The impact of credit rating changes in Latin American stock markets.
| Autor | Freitas, Abner de Pinho Nogueira |
| Cargo | Report |
Introduction
Several investors and financial institutions rely on credit ratings because they summarize the creditworthiness of an issuer or issue in a single grade. The main rating agencies are Moody's, Fitch and Standard & Poor's (S&P).
The agencies issue a credit opinion based on analysis of financial and qualitative aspects of the issuer or issue. This grade reflects a default probability. AAA to BBB- for S&P and Fitch and Aaa to Baa3 for Moody's, ordered from best to worst credit quality, are considered investment grades and reflect a very low or almost nonexistent default probability. BB+ to CC for S&P and Fitch and Ba1 to Ca1 for Moody's are considered speculative grades and reflect a higher default probability. There are also grades for selective default (SD) and default (D).
The agencies disclose rating changes (upgrades and downgrades) of an issuer or issue. They also announce Credit Watch (S&P), Rating Watch (Fitch) or Watch List (Moody' s). According to Standard and Poor's (2009), a Credit Watch means that a rating has been placed under review until further data about the event causing the change in credit perception have been obtained, without necessarily changing the rating after obtaining the missing information. S&P uses Credit Watch when it believes that a credit opinion is likely to be issued within 90 days.
Agencies apply through-the-cycle methodology in rating assignments, and many times they are criticized for delaying rating downgrades or upgrades in relation to financial markets. But according to Altman and Rijken (2006), investors and regulators desire some level of stability, and do not want rating changes to reflect small changes in financial conditions. Therefore agencies filter out temporary credit risk components. This way rating changes reflect only long-term structural components, and agencies avoid excessive rating reversals, bearing the cost of some delay in relation to the financial market pricing of securities. Altman and Rijken (2006) also point out that agencies monitor the permanent credit risk component for substantial changes. A rating change, on average, only partially adjusts to the perceived level of a long-term credit risk component. The authors called this policy prudent migration, but emphasized that it is not officially disclosed by the agencies.
Regarding rating and capital market development in Latin American, Figure 1 and Figure 2 reflect the evolution of investors' interests in the region. Figure 1 shows a significant increase in market capitalization since 2004 in the four countries we analyze.
Rating agencies' coverage of Latin America has also increased significantly since 2004, as we can observe in Figure 2. Latin American companies' credit quality has improved considerably. In July 2010, 40% of Moody' s ratings in Latin America consisted of investment-grade companies, whereas in December 1999, this percentage was only 19% (Moody's, 2010).
Despite rating agencies' growing interest in Latin America, the region still displays significant vulnerabilities. For example, Argentina went into default in 2001 and still has a limited bond-issuing market in terms of volume and duration when compared to the Chilean market. Argentina is the only country analyzed in this study to receive a speculative grade at the time of this research.
We decided to focus on the four major economies in Latin America instead of a single one. Many international investors, for instance pension funds and mutual funds, consider Latin America in their portfolio as a whole instead of a single country. By consolidating the four countries we examined a larger number of observations. It is also possible to analyze each country individually and compare similarities and differences in the way each one reacts to rating change announcements.
Some authors (Vassalou & Xing, 2004) indicate that the cost of debt may increase due to rating downgrades. Minardi, Sanvicente and Artes (2007) develop a model for relating cost of debt to credit rating. The increased cost of this debt could influence stock prices (Jorion & Zhang, 2007). However, as agencies are criticized for delaying credit rating changes in relation to financial markets, there is a question whether agency information is relevant to the market.
We intend to investigate whether the information provided by rating changes or Credit Watch announcements in Brazil, Mexico, Chile and Argentina impact investors' expectations and thus contribute to stock price appreciation or depreciation. According to Ee (2008), there are at least three reasons why equity reactions to credit rating change announcements in Latin America can differ to reactions in other regions. Corporate Governance (1) and regulatory issues (2) may differ from region to region and from country to country. Credit ratings are based on public and private information, and it is not clear if rating agencies can be as effective at collecting private information in Latin American countries as they are in developed countries (3).
