Rating a mention

S&P HAS downgraded the US debt rating for the first time ever, from AAA to AA+. this decision, and S&P's subsequent downgrading of italy, has caused much consternation. We asked Jack Foster, head ?of global real asset of Franklin Templeton Real Estate advisors, how investors really feel about credit ratings agencies

Nathan North, 'Eurobuild CEE': How seriously do you take ratings agencies?
Jack Foster, FTREA: This is an important question. After the recent downgrade, it's highly likely that in 2013 that the US will be downgraded again, as it's hard to see how the government will have put an appropriate fiscal package together by the next election. These are crucial issues, so we cannot ignore what the agencies say or are going to say.

Do they give a true reflection of the situation on the ground, or can they just add to the general panic?
Our view is that ratings agencies play a useful role. Their findings are usually a response to changes that have occurred, but they can also cause them to happen. In both cases investors have to watch their calls. In the case of the US they are playing an important role, as there is a level of dysfunction in the US government over debt and fiscal policy at the moment. The message from the agencies reverberates at the top, as it is also a message for voters and their voting intentions. Their role is to assess risk and to evaluate governments. And though they may have an effect on the macro-sphere, they provide more of a financial call, putting pressure on the government to get their act together.

When it comes to real estate investment in particular, is the influence that agencies have on investors also crucial?
As a real estate investor this is especially the case. Real estate is extremely localised - the value of a building is not in the concrete or its construction, but in what's outside the windows, what the levels of demand and supply are. We have to be very conscious of macro-factors, such as exchange rates, as it is more difficult to hedge against real estate than other products. There is a whole plethora of factors that we have to take into account, and usually it isn't just one of them that can make orbreak a decision. However, if a ratings agency comes out with a severe warning or a major upgrade, we do have to take it on board and it could influence a decision - but it would still be one of many factors taken into consideration.

To what extent do you use the ratings? Or is your own research more important?
It depends on the situation. In individual micro cases, agencies can influence a decision. What is more important is that they can indicate the leading trend line over the long term. But in more cases than not, on the lower end of the scale we in the market have already seen the trend line coming, we are ahead of the curve. However, they can surprise us over factors that may not be a priority for us - such as when it comes to a company that we haven't been paying much attention to.

Do the ratings have a more or less decisive effect on decisions to invest in our part of the world?
In general, CEE countries from the perspective of institutional investors are shallower markets - so we can make our decisions well ahead, confident that property prices are going to keep going up. Our decisions are usually well ahead of ratings changes. But a rating agency's call might make us take another look at the situation. For instance, if we are looking at yields similar to the West End or the City of London, then probably the product in CEE countries would be too expensive for us. So in this case the agencies wouldn't influence us too much anyway. But if we are already embedded in a market, then an agency call might make us invest further or adapt our exit strategy. We have to act on a case-by-case basis and it's difficult to pin down just how important agencies are in every case. But they do give indications for trend lines.

Who in the real estate market tends to act on the ratings most?
There tends to be more usage of rating agencies by the sell-side than the buy-side. With the buy-side, the agencies tend to only confirm decisions that have already been made; but for the sell-side a rating can confirm an ability to sell. Buyers have already done a tremendous amount of work researching the product and have to be on top of the market - in CEE countries, for example, we will have already done extensive research as buyers. Sellers, however, can use the ratings to say Look! Our ratings have gone up - you should buy this!

Is there any justification in the criticism that ratings agencies have come under during the recent market turmoil?
New pressures and challenges have been put on ratings agencies recently and they have come under increasing scrutiny. They have had a number of bad press days and a degree of criticism recently - and there may be some justification for this. But they definitely still have a role to play. And from my observation, ratings agencies have become very careful and introspective over the last four years when it comes to their methodology, and so they have successfully rebuilt the trust of investors.

What are credit ratings agencies?
A credit rating agency (CRA) publishes credit-worthiness ratings for the issuers of specific types of debt obligations and debt instruments. The "big three" credit rating agencies are Standard & Poor's, Moody's Investor Service and Fitch Ratings, which together control more than 50 pct of the market. Others include Dominion Bond Rating Service and A.M. Best, with the Chinese-based Dagong Global so far being the only non-US agency to have received some financial media recognition in the West. S&Ps grades borrowers on a scale of AAA to D, in which those rated as lower than BBB- are considered to be holding "junk bonds" of lower than investment grade. CRAs have been subjected to increasing criticism since the credit crunch and particularly during the EU sovereign debt crisis. In our region, the country ranked highest according to S&P's latest ratings is Slovenia (AA with a negative outlook), followed by the Czech Republic and Estonia (both AA- stable), Slovakia (A+ stable) and Poland (A- stable). The lowest rating is given to Bosnia-Herzegovina (B+ negative).