Understanding sovereign credit ratings

Module 1: Generalities on sovereign credit ratings

 Expected learning outcomes

By the end of the course, the participant will be able to:

• Understand the sovereign credit rating process;

• Understand the determinants of a rating;
• Understand the regulation of the credit rating industry;
• Understand the role data plays;
• Understand how to engage rating agencies and investors more
effectively;
• Build a community of experts for better knowledge of credit
rating on the continent.

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 Training content

Module 1: Generalities on sovereign credit ratings

– Definition of sovereign credit rating

– Key concepts in sovereign credit ratings
– The rating agencies
– Credit rating scales
– Factors affecting sovereign credit ratings
– Role and usefulness of credit ratings in capital markets
– The link between ratings and credit risk premiums
– Key takeaways

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Definition of sovereign credit rating
 Definition of sovereign credit rating

• A credit rating is a forward-looking opinion on the

probability that an issuer will be able to meet its
obligations.

• A sovereign credit rating is a score assigned by a rating

agency to a country for its credit default risk assessment.

• It is an overall assessment of a country’s creditworthiness,

and indicates the level of risk associated with lending
to a particular country.

• It is a synthetic aggregate indicator of the overall credit

quality of the issuer derived from a set of risk factors.
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 Definition of sovereign credit rating
• Investors require a sovereign rating to assess the counterparty
risk associated with a transaction or an issue by a sovereign
entity.

• When evaluating the creditworthiness of a country, credit rating

agencies consider various factors such as the political
environment, economic status, risk vulnerability, and its
creditworthiness to assign an appropriate credit rating.

• Obtaining a good credit rating is important for a country that

wants to access funding in capital markets. Also, countries with
a good credit rating can attract more investors at favorable
terms (longer maturity and lower borrowing cost).

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 Definition of sovereign credit rating

There are different types of sovereign credit ratings:

• Local versus foreign credit ratings

• Local/domestic currency credit ratings: measure credit risk on
loans issued by the country in national currency
• Foreign currency credit ratings: measure the credit risk on
loans issued by the country in a foreign currency

• Short versus long-term ratings

• Short-term ratings: measure credit risk on short-term loans
issued by the country (usually maturity less than 13 months)
• Long-term ratings: measure the credit risk on long-term loans
issued by the country (usually maturity over 11 months)

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Key concepts in sovereign credit
ratings
 Key concepts in sovereign credit ratings

• Private and public ratings

– Credit ratings are said to be public when they are

monitored and published on the rating agency's
website, making them accessible to market
participants. These ratings are in the public domain
and are subject to specific dissemination requirements
by regulatory authorities.
– Private ratings are not published. They are
communicated to the rated entity, its agents, the
applicant, or a limited number of third parties, in the
form of a confidential rating letter and rating report.

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 Key concepts in sovereign credit ratings

• Solicitation and participation

– A rating is 'solicited' when a CRA receives or expects

to receive monetary compensation from a third party
for its services
In the case of an unsolicited credit rating, the rating
agency does not receive or expect to receive any
remuneration for assigning or maintaining the rating.

– Participation status indicates the level of active

engagement between the rated entity and the rating
agency's analysis teams during the rating process.

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 Key concepts in sovereign credit ratings

• Rating scales
– A rating scale is a system of letters and numbers used
to classify complex assessments in a way that can be
easily and instantly assimilated by investors.
Category Status
"AAA" to "BBB" investment grade
"BB" to "D" speculative

These terms are market conventions and do not imply

any recommendation or endorsement of any specific
security for investment purposes by the rating
agencies.
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 Key concepts in sovereign credit ratings

• Rating modifiers
– Two types of modifiers : rating outlook and rating
watch.

– The rating outlook indicates the potential direction of

a rating over a 12 to 24-month horizon. Outlook could
be stable, positive or negative.

– The rating watch indicates that there is an increased

likelihood of a rating change and the likely direction of
that change. Rating watch could be uncertain, positive
or negative.

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The rating agencies
 The rating agencies

▪ The 3 influential rating agencies are:

▪ S&P Global Ratings
▪ Moody’s Investors Service
▪ Fitch Ratings

▪ Although there are other credit rating agencies, these

agencies exert the highest influence on capital markets and
over market decision-makers.

