A Time to Get Even More Moody?

28 April 2017


Moody’s downgrade Trinidad and Tobago Again

Photo courtesy: http://www.reuters.com/article/us-usa-ratings-moody-s-idUSKCN0S11AM20151007

A Firstline Securities Limited Blog by: Mike

Yesterday we reported on S&P’s recent Trinidad and Tobago downgrade…now let’s look at what Moody’s thinks:

On the 25th April 2017, Moody’s Investor Services (Moody’s) downgraded Trinidad and Tobago’s government bond rating from Baa3 to Ba1 and assigned a country outlook classification of stable.

This downgrade is the third successive Moody’s downgrade of Trinidad and Tobago. On the 30th April 2015 Moody’s downgraded Trinidad and Tobago’s government bond rating from Baa1 to Baa2, and on the 15th April 2016 Moody’s downgraded the same securities from Baa2 to Baa3.

The grading on the 25th April 2017 moves Trinidad and Tobago’s government bonds out of investment grade into speculative grade – or to use an often-misunderstood term – junk status.

Moody’s cited three factors for the downgrade:

  1. The attempts of the government to offset the impact of low energy prices on the level of government revenue have not been sufficient.
  2. Large and increasing government deficits have eroded the fiscal strength of the country.
  3. Production from maturing oil and gas fields has declined and sustained low oil and gas prices make the prospect of new energy investments doubtful.

But upgrades the “Outlook”

The rating on the 30th April 2015 downgraded Trinidad and Tobago’s outlook from stable to negative, and the rating downgrade on the 15th April 2016 reaffirmed this negative outlook.

In moving Trinidad and Tobago’s bonds into speculative grade, Moody’s have assigned a stable outlook.

The rationale for assigning a stable outlook is as follows:

  • Sizeable buffers exist to offset future downside risks.
  • Asset sale proceeds and dividends from the National Gas Company, together with further drawdowns from the Heritage and Stabilisation Fund will assist the government to finance its budget deficit.
  • There are moderate external risks given low external payments relative to reserves of foreign exchange and a modest current account deficit.
  • Low gross borrowing requirements and access to a relatively deep domestic financial market buffer against international financial risks.

Other ranking changes made

Trinidad and Tobago’s foreign currency bond and deposit ceilings were lowered from Baa2/P-3 and Baa3/P-3 to Baa3/P-3 and Ba2/NP respectively. At the same time, the local currency bond and deposits country ceilings were lowered from Baa1 to Baa2.

Looking at the first driver in more detail – seeing from both sides now

Policy response to the energy price shock continues to be insufficient to contain elevated budgetary pressures

Budgetary pressures arise from two sides. There are those that impact the revenue side, and those that impact the expenditure side. To effectively control a deficit, the government must look at both sides.

On the revenue side:

Energy related revenues fell to 1% of GDP in 2016 (compared to 8% of GDP in 2015). This fall helped contribute to a decline in overall government revenue of 28% below the level of government revenue received in 2015.

The government has relied on dividends from the National Gas Company, asset sales (the sale of shares in TTNGL and the sale of additional shares in FCB) and drawdowns from the Heritage and Stabilisation Fund (HSF). Measures to increase revenue by extending the tax base have had limited effects, and the imposition of property tax from this month is likely to have an insignificant impact in 2018.

On the expense side:

The government has removed and reduced many subsidies (including the fuel subsidy) and transfers, but has limited room to manoeuvre as the expenditure structure of Trinidad and Tobago is rigid and difficult to alter given that 70% of total government spending comprises of wages, subsidies, and transfers, and the nature of those expenses is that they are fixed in nature.

Looking at the second driver in more detail

Steady rise in debt ratios driven by large government deficits has been eroding fiscal strength

Moody’s expect that Trinidad and Tobago’s fiscal deficit will be close to 6% of GDP in fiscal year 2016/17. Successive governments have over the last three years relied on asset sales (see for example FCB and TTNGL) to assist closing the fiscal gap, but despite these sales the debt to GDP ratio has risen from 42% in 2014 to 56% in 2016.

Based upon projected data Moody’s expect significant challenges over the next three years and project that the debt to GDP ratio will climb to 70% by 2019.

