They are eyeing for more macroeconomic measure from Malaysia government to reduce the fiscal deficit.
We could expect some direct measures like subsidy rationalization, tax implementation (Goods and Service Tax) and boosting private sectors investment from the government. Having said that, the transformation program that is in the may provide a quick affirmation on seriousness of the government on fiscal reform.
The key takeaway is debt is widen.
The question is, is it enough? They have a few months before the tabling of Budget 2014 in October this year.
In a recent wake of European countries crisis plus the fallen of sub-prime mortgage, investment in bond and asset backed securities issued by countries or corporations are becoming riskier. Defaulted due to economic crisis and inability to meet the legal obligation of repayment plan, bonds issued by European countries especially are seemingly not safe anymore. Would the notion of bond is the safest investment be void?
Investment in bonds is massively relied on the rating agencies to interpret the fundamental credit worthiness of the issuers. +Standard & Poor's Ratings Services (S&P), Moody's, +Fitch Ratings, Malaysia Rating Corporation Berhad (MARC) and Rating Agency Malaysia Berhad (RAM) have been playing a vital role in verifying private, investment banks and institutional investors in choosing the favorable rated bonds in their portfolio.
Rating agencies provide credit ratings on issuers of commercial papers, bonds, long or short term debts, preferred shares and asset-backed securities. In certain countries including Malaysia, Indonesia and Middle Eastern countries, their functions extend to the issuance of Islamic Bonds (Sukuk) as well.
Relying on credit ratings in providing an independent verification of issuer own credit-worthiness boosts a significant value especially in marketing purposes. In most cases, bond funds have at least three ratings from the Big Three rating agencies. Without credit ratings, the market confidence would not be likely there and as the result, the issuance may be under-subscribed.
What is more, the credit rating agencies play a vital role in structured financing including pool financing alike mortgage backed securities. Although the term is often referred as collateralized debt obligation (CDO), the mechanism is still similar. The assessment on the credit-worthiness provided by the rating agencies are based on the same criteria. They assessed usually on tranches with different ratings. The effective interest rate payment will be much lower on the A-rated bonds compared to B-rated bonds.
Having said that, heavy reliance on credit ratings agencies is not healthy, in my opinion. Although they offer an independent credit-worthiness service, the fact that they are not independent is something everybody should be aware of. For instance, +McGraw Hill Cos, the owner of the world's largest ratings company, is publicly traded whilst Moody's is a publicly held corporation.
Regardless of what they stated in the brochure, the conflict of interest has to be there. Do you know who are the shareholders of Rating Agency Malaysia Berhad? The biggest is +CIMB Bank Berhad with the majority of 14.425%. RHB Bank and Malayan Banking Berhad are the second and the third respectively. MARC's shareholders are divided to insurance companies, discount house, stockbrokers and investment banks including Hwang-DBS, +Maybank Investment Bank and MIDF Amanah Investment Bank Berhad. Isn't the essence of business to serve the shareholders? By the way, Berkshire Hathaway owns about 12.75% of Moody's Corp.
Undoubtedly, the client relationship with management of institutional investors or investment banks may possibly impose inaccurate assessment with 'fair and true' or honest ratings. Issuers do seek advice from rating agencies, as clients, on the strategies of structuring financial products with desired ratings.
Sub-prime mortgage issue, the bankruptcy of some countries, Freddie Mac and defaulted bonds have highlighted continuous errors of judgement made by credit rating agencies. According to +Bloomberg News, the U.S. government accused Standard & Poor of deliberately misstating the risks of mortgage bonds, whose collapse helped trigger the worst financial crises since the Great Depression. S&P graded more than $2.8 trillion of residential mortgage-backed securities and about $1.2 trillion on collateralized debt obligations (CDO
) from September 2004 through October 2007, according to the complaint filed in federal court in Los Angeles
. The U.S Justice Department already filed a lawsuit against McGraw
-Hill on Feb 4, 2013.
The best part is the Big Three rating agencies are downgrading each other now! So much for the future of credit ratings. I like their disclaimers. The rating is just an opinion given the information available during the point of assessment as they never guarantee the rating should any change in circumstance related to risk factors analysis do take place.
If it did, should they change the ratings instantaneously rather than wait for a couple of year to witness the reality to unfold?
