RPT-Fitch: CDS Implied Ratings More Volatile Than Fundamental IDRs

Fri Apr 19, 2013 6:40am EDT

April 19 (Reuters) - (The following statement was released by the rating agency)

Fitch Ratings highlights in a new report that the market typically rates well-performing companies higher and worse-performing names lower than Fitch, with CDS-implied ratings (CDS IRs) being more volatile than Fitch's Issuer Default Ratings (IDRs). CDS IRs are more affected by market overreaction and the impact of changing market sentiment. The impact is more severe for small firms than for large ones.

CDS IRs are also higher at the extremes of the rating scale compared with IDRs by an average of one notch at end-2012, although this differential slightly converged compared with early 2011 when the difference was two notches. IDRs are centred around an average rating of 'BBB'/'BBB+' with a bell-shaped distribution around this mean, whilst CDS IRs for the same sample of names are more evenly distributed throughout the rating scale.

However, the market punishes peripheral corporates, as it is less forgiving of companies operating in the periphery of the eurozone - given current uncertainty regarding its unified future and weak market outlooks. Corporate CDS spreads continue to trade wide of weaker peripheral sovereign spreads. Utilities companies Portugal Telecom SGPS SA (BBB/Negative) and EDP-Energias de Portugal, S.A. (BBB-/Negative) have differences of six and five notches respectively, while Spanish telecoms giant, Telefonica SA's (BBB+/Negative) CDS IR is four notches below its IDR.

Notable sector disparities exist, with pharmaceutical and beverage companies benefitting from less perceived market volatility and stable cash flows, driving higher CDS IRs relative to Fitch IDRs in these sectors - by an average of three rating levels. By contrast, Fitch takes a slightly more pessimistic view on the pharmaceutical sector on the back of an impending patent cliff and expected favourable shareholder remuneration practices over the medium term.

Technology and metal and mining firms such as Motorola Solutions Inc, (BBB/Stable), Pitney Bowes Inc (BBB-/Negative), BHP Billiton Plc/Limited (A+/Stable) and Vale S.A. (BBB+/Stable) have lower CDS IRs than their fundamentals suggest - at an average CDS IR one notch below the average IDR. This is a function of cyclical commodity prices for metals and mining firms driving greater volatility in CDS prices and Fitch's through-the-cycle rating approach.

The full report, ''CDS Implied Ratings Versus Fitch Fundamentals" is available at fitchratings.com or by clicking on the link below.

Link to Fitch Ratings' Report: CDS Implied Ratings Versus Fitch Fundamentals

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