With a Longer Time Horizon, The US Credit Downgrade Helps the Market
Providing third-party research and analysis that then ranks an entity’s debt or equity outlook, including companies and sovereign nations, requires extremely high integrity. The mostly negative news headlines responding to the Fitch Ratings downgrade of the United States Long-Term issuance to AA+ from AAA is an indication of how much pressure analysts must be under to avoid issuing a downgrade. This is true whether the rating impacts the entire free world, or the stakeholders and their families of a small public company through company-sponsored research.
Most high-caliber analysts have built a model that gives them little room for pressure from the outside, either from the ranked entity, the investors, or even the financial media. It is undoubtedly easier to do nothing and cross your fingers as an analyst, but that doesn’t actually serve anyone well, including investors or the entity.
Background
In late May, while investors and other market watchers were trying to determine on which day in June the US Treasury would run out of money, Fitch, a securities rating service, placed a ratings watch on US debt which they had held at triple-A, the highest rating, indicating the lowest default risk for the issuer.
On July 31, the US Treasury unveiled an overview of its third-quarter debt issuance needs. At $1.007 trillion, it would be the largest third quarter on record. I have experience as an issuer ranked by Fitch and Moody’s while CIO of two funds that held a rating in order to meet specific investor guidelines. Rating agencies are the first to be made aware of any changes being considered. So I suspect that Fitch, Moody’s, and S&P analysts were all aware of the details of what the Treasury planned and projected going forward. Moody’s downgraded the US back in 2011 from its lowest default risk rating. Its treatment back then was also not one of appreciation from the markets, investors, or the issuer.
Thoughts on Ratings Move
Cathie Wood had a conversation on (Twitter) Spaces this morning with Pension & Investments’ Jennifer Ablan in an exclusive mid-year interview. Ms. Ablan asked Ms. Wood’s thoughts on the US downgrade. The Ark Invest founder didn’t hesitate to say that there is “a side that is happy to see it.” She went on to explain that it helps those managing the organization, in this case Washington, to do a better job. She explained that it says, “legislature, let’s get your act together.” Wood, added “government spending is taxation.”
While Cathie Wood was discussing the most powerful nation in the world, the same concept should be applied to a company she holds, or you own that experiences a downgrade. It serves to help management discover weak areas they could pay more attention to and gives the investor the understanding and confidence that a third party is looking on and even consulting with management before they make any moves that may alter the rating.
Michael Kupinski, the Director of Research at Noble Capital Markets, is a veteran analyst that has undoubtedly had to ignore pressure from the outside and follow models he’s created to the path they help provide. Mr. Kupinski says, “Ratings and earnings revisions are a function of the dynamics of new, and, likely extreme, inputs on the investing continuum.” He then explained how all could benefit, “Such revisions then present management a roadmap for the new baseline in expectations or for a course correction. As such, ratings provide a valuable currency to determine investment merits, set investment expectations, and for investors to determine risk,” said Michael Kupinski.
Take Away
Don’t shoot the messenger – instead, thank them.
A negative change in ratings, whether it be on debt issuance, equity issuance, or frankly ones own credit rating could serve to preserve something before it goes further down a bad path, and can be used as a guide to adjust and do better. While there was a lot of criticism for Fitch placing the USA on credit watch for a downgrade back in May, if they had not issued a downgrade as US Treasury issuance climbed even higher, it would cause investors to think that no one is paying attention. The outcome of not having another trusted set of eyes, on any security issuance, is weaker pricing.
Managing Editor, Channelchek
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