Moody’s Downgrades Spain’s Rating

Ratings agency Moody’s has downgraded its sovereign credit rating on Spain and Cyprus, which is also a Eurozone member. In the case of Spain, the rating has been dropped by three levels from A3 to Baa3, leaving it just one grad above junk status. Cyprus saw its rating dropped from Ba1 to Ba3, sinking it further into the mire of junk status.

A bond issued at junk status does not mean that it is either worthless or that it will not be honoured when called or even that interest payments due on it are in doubt. It simply means that the rating agency believes that there is a significantly higher probability of a default than on a higher rated bond. As a consequence, the issuer has to offer a more attractive rate of interest in order to persuade investors to accept the higher perceived risk and buy the bonds. Michael Milken made a fortune from trading junk bonds and they were used to fuel a rash of mergers, acquisitions and hostile, leveraged, take-overs in the 70s and 80s.

Moody’s gave the reasoning behind the latest downgrade of the Spanish rating as the weakness of the economy, the €100 billion banking bailout (which is added to the nation’s debts) and, ironically, the nation’s difficulties in borrowing from the financial markets.

For good measure, Moody’s will also reassess the Spanish situation in three months and further downgrades could follow. They also suggested that the credit ratings of all Eurozone members might be downgraded if it concludes a Greek exit from the Euro is likely. Greeks go to the polls on Sunday and the election of a radical left-wing anti-austerity coalition would almost certainly lead to a Greek exit if they honoured election promises to tear up the austerity agreements linked to the second EU/IMF bailout. Worryingly, the leader of Syriza, Alexis Tsipras, is convinced that EU partners would be unwilling to countenance a Greek exit, believing they’d have too much to lose. The Eurozone would lose much more credibility in financial markets, if it stood still whilst a sovereign nation reneged on promises that it freely entered into for desperately needed support.