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 The rating agencies

▪ Some of the other regional/local rating agencies:

– Bloomfield
• Bloomfield operates in West and Central Africa. It is based in Abidjan,
Côte d'Ivoire, with a presence in Douala, Cameroon.
– GCR Ratings
• GCR has become Africa's top rating agency, with the majority of
ratings on the continent. It has a presence in Mauritius, South Africa,
Nigeria, Kenya, and Senegal.
– Agusto & Co.
• Agusto & Co. was licensed in Nigeria. It has expanded to Kenya and
Rwanda.
– CARE Ratings (Africa) Private Limited (CRAF)
• CRAF is incorporated in Mauritius and is the first credit rating agency
to be licensed by the Financial Services Commission of Mauritius.
– Sovereign Africa Ratings (SAR):
• SAR was launched in September 2022 by a group of investors and is
based in South Africa.
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 The rating agencies
Standard & Poor’s Global ratings

- S&P Global Ratings was founded in the

1860s by Henry Varnum Poor as a publishing
company providing financial information.
- Over the years, it evolved into one of the
most recognized names in the credit rating
industry.
- S&P Global Ratings evaluates the
creditworthiness of debt issuers, including
sovereign and other entities that raise capital
through debt instruments such as bonds.
- It assigns credit ratings to these issuers and
their debt securities to help investors make
informed investment decisions.

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 The rating agencies
Moody’s

- Founded in 1909 by John Moody, Moody's is an

American global company that provides risk
assessment services.
- Moody's Investors Service, its credit rating agency,
rates debt securities in several market segments
related to public and commercial securities in the
bond market. These include government,
municipal and corporate bonds; managed
investments such as money market funds, fixed-
income funds and hedge funds; financial institutions
including banks and non-bank finance companies;
and asset classes in structured finance.
- Moody's assigns ratings to both issuers and
specific financial instruments.

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 The rating agencies
Fitch Ratings

- Fitch Ratings was founded in 1913 by John

Knowles Fitch as the Fitch Publishing
Company.
- Over the years, it evolved into a leading credit
rating agency, providing credit assessments
and credit risk analysis to help market
participants make informed investment
decisions.
- Fitch Ratings offers a wide range of credit
rating services across various sectors and
asset classes, including: sovereign ratings,
corporate ratings, structured finance
ratings, municipal ratings…

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Credit rating scales
 Credit rating scales
S&P Global Ratings
Long-term credit ratings scale at S&P Global Ratings

Source: S&P - Guide to Credit ratings essentials

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 Credit rating scales
S&P Global Ratings
• Ratings are group into two categories:

– Investment Grade (AAA to BBB-): describes bonds and

other debt securities that were deemed suitable for
financial institutions by both bank regulators and market
participants. Nowadays, this term is more broadly applied
to denote issuers and issues with relatively strong
creditworthiness and credit quality.

– Speculative Grade (BB+ to D): also called non-

investment grade typically refers to debt securities where
the issuer currently possesses the ability to repay but faces
significant uncertainties. These uncertainties may arise
from adverse business or financial circumstances that
could impact credit risk.
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 Credit rating scales
S&P Global Ratings
Short-term credit ratings scale at S&P Global Ratings

Short-Term Issuer Credit Ratings

Category Definition
Strong capacity to meet its financial commitments. Highest category by
S&P Global Ratings. Within this category, certain obligors are designated
A-1
with a plus sign (+). This indicates that the obligor's capacity to meet its
financial commitments is extremely strong.
A-2 Satisfactory capacity to meet its financial commitments.
A-3 Adequate capacity to meet its financial obligations.
B Vulnerable and has significant speculative characteristics.
Currently vulnerable to nonpayment that would result in an 'SD' or 'D'
C issuer rating and is dependent upon favorable business, financial, and
economic conditions to meet its financial commitments.
An obligor is rated 'SD' (selective default) or 'D' if S&P Global Ratings
SD and D
considers there to be a default on one or more of its financial obligations
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 Credit rating scales
Moody’s
The matching between long-term and
• Moody's has established 2 short-term rating scales:
global credit rating scales:
Long-term rating scale and
Short-term rating scale.
– Long-term ratings are for
obligations with maturities
over 11 months
– Short-term ratings are for
obligations under 13 months
• For example, on September 8,
2023, Ghana had a long-term
rating in foreign currency of
Ca.
Source: Moody´s - Ratings definition and symbols
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 Credit rating scales
Moody’s
• Global long-term rating scale:

Source: Moody´s - Ratings definition and symbols

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 Credit rating scales
Moody’s
• Global short-term rating scale:

Source: Moody´s - Ratings definition and symbols

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 Credit rating scales
Moody’s
The matching between long-term and
• Moody's uses numerical short-term rating scale:
modifiers 1, 2, and 3 for rating
classifications from Aa to Caa.
– Modifier 1: means the
obligation is at the higher end of
its category,
– Modifier 2: signifies a mid-
range ranking,
– Modifier 3: suggests a lower-
end ranking within that category.
• For example, on September 8,
2023, Côte d´Ivoire had a long-
term rating in foreign currency of
Ba3
Source: Moody´s - Ratings definition and symbols
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 Credit rating scales
Fitch Ratings

• Long-term ratings scale: • Short-term ratings scale:

– AAA: Highest Credit Quality. – F1: Highest quality.

