From Investment-Grade to Bankruptcy in 4 Months: Why Ratings Agencies are Still a Joke

Whom are they trying to fool?

The largest bankruptcy in Brazil’s history occurred on Monday when telecommunications carrier Oi SA threw in the towel. On Tuesday, it also filed for Chapter 15 bankruptcy protection in the US. A euro-denominated debt payment is coming due in less than a month, and it doesn’t have the money.

It owes creditors 65 billion reais ($19 billion). This includes 50 billion reais in bonds and bank loans, some of them denominated in foreign currencies.

It has been trying “restructure” its debt by stiffing creditors and practically wiping out stockholders. But ten days ago, CEO Bayard Gontijo resigned over a disagreement with some board members on the negotiations with the creditors. Last week, talks fell apart when board members rejected a plan by bondholders to swap their bonds for 95% of the company’s equity.

These creditors – among them Banco do Brasil and Itau Unibanco Holding – are licking their wounds. According to Bloomberg, the bankruptcy could also “trigger payments on $14 billion of derivatives contracts that are designed to pay out in an event of a default.”

Shareholders will be left with next to nothing. They include Pharol SGPS – a Portuguese telecom service provider – the Ontario Teachers’ Pension Plan, the state-owned Brazilian development bank BNDES, and BlackRock.

The bankruptcy is sending “shockwaves” through Brazil’s financial System, Bloomberg said. And the ratings agencies that were supposed to warn creditors of this sort of collapse before it happens?

So here’s how Fitch Ratings has been dealing with this:

On June 21, today, a day after the bankruptcy filing, Fitch downgraded Oi’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) from ‘C’ to ‘D’ (Default), and its National Long-Term Rating and local debentures rating from ‘C(bra)’ to ‘D(bra)’. But it left the senior unsecured notes for the moment at CCC:

Oi, beset by its debt-laden precarious capital structure and consistently negative FCF [free cash flow] generation in recent years, was seeking to reach an agreement with its creditors for potential debt restructuring. However, the negotiation fell through and the company decided to file for judicial reorganization as an alternative for financial restructuring.

On June 17, last Friday, Fitch slashed Oi’s IDR and its senior unsecured notes from CCC to C without even stopping at CC.

Those two moves combined amount to a mega-downgrade from CCC to D in three business days.

On March 11, Fitch slashed Oi from B to CCC, and amazingly removed the ratings from “Negative Watch.” At the time, it said:

The downgrades reflect the increased possibility for Oi to undergo debt restructuring in the near term, following the company’s press release on March 9, 2016, regarding its engagement with PJT Partners to optimize its liquidity and debt profile.

That’s code for a debt restructuring. And Fitch added:

Fitch believes that any meaningful turnaround in the company’s credit profile based on its stand-alone operational fundamentals is unlikely in the absence of industry consolidation. As such, Oi will likely face serious liquidity issues from 2017 as its access to capital markets for refinancing would remain constrained given its precarious balance sheet amid continued negative free cash flow (FCF) generation.

“Serious liquidity issues from 2017?” But wait… Oi can’t even make the euro-bond payment due in less than a month.

On February 26, after Oi’s shares had already been reduced to a penny stock, as everyone knew what would happen pretty soon, Fitch slashed Oi’s IDR and its senior unsecured notes from BB to B. And here’s a gem: it slashed Oi’s National Long-term rating and local debentures rating from ‘AA-(bra)’ to ‘BBB-(bra)’.

BBB- is still investment grade! Not even junk! What a rapid-fire-downgrade trip: In four months, from investment grade to bankruptcy!

At the time, Fitch blamed the scuttled merger with TIM Participacoes S.A. and its “view that any meaningful turnaround in the company’s credit profile based on its stand-alone operational fundamentals is unlikely in the short- to medium-term.” And it was worried about “serious liquidity issues from 2017 on.”

