Downgrades — VietEcon

There has been a lot of writing in the financial press about the impact of lower bond ratings, fallen angels, bond ETFs and what all this will mean for the bond market. To back up, many bond funds are unable to invest in bonds with non-investment grade ratings. This makes sense: You buy a fund that says it invests in investment grade bonds, so the fund manager needs to make sure that’s true.

Occasionally, some of those investment grade bonds (usually not many and not all at the same time) may be downgraded to a “junk” rating, which is anything below investment grade. The cut off is Baa (Moody’s) or BBB (S&P), which is the same score, different letters.

When a bond falls from investment grade to non-investment grade, it is called a fallen angel, and the funds have to sell them. For the fund, it’s probably fine, because it would just be one bond that makes up a small portion of the fund. But for the company that holds the bond, it can mean a very big fall in price because lots of funds may have to sell at the same time.

The situation with fallen angels today is different. Lots of bonds are being downgraded, and that means a lot of funds need to sell them. So some people are say: “Well, maybe the ratings agencies don’t have to be so quick on the draw here. Maybe they can wait a bit and see what happens.” Who is saying that? Surely, the companies that own the bonds. They don’t want their yields to go up (remember, prices and yields are inverse). Also maybe the funds: they don’t want to be forced to sell a bond that may jump back in price when the world opens up again.

In Vietnam, this isn’t much of an issue, at least right now, because it doesn’t have any companies with ratings that are investment grade. But we did see the first round of ratings reviews from Moody’s yesterday.

These are mainly finance companies, and because both FE Credit and SH Bank Finance are subsidiaries of bigger banks, the parent banks ratings are also under risk of downgrade.

Moody’s has put all five entities under review for a downgrade. The reasoning is such:

The consumer finance industry in Vietnam is vulnerable to the disruptions given its risky borrower profile and heavy reliance on wholesale funding…Today's action reflects the impact on Vietnamese consumer finance companies and their parent banks of the breadth and severity of the shock, and the deterioration in credit quality it has triggered.

Basically, these consumer finance companies have riskier loans outstanding, and that was fine when we saw massive growth in GDP, income, wages, etc. But now, something that was only mildly risky before is much more risky, something that was high risk before is “don’t touch” levels. Consumer finance is generally medium or high-risk, depending on how aggressive the company was.

Ultimately, I think the government’s stimulus needs to be targeted towards making sure that the consumer and small businesses are solvent. Then that will help the bigger companies also say solvent, because people will still be paying their bills and buying things, when we come out of this. But it definitely is going to be a blow to consumer finance companies, and I could see them having to raise more capital if it gets really bad.