Looking at the third driver in more detail

Declining production from maturing oil and gas fields coupled with limited investment prospects in a context of low energy prices have undermined medium term growth prospects

Declining oil and gas prices have, to some extent, masked the problem that Trinidad and Tobago’s oil and gas fields are mature and production from those fields has been in decline.

The Trinidad and Tobago economy contracted by 2.3% in 2016, and Moody’s expect the economy to grow in the region of 0% to 1.5% in 2017. The expectation that the economy will grow assumes that BP’s Juniper Platform and its Onshore Compression Project will come on line in the final quarter of 2017.

Beyond 2017, increased investment is required to reverse the declining trend in oil and gas production. Despite the Prime Minister’s recent efforts, no new major projects are currently known to be in the pipeline with the exception of BP’s Angelin platform. Given that a gas sales agreement has still not been negotiated between BP and NGC, the estimate of a production start for early 2019 looks increasingly unlikely.

Using the Heritage and Stabilisation Fund will erode credit standing

Moody’s acknowledge that without meaningful fiscal adjustment on the part of the government to control budget deficits, further drawdowns from the HSF are inevitable.

Even though the assets of the HSF recovered from the first withdrawal, and with the current assets of the HSF standing at US$5.7 billion, representing 24% of GDP, continued withdrawals will erode the credit standing of the country further.

Moody’s and S&P Global Ratings Side by Side

Both Moody’s and S&P Global Ratings rank the outlook of Trinidad and Tobago as stable.

However, S&P Global Ratings rank Trinidad and Tobago bonds as well within investment grade at BBB+ while Moody’s now rank them as speculative at Ba1 (the current revised ratings are highlighted in yellow).

The downgrade is in part explained by S&P placing greater value on Trinidad and Tobago’s external buffers than Moody’s – notably the US$5.7 Heritage and Stabilisation Fund, and the US$9 billion it holds in foreign reserves.

Given the recent recovery of oil prices, the stated intention of OPEC and Russia to continue restricting output to support the recovery of prices, and the political uncertainty over North Korea, the demotion of bonds issued by Trinidad to “Junk Status” seems harsh

Irrespective of the discrepancy between the two, downgrading is never a positive sign.

The bottom line is that Trinidad and Tobago will find it more expensive to raise capital on domestic and international markets.

 

 

How the market reacts

The Moody’s downgrade will have a greater impact on prices than the S&P downgrade purely because the Moody’s downgrade demotes Trinidad and Tobago bonds from investment grade.

Trinidad and Tobago’s 4.5% 2026 bonds were being marked down by approximately 1.5 points at 96.50 – 97.50 in early trading on the 26th April 2016 (the time this blog entry is being written) as some investors sold to rebalance portfolios. The Moody’s downgrade is likely to trigger a sustained period of selling as Fund Managers who are unable to hold investments classified as non-investment grade, unload the bonds. To those able to hold non-investment grade assets this may be a buy. The narrowing spread between Jamaica rated B3 at 5 notches below Trinidad & Tobago now at Ba1 suggests that there is a relative value pickup for the latter.

Other blog entries in respect of Moody’s grading of Trinidad and Tobago

We have written two further blog entries in respect of Moody’s grading of Trinidad and Tobago.

A blog entry in respect of Moody’s downgrade of Trinidad and Tobago’s credit rating made on the 30th April 2015 can be found here:

http://firstlinesecurities.com/a-time-to-get-a-little-moody/

A blog entry in respect of Moody’s downgrade of Trinidad and Tobago’s credit rating made on the 15th April 2016 can be found here:

http://firstlinesecurities.com/a-time-to-get-a-little-moody-the-reboot/

Closing thoughts – a time to chill and a time to invest?

Firstline Securities Limited offers comprehensive coverage of local and international markets with a bias for the energy sector. Firstline offers many unique opportunities to put surplus cash to work either as your asset manager or investment advisor. Please contact us for more details at info@nullfirstlinesecurities.com or at 868.628.1175, we can discuss your investment needs in detail and craft a portfolio that makes sense for you. We look forward to hearing from you.

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