On July 15, 2015, Fitch downgraded Oi’s IDR from BB+ (one notch below investment grade!) to BB and lowered its National long-term rating and National long-term debentures from ‘AA(bra)’ to ‘AA-(bra)’, still nicely in investment grade territory. Everyone loves Fitch. Fitch has your back. Nothing to worry about.

On July 16, 2014, Fitch downgraded Oi’s IDR from ‘BBB- (investment grade) to BB+ (first feeble foray into junk) and its national long-term rating and national long-term debentures from ‘AA+(bra)’ to ‘AA(bra),’ both with stable outlook.

As Fitch even admitted, Oi’s problems have been festering for years, with negative free cash flow as far back as the eye could see, and with debt out the wazoo. The problems were no surprise. With financial and operating problems that have been obvious for all to see, how can a ratings agency make the trip from investment grade to bankruptcy in four months?

Well, via hasty, last-minute, multiple-notch mega-downgrades.

Those downgrades over the past four months should have been spread over two or three years! But this is why ratings agencies are still a joke, despite the bitter lessons learned during the Financial Crisis when they slapped tripe-A ratings on subprime mortgage-backed securities shortly before they imploded. Of course, ratings agencies still being paid by the issuer and thus are reluctant to bite the hand that feeds them. Investors are on their own, always eager to get fleeced in their search for yield!

Now subprime mortgages are moving into the crosshairs of regulators, who’re fretting about “astronomical” default rates. Read…  NY Fed Warns about Booming Subprime Mortgages, now Insured by the Government

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  32 comments for “From Investment-Grade to Bankruptcy in 4 Months: Why Ratings Agencies are Still a Joke

  1. economicminor says:

    Tick Tock Tick Tock Tick Tock

    • alexaisback says:

      .”” and its National Long-Term Rating and local debentures rating from ‘C(bra)’ to ‘D(bra)’. “”


      Should have been

      Berlosconi Grade ABRA ‘ CA’ ‘DAB’ BRA to BUNGA BUNGA.


  2. John Doyle says:

    I guess it’s too small a beer for the government to step in.

  3. David Calder says:

    These rating agencies are a joke or worse.. People who rely on them to make an honest and accurate assessment are playing Russian roulette with a full cylinder. 2008 was supposed to be the wake up call but here we are again.. Get used to it.

  4. Davebee says:

    Well from our perspective here in South Africa they are no joke. This country has just had a ‘final warning’ from both S&P and Fitch that if the dotgov do not get their political house in order and stop firing finance ministers at will, we will be downgraded to Junk Status by Dec 2016.
    Let’s see if the joke is on Wolf Street then?
    PS: Of course us taxpayers who have absolutely NO control over the dotgov will suffer the bad results of this dotgov’s incompetence. You have Hillary we have the ANC/Jacob Zuma. May the good Lord preserve us all from POLITICIANS!

    • nick kelly says:

      I know who I’d pick out of those two.
      South Africa could be the next Zimbabwe, formerly Rhodesia, once a bread basket, now a ruin.

    • Bobane says:

      December…? Humm…
      That’s exactly when the global SHTF starts.
      You are scheduled to bite the dust right on time.

  5. Maybe instead of selling their services to the corporations and governments, they should sell their ratings to us, the consumers…sort of like Consumer Report. But…all those high paid analysts would have their salaries slashed. At least we MIGHT get some much needed honesty.

    But asking for honesty in any form from almost anyone is sooooo 1970.

  6. wkevinw says:

    In my university studies, (I am a chemist! but took courses in finance), the professors EMPHASIZED that the rating agencies were private and suffered from potential conflicts of interest. Only incompetent/ignorant professionals in finance don’t understand this- or they are negligent and/or fraudulent in their usage of these ratings.

    These ratings should be used as guidelines only. I have never invested based solely on these ratings, and would suggest others use that as they may.

  7. Agnes says:

    My family steadfastly refuses to believe that their pensions could be in danger.

    I don’t have the emotional energy to get worried about it anymore, but the repercussions of the parabolic increase in the money supply is not FIRST going to be paid by bankers or those inside the beltway.

