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June 22, 2016

From Investment-Grade to Bankruptcy in 4 Months: Why Ratings Agencies Are Still A Joke

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.

But those downgrades over the past four months should have been spread over the past 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 mortgages-backed securities shortly before the imploded. Of course, they’re 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!

Courtesy of Wolf Richter, Wolf Street

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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Item Reviewed: From Investment-Grade to Bankruptcy in 4 Months: Why Ratings Agencies Are Still A Joke Rating: 5 Reviewed By: EconMatters