No strings attached

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When S&P placed Ford’s BBB rating on review for possible downgrade on October 21, it looked as if a market with a healthy risk appetite suddenly found that it wasn’t hungry just as the main course arrived. With Ford on the brink of high-yield status, the prospect of such a huge serving of risk put most investors off their food. Admittedly, investors didn’t stop eating altogether, but most real money accounts took a breather, content with the bucket load of bonds they bought less than a month ago, and let fast money investors push spreads up by 70bp.

The market had been aware that S&P was likely to move again on the auto giant – it had communicated that clearly enough when it downgraded Ford to BBB a year before and repeated its breakeven mantra in just about every comment it had made since. But investors at least expected that there would be a tangible trigger event for the move.

And most expected it would actually have something to do with Ford. After all, negotiations with the auto unions had been concluded more favorably than most expected. The rollout of the new F150 truck was quick off the mark. The latest auto sales numbers were reinforcing strong demand levels. And the most recent earnings data was actually allowing the company to offer increased earnings guidance for the remainder of the year. Given all these factors, it’s not that unreasonable that no one was expecting the ratings action now. In fact, it looks suspiciously like S&P wanted to take DaimlerChrysler down (it was dropped to BBB on the same day) and Ford just got hit in the drive-by.

Which would be bad enough when you consider that, with Lehman Brothers’ recent decision to include S&P ratings in the qualifying rules for its index, the agency has the power to tip the largest single issuer in the investment-grade index, out of it. What makes it completely reprehensible is that all this occurred less than 30 days after a $3 billion bond deal that S&P was asked to rate. A deal made all the more important in that it ended Ford’s extended hiatus from the term debt markets. If S&P consider Ford to be a BBB- credit, then why didn’t it say so when the bond was launched?

But S&P collected its not insubstantial fee by stamping that deal with a BBB seal of approval, which makes the lack of rationale behind the timing of the watchlisting even more egregious. Ratings are, after all, a consumer product. In this competitive day and age they should come with a 30-day warranty. This would suggest that the agency that delivered the rating had some level of conviction behind its accuracy. Not a capricious and irresponsible insensitivity to the impact on the securities markets of unexpected negative actions delivered hot on the heels of sizeable bond deals.

But timing is everything. The hue and cry that has gone up in the wake of this latest misdemeanor is certain to be heard by the SEC as it wraps up its Sarbanes-Oxley mandated review of the rating agencies. The argument that they are entitled to exemption from Reg FD, giving them access to market-sensitive information, and can be trusted to use it well without direct regulatory oversight is looking a little tenuous lately. With this latest example of bad behavior, S&P may have given investors cause to question their risk appetite but it is quite possible that they themselves took a much bigger risk than they realized at the time.

Louise Purtle is corporate strategist at independent research provider CreditSights

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