Ee (2008) investigates how the equity markets of non-U.S. companies react to rating change announcements. Differently from his paper, we focus only on Latin American countries. We also enlarge the number of observations for Argentina, Brazil, Chile and Mexico, since we include data from 2008 and 2009, and we conduct significance testing for individual and consolidated countries.
The remainder of this article is organized as follows. Second section presents a literature review. Third section discusses the methodology and database. Fourth section discusses our findings. Finally, the fifth section concludes the work.
Literature Review
Several articles analyze credit-rating information in Latin America. Cisneros, Lizarzaburu and Salguero (2012) point out that the improvements in the regulatory environment in Peru, Chile and Colombia increase the quality and importance of rating agencies' credit risk reports. Minardi (2008) estimates Brazilian companies' default probabilities using the Black&Scholes-- Merton Model, compares them with Moody's mortality rates, and associates them with a credit rating. In most cases, S&P's and Moody's credit ratings and ratings as estimated by stock prices coincide in terms of the rating's capital letter. The author interprets this as evidence that credit rating information is efficient in Brazil. Damasceno, Artes and Minardi (2008) do not reject the hypothesis that credit ratings are stable in Brazil and develop a credit-rating model based on financial ratios that predict 64% of S&P's, Moody's and Fitch's credit ratings in Brazil.
Bone and Ribeiro (2009) examine the impact of rating changes in the Brazilian stock market during the period from 1995 to 2007. They investigate if rating change announcements impact systematic risk measured by beta. They use the Chow stability test and find no evidence of structural breaks before or after the change.
The international literature investigates how credit rating changes impact publicly traded companies' share prices. Most authors find evidences that rating downgrades generate a significantly larger impact than rating upgrades (Dichev & Piotroski, 2001; Goh & Ederington, 1999).
Griffin and Sanvicente (1982) examine stock price changes in two periods: during the month of a rating change announcement and during the previous eleven months. The results indicate that downgrades convey information to shareholders, whereas upgrades result in minor price adjustments in the month of the rating adjustment. They observe that, in the case of upgrades, there is a positive abnormal return in the eleven months preceding the adjustment.
Jorion and Zhang (2007) study the effects of rating changes (1,195 downgrades and 361 upgrades) in senior unsecured debt in the U.S. corporate bonds market from January 1996 to May 2002. They find that the impact of downgrades tends to be larger than the impact of upgrades. One possible reason is that companies postpone the disclosure of negative information, but they immediately disclose positive information that may eventually result in a rating upgrade. They also point out that downgrades in speculative grade bonds significantly increase default probability and cost of capital, while downgrades in investment grade bonds create small fluctuations in default probability and cost of capital. Therefore downgrades in speculative issues more heavily impact price changes than downgrades in investment grade issues.
Table 1 shows the cumulative default rates in Latin America by Moody's rating category (Moody' s, 2010). In line with the global pattern, Latin American companies rated Ba or less (i.e., speculative grade) tend to have very significant variations in default rates.
Jorion and Zhang (2007) analyze the effect of rating changes on stock returns by measuring the CAR (cumulative abnormal return). They examine a window from one year before until one year after (-1 year, +1 year) the announcing date, where (0) is the effective date of the announcement. The sample of downgraded companies has an average CAR of -4.43%, which is statistically significant. For upgraded companies, the price change comes very close to zero (CAR=0.31%). However, they find a positive and significant average CAR for upgrades of speculative grade issues, although of a smaller magnitude than the downgrade impact.
Dichev and Piotroski (2001) analyze 4,700 changes in bond ratings by Moody's between 1970 and 1997. They find negative abnormal returns of between 10% and 14% in the first year after the announcement of downgrades, whereas for upgrades this abnormal return is less significant. Similar to Jorion and Zhang (2007), they observe that abnormal returns magnitudes are even higher for companies with low credit quality.
Choy, Gray and Ragunathan (2006) study the impact of Moody's and S&P ratings revisions of 63 companies on the Australian stock market between 1989 and 2003. Their results show a...
Para continuar a ler
PEÇA SUA AVALIAÇÃOCOPYRIGHT GALE, Cengage Learning. All rights reserved.
