I spent some time this weekend looking through Moody’s (MCO) databases on implied ratings, as given by market pricing. My main point of interest was the relation that implied pricing from credit default swaps (CDS) has to Moody’s ratings on senior debt, as well as the actual pricing given by the bonds as they trade. For a quick and broad proxy, I looked at the 30 components of the Dow Industrials, all of which except for Chevron (CVX), Intel (INTC), Microsoft (MSFT), and Exxon Mobil (XOM) had data for all three categories.
In particular, I wanted to focus on financials because that’s where the real action is taking place. There are five companies I consider pure financials in the Dow – AIG, American Express (AXP), Bank of America (BAC), Citigroup (C), and JPMorgan (JPM) – as well as General Electric (GE), which has some heavy financial exposure and thus will be counted in here.

The neat and condensed piece of data Moody’s gives is the gap between its rating and the market implied pricing, be it for the actual bonds or the CDS. For example, Wal-Mart (WMT) is rated Aa2 by Moody’s, and its bond-implied rating is also Aa2; this means the gap between the two is 0. CDS on Wal-Mart debt, however, imply a rating of Aa1, giving a positive ratings gap of 1. Positive gap numbers mean the market is pricing the security as if it were more highly rated than it is; negative gap numbers mean the market things the rating should be worse than it is.

The best gap number on the bond implied side for any of the financials is GE, at -3 (effectively one full notch down). Interestingly enough, however, GE also has the worst gap number as given by CDS, at -9. At an implied rating of Baa3, the swap market is saying GE is barely investment grade, and equal to Citigroup, which also has a CDS implied rating of Baa3.

Of all the Dow components, the average gap given by the bond implied ratings is -0.3; the average gap given by the CDS market is -0.46. This isn’t that substantial of a difference, but when limited to the six financials, the differences become much more clear – the average bond implied gap is now -4.5, and the average CDS gap is -6.5.

Below is a graph of the implied ratings gaps for all Dow components where the sum of the absolute gaps was greater than or equal to three.

I think the tentative conclusion to draw from this data is that there is more stress in the CDS market than there is in the traditional fixed income market, and thus pricing tends to be a bit more aggressive on both the upside and downside.

While I have a few more article ideas lined up for later in the week, I’d like to come back to this with a strictly financial stock index (i.e. the XLF), and look into more implied data relating to those soon.