– AA: Very High Credit Quality.
– A: High credit quality.
– BBB: Good credit quality.
– BB: Speculative.
– B: Highly speculative.
– CCC: Substantial credit risk.
– CC: Very high levels of credit risk.
– C: Near default.
– RD: Restricted default.
– D: Default.
– F2: Good credit quality.
– F3: Adequate credit quality.
– B: Speculative credit quality.
– C: High risk of short-term
default.
– RD: Default on some
commitments.
– D: Broad-based default event.
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 Credit rating scales
Fitch Ratings

Fitch rating scales

• Fitch uses modifiers like "+" or "–"
to indicate the relative position of a
rating within its major rating
categories.
• For example, in the long-term
category, within the 'AA' category,
there are three specific levels:
'AA+', 'AA', and 'AA–’.
• These suffixes are not used for
ratings higher than 'AAA' or
ratings below the 'CCC' category.
• In the short-term rating category
'F1', a '+' can be added. Source: Fitch Ratings - ratings definition

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 Credit rating scales
Comparison of the rating scales of the 3 rating agencies
Moody's S&P Fitch
Explanation of the
Category
Long term ratings Short term ratings Long term ratings Short term ratings Long term ratings Short term ratings ratings

Highest credit
Aaa AAA AAA
quality /Prime
P-1
Aa1 AA+ A-1+ AA+ F1+
High quality /High
Aa2 AA AA

Investment grade
grade
Aa3 AA− AA−

A1 A+ A+ Upper-medium
A-1 F1 grade Good credit
A2 A A quality / Upper
medium grade
A3 A− A−
P-2 A-2 F2
Baa1 BBB+ BBB+ Below-medium
Baa2 BBB BBB grade /
P-3 A-3 F3 Lower medium
Baa3 BBB− BBB−
grade
Ba1 BB+ BB+
Speculative/Specul
Ba2 BB BB
ative grade
Ba3 BB− BB−
B B

Speculative grade
B1 B+ B+ Highly
B2 Not B B speculative/Highly
Prime/ speculative
B3 B− B−
Non
Caa1 CCC+ High risk
prime
Caa2 CCC CCC Ultra speculative
Caa3 CCC− C C
Default with some
Ca CC CC
hope to recover
C/CI/R C
C
SD RD Selective default
D D
D D D Default

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 Credit rating scales

▪ Rating outlooks:

- A “Stable” outlook indicates a low likelihood of rating change

in the near to medium term.

- A “Positive” outlook indicates a high likelihood of an upward

rating revision in the near to medium term.

- A “Negative” outlook indicates a high likelihood of a

downward rating revision in the near to medium term.

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 Credit rating scales

• Rating outlook indicates the likely rating trajectory may

typically stay over six months to two years before the rating
movement, whereas rating watch is expected to be resolved
within a shorter duration.
• A “Negative watch” indicates that the agency has noted a
circumstance or circumstances that might cause it to downgrade
the company's credit rating in the near future.
• Example of Gabon:
• Following the coup, Fitch moved Gabon from B- outlook stable to B-
negative watch (5 sept. 2023), while Moody’s changed it from Caa1
outlook stable to negative (12, 14 sept. 2023).

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Factors affecting sovereign credit
ratings
Factors affecting sovereign credit ratings

• Ratings are derived from agency-specific templates or

scorecards.
• In general, the main risk factors considered come from the
following dimensions:
• Macroeconomic performance of the country: real GDP growth rate,
volatility of GDP growth, GDP per capita, inflation, external position
• Sustainability of public finances and debt: budget deficit, public debt,
debt service
• Quality of institutions and governance: quality of institutions, civil
society and justice
• Risk vulnerability: political risk, government liquidity risk, banking sector
risk, external vulnerability risk
• Socio-political environment, Business environment
• ESG (environmental, social and governance).

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Factors affecting sovereign credit ratings

S&P sovereign credit rating framework

• S&P uses 5 five key areas to determine a sovereign’s

creditworthiness:

– Institutional assessment
– Economic assessment
– External assessment
– Fiscal assessment
– Monetary assessment

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Factors affecting sovereign credit ratings

Moody’s rating methodology

• Moody’s uses the following qualitative and quantitative

factors that are likely to affect rating outcomes:
– Economic strength
– Institutional and governance strength
– Fiscal strength
– Susceptibility to event risk

– ESG considerations are integrated into each of these

factors.