    Those who inflate the currency are stealing the livings of widows and orphans and I need not curse them..they are already cursed.

    The fees generated by the “insurance” of derivatives won’t be given up by big banks and are now higher than in 2007 and as pointed out in the next most recent article are now in the quadrillions.

    It used to be that 3 of 50 states were solvent (including fracking states), taking into account increased medicaid payments after the grace period and including pensions. Some states were “averaging” inputs and lagging in reporting, but that can only go on so long. And finding the information on States solvency has become mysteriously harder—the metrics are wobbly.

    • Dan Romig says:

      If one is managing a pension fund’s portfolio today, how does one generate a 6% to 8% annual return in the land of NIRP & ZIRP?

      • DashMann says:

        I work with institutional investors (in alternative assets) and you have hit the proverbial nail on the head.

        For the most part (at least what we are seeing) most are desperately trying to ignore the “obvious” math. They absolutely “have” to believe that long-term equity returns will get them there.

        Boy you should see their eyes glaze over when you point out poor potential GDP growth in developed markets, over-levered capital structures, etc, etc.

        I am biased (focusing on alternatives) but I think the fact that equity is typically the denominator that drives portfolio allocation is a problem and only gets worse from here.

    • Petunia says:

      Tell your family about what is going on with the Teamsters Union, which may get extreme cuts in their current pensions. And then there was Jeb who left Florida, went to Lehman Brothers, and then used his connections to stuff the Florida State Pension fund with Lehman junk. The state is now trying to repair the damage from that by cutting pensions for future retirees. This is only a drop in the ocean of troubles to come.

    • economicminor says:

      My closest relations are retired civil servants (Postal). One also has a services related disability, SS and a separate pension from being a union boss. They also retired with life time government health insurance which is much better than Medicare. They believe so entirely in the perpetuation of the existing system that they have virtually no savings either. To them, because most of their income is guaranteed by the federal government they have no concerns about how the economy is run either. I have friends with good union pensions and state pensions and they are pretty much the same way.

      They joined something that made them promises and so far those promises have been fulfilled. Why should they worry? So far none of the shenanigans in the financial markets have really affected them much. And all this talk of the big one is like Fed Sanford of Sanford and Son’s always grabbing his chest and yelling, “This is it, its the Big One!”

      So we have a bifurcated society whereas those with don’t give a shit and you can not make them see what is going to happen. Very few understand and fewer believe in Super Cycles. This is why they are so devastating.

      • Petunia says:

        My dead in laws lived on a US postal pension and SS. They are now being foreclosed on by Medicare over a hospice bill. I don’t know the details of their medical coverage, but they put a 60K lien on their 40K condo. Tell your family about that.

        • Enquiring Mind says:

          The hospice bill foreclosure story provides an example of the government-style clawback. If you fall into a certain income category, and use certain health services, for example, they will come after your estate with all the humor and competence they can muster, across agencies. The grieving survivors will go into some Kafkaesque situation for a while, until exhausted and further demoralized.

          One moral of any related story is to avoid government programs like that if possible. When it seems too good to be true, it probably is. It may be a very expensive free lunch.

      • Meme Imfurst says:

        this why the system will break:

        I recently met a retired policeman from New York state, retired at 41 with a ‘disability’. His ‘disability’ is a bad lower back ( I have one too).
        He plays golf and carries his own clubs. He goes deep sea fishing a couple of times a month for Marlin and the like. He tends his yard. He plays tennis at the public courts and sometimes basketball. He has a brand new Lincoln truck. He seems quite happy.
        WE both have exactly the same back condition, c5 disc.
        His disability retirement is $126,500 per year.
        Me, I am still working at 69, bad back and all.

        • nick kelly says:

          A lot of people trying to understand the fundamental weakness of the economy fail to consider the ‘rent’ extracted by the public sector. Rent being the compensation in addition to the value of the work performed.
          In Canada it has now entered law that only public sector salaries can be used in arbitrating settlements.
          It’s funny how people will rave about banksters, CEO’s etc. without realizing that there aren’t enough of them to constitute a class.
          Sure, crack down on them, but if all income over 500K was taxed 100% it wouldn’t fundamentally change the dim budget outlook re: entitlements.

