Fitch Ireland Downgrade No Surprise, More To Come

by Win Thin

Here are some more thoughts on Fitch’s downgrade of Ireland to A+ from AA- with negative outlook kept in place.  Of course, we view the Fitch downgrade as completely justified, and look for further cuts ahead as our model rates Ireland as A-/A3/A- vs. actual ratings of AA-/Aa2/A+.  After putting its Aa2 Ireland on review this week for possible downgrade, Moody’s is very likely to cut in the coming weeks.  Indeed, we cannot rule out a two notch move to A1 (equivalent to A+) as debt ratios continue to blow out due to combination of increased banking sector bailout costs as well as on-going recession/deflation.  We’ve said it before and we’ll say it again.  The sovereign downgrade story in Europe will remain alive well into 2011.  Here is our most recent ratings summary for Q3.  We are currently in the process of producing our Q4 update to our ratings model, with results to be published shortly.

  1. After losing its AAA status from S&P last year and now this year from both Moody’s and Fitch, Spain still remains vulnerable to further downgrades.  Our model rates Spain as A+/A1/A+ compared to actual ratings of AA/Aa1/AA+, and we believe Moody’s was too optimistic in moving to a stable outlook after its recent downgrade
  2. After the most recent downgrade to A- by S&P, we believe Portugal is correctly rated there but Moody’s A1 and Fitch’s AA- need to be adjusted downward as our model rates Portugal at A-/A3/A-
  3. After the downgrades to BB+ by S&P and Ba1 by Moody’s, Greece appears to be correctly rated as our model shows it at BB+/Ba1/BB+.  However, Fitch’s BBB- is vulnerable to downgrade and we disagree with Moody’s comments this week about upside risks to the rating
  4. Italy has so far escaped any rating action during this cycle, but is vulnerable as our model puts it at A+/A1/A+ compared to actual ratings of A+/Aa2/AA-
  5. Our sovereign ratings model now puts France as a borderline AA+/Aa1/AA+ credit, so there are rising risks that France falls below AAA/Aaa/AAA in the coming quarters.  Because France is on the borderline, the case for an immediate cut is not compelling but certainly needs to be monitored closely.
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Meanwhile, peripheral bond spreads to Germany have stabilized, albeit at much higher levels for both Portugal and Ireland.  Interestingly, Greece spreads have tightened in recent weeks even as Portugal and Ireland blew out.  From policy-makers viewpoint, Europe must be very happy with lack of contagion to Spain and Italy.  As long as the sovereign debt crisis can be contained to Greece, Ireland, and Portugal (with combined GDP of around $785 bln), then the EFSF and bank stress test could be considered a success.  It’s only if Spain (GDP of $1.5 trln), Italy ($2.1 trln), or France ($2.65 trln) were drawn into the debt crisis that the story gets ugly, but their spreads and CDS prices have all held up very well.  That is one big reason why the euro has been able to continue rallying even as Ireland and Portugal were getting hit.

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