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Factors affecting sovereign credit ratings

Fitch sovereign risk analytical pillars

• Fitch’s approach to analyse sovereign creditworthiness is

based on the following 4 analytical pillars:
– Structural features of the economy that render it more or
less vulnerable to shocks;
– Macroeconomic performance, policies and prospects;
– Public finances;
– External finances;
+
– Environmental, social and governance (ESG) factors.

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Role and usefulness of credit ratings in
capital markets
 Role and usefulness of credit ratings in
capital markets
• Credit ratings play a pivotal role in capital markets,
serving as a critical tool for various stakeholders,
including investors, issuers, and regulators
• In addition to issuing bonds in external debt markets,
another common motivation for countries to obtain a
sovereign credit rating is to attract external investments.
• A better credit rating translates into attractiveness for the
country's debt, which improves accessibility in
international markets. A poor or deteriorating credit rating
is a sign of the deterioration of the borrower's
creditworthiness and could reduce attractiveness.

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 Role and usefulness of credit ratings in
capital markets
• Many countries seek ratings from the largest and most
prominent credit rating agencies to encourage investor’s
confidence.

• Investors use sovereign credit ratings as a way to assess

the riskiness of a particular country's bonds.

• Credit rating agencies (CRAs) are instrumental in this

process, providing valuable information and assessments
that facilitate the smooth functioning of capital markets.

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 Role and usefulness of credit ratings in
capital markets
• The role and utility of credit ratings are:

– To provide information and assessment for investors

– To ease issuer access to capital markets
– To help regulators to regulate
– To facilitate structured products and collateral
assessment
– To facilitate the structuring of Special Purpose Vehicles
(SPV)

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The link between ratings and credit risk
premiums
 The link between ratings and credit risk
premiums

• Cost of indebtedness: In capital markets, interest rates

include a component to cover the cost of credit risk according to
the following formula:

Interest rate = Cost of funds + Operating expenses + Operating margin

+ Maturity premium + Cost of credit risk

• Improvement in rating translates into a decrease in the cost of

credit risk, and therefore the borrowing interest rate.
• While a rating that deteriorates results in an increase in the cost
of risk, therefore causing an increase in the cost of debt.

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 The link between ratings and credit risk
premiums
• Credit risk premiums are the additional yields that investors
demand for holding sovereign bonds based on their riskiness.
• Investors require higher compensation for taking on more risk.
Lower-rated bonds are inherently riskier due to their higher
likelihood of default.
– When a sovereign credit rating is downgraded, the credit risk
premium on the country’s debt typically increases.
– Conversely, an upgrade in credit rating can reduce the credit risk
premium, resulting in lower borrowing costs for the sovereign.
• The link between credit ratings and credit risk premiums has
profound implications for investors, borrowers, and the broader
economy.

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 The link between ratings and credit risk
premiums
Average credit spreads vs Ratings (2020)

Credit spreads as a function of S&P ratings Credit spreads as a function of Fitch ratings
3500 3500
3000 3000
CREDIT SPREADS IN BPS

CREDIT SPREADS IN BPS

2500 2500
2000 2000
1500 1500
1000 1000
500 500
0 0
BBB BB+ BB B CCC+ CCC CC BBB BB+ BB B CCC CCC CCC CC

Credit spreads as a function of Moody's ratings Credit spreads as a function of rating categories
3500 In default with little prospect for recovery
3000 Extremely speculative
CREDIT SPREADS IN BPS

2500
Substantial risks
2000
Highly speculative
1500
1000 Non-investment grade speculative

500 Lower medium grade

0 0 1000 2000 3000 4000
Baa2 Baa3 Ba1 Ba2 Ba3 B2 B3 Caa1 Caa2 Ca

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Key takeaways
 Key takeaways

• A credit rating is a forward-looking opinion about an obligor's

overall creditworthiness.
• The three largest rating agencies are Standard & Poor’s (S&P)
Global Ratings, Moody’s Investors Service, and Fitch Ratings.
In Africa, there are local/regional credit rating agencies
operating alongside these three main CRAs.
• A total of 33 African countries are rated by one of the three
largest rating agencies.
• Ratings are grouped into two categories: Investment grade
and speculative grade also called non-investment grade.

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 Key takeaways

• In general, the main risk factors considered come from the

following dimensions: Macroeconomic performance of the
country, Sustainability of public finances and debt, Quality of
institutions and governance, Risk vulnerability and Socio-
political environment, business environment, and ESG
(environmental, social and governance).
• Credit ratings: i) provide information and assessment for
investors; ii) is a prerequisite to issuer access to capital
markets; iii) help regulate the market; iv) contribute to assess
the risk associate to Structured and collateral instruments.
• The link between credit ratings and credit risk premiums has
profound implications for investors, borrowers, and the broader
economy.

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