A question that has been bothering me for a while: what are financial rating firms like the American Moody’s and S&P for in the economy? Also, why do they have so much influence on the budgetary policies and financial management of our governments?
– J.-F. Couture
To answer these questions, The Press called on Louis Lévesque, a career financial economist and former senior executive at the finance departments in Quebec and Ottawa. Mr. Lévesque is Chairman of the Public Policy Committee at the Association of Quebec Economists (ASDEQ).
“What credit rating firms do, essentially, is an assessment of the credit quality of large borrowers and issuers of debt securities like bonds. It is also an assessment of the risk of default for financial lenders and investors in debt securities in the financial markets,” explains Louis Lévesque.
This function of financial rating firms concerns both large companies in the private sector and governments and their main state corporations that issue debt securities to finance themselves.
Based on detailed analyzes of the financial statements and budget plans of these heavy borrowers, financial rating firms assign them a credit rating on a scale that ranges from the best AAA level rating, given to borrowers of the highest financial quality, to the worst D rating, which is given to borrowers who are insolvent and default on their loans or debt securities.
Then, these credit ratings assigned by financial rating firms serve as a benchmark for lenders and investors in debt securities to determine their financing costs to borrowers based on their risk profile.
These financing costs include the interest rate and the borrowing conditions (collateral assets, payment period, maturity, etc.) requested from a borrower.
Market value risk
Furthermore, changes in the credit ratings granted to a major borrower may affect the market value of its debt securities (bonds) issued on the financial markets.
For example, a deterioration in the credit rating of a company or, more rarely, a government usually causes a loss in value of its debt securities already on the market.
If it persists, this loss in market value may then have repercussions through an increase in the interest rate yield demanded by buyers of their next issues of debt securities.
“For governments that borrow and issue bonds, the level of their credit rating is decisive for their financing costs to be included in their current budget, and in their next budgets according to the evolution of their financial capacity and their level of indebtedness”, indicates Louis Lévesque.
In Canada, the federal government enjoys the highest credit rating, AAA level, among all major borrowers and issuers of debt securities of Canadian origin.
This is followed by the governments of the main provinces, i.e. Ontario, Quebec, Alberta and British Columbia, which obtain credit ratings of level AA or A.
Quebec advantaged
How do these credit rating differences between the federal government and the provinces materialize?
First, these AAA or AA level ratings signal to the Canadian and international financial markets that the debt securities of these governments are the safest available in Canada, and therefore have a very low, if not almost zero, risk of default for lenders and investors.
Louis Lévesque, career financial economist and former senior executive at the finance ministries in Quebec and Ottawa
“Then, it is in terms of the interest yield of the debt securities issued by these governments that the gap in their credit rating manifests itself. These days, for example, the federal government is issuing 10-year bonds with an interest rate of around 3.55%. This rate is slightly increased to around 3.75% for 10-year bonds issued by the Québec government, and around 3.8% for bonds issued by Ontario. »
Quebec finances itself at a lower cost than Ontario?
” In effect. For the past few years, the Québec government has had a slightly better credit rating than Ontario’s, and can therefore finance itself at advantageous cost despite the sharp rise in interest rates,” points out Louis Lévesque.
” This gap [de cotes de crédit] favorable to Québec stems essentially from the budgetary management and debt reduction measures taken by governments in Québec during the 2000s and 2010s.