  8. Tom Welsh says:

    I understand that the Russians and Chinese have set up some more honest and objective credit rating agencies.

    • Petunia says:

      They won’t be more honest, just different. The rating agencies need to be non profit research centers in order to keep them honest, with non compete agreements, just in case.

    • nick kelly says:

      I am assuming that is sarcasm. Both are notoriously opaque. In Russia there is not a whole lot of private business to rate anyway. The large resource extraction companies, Gazprom, Rosneft etc. are state controlled. Downgrading them by Russian analyst could be a health risk. Individual Russians were prominent in the recent massive leak from the tax haven lawyer, most of the money having been diverted from above state resources.

      As for the Chinese, their outfit Sino-Forest remains one the largest frauds ever listed on the Toronto exchange.
      Internally, serious analysts are always trying to pierce the veil over China’s ‘shadow banking’ system. It is probably the size of the official system, but…
      Thousands of SOE”s State Owned Enterprises in heavy industry are bankrupt, but they are forced to keep running at a loss by SOE banks.

      Little tidbit from the payday loan industry- apparently young women wanting a loan must supply nude photos as collateral- so defaulting will be extra embarrassing.

  9. pete stubben says:

    Too bad Fitch, Moody ‘s & S&P weren’t even slapped on the wrists in the ’07 aftermath. In a free market, self regulation is our first line of defense, and of course they were our Maginot wall. .PJS

  10. Ptb says:

    Find a conflict of interest and you’ll find corruption and general dishonesty. It’s human nature.
    When I was younger I thought there was integrity becaus our BS system (at the time) brainwashed kids to think our country worked that way. Well, life schooled me otherwise. Observing behavior is far more valuable than the crap they foisted on us in school.

  11. Paulo says:

    People absolutely believe their pensions are rated solvent because they need to believe it, just like some people need to believe the world was created in 6 days/nights and that God is influencing the minutae of their everyday lives. To believe otherwise is to accept their perceived firmament is not so solid. Some people just cannot accept or handle that reality.

    I have a modest pension which is quite nice to have. I also am led to believe it is pretty solid, and actual reports indicate that it is. For now. Nevertheless, I am prepared that one day it will be reduced, or worse. I have put money aside for this eventuality, and yes it makes almost no interest, but it is in an insured local Credit Union in the form of GIC and Terms. I have friends with no pension and almost no savings. Anything is better than that when the clock is ticking.

    Get rid of debt and the worries lessen. Plus, it is important to develop an attitude that no matter what happens, “We’ll get by okay”. It takes surviving tough times to develop that attitude. If you’ve been a ‘hot house flower’ your entire life, good luck with that.

    I have not believed one rating agency report after 2009. I also don’t buy those X-ray glasses in the back of comic books, or those phermone scents that are supposed to attract beautiful women. (What would my wife say?)


  12. bead says:

    Trump had the temerity to suggest the system is rigged. Could it be that the ratings agencies tell the world after their better clients are clean and free? Naw, that couldn’t happen. Let the coronation proceed! Status quo, forever and ever, Amen.

  13. nick kelly says:

    The only thing that surprises me is that the victims include the Ontario Teachers Pension Fund. They are generally pretty savvy and do some of their own analysis.
    Brazil has been a long time breaker of financial hearts. In Britain, when the Empire was still chucking money around- Brazilian Traction ( rail) was a one time darling.
    I hope they, and Argentina can turn the corner. For one thing they are the giant, screwed- up neighbors of tiny Uruguay, where I have friends.
    Uruguay is doing pretty good but is heavily affected by its much larger neighbors, especially Brazil.

  14. Agnes says:

    Thanks for all the responses. Mercatus, whose report on U.S states just came out, is using 2014 numbers as they are the most recent…things are much worse in all the energy states..and I wonder what Nebraska has going for it???? The other link is about Colorado pera.

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