The Sovereign Ceiling

Let's say you're a well run company with a low debt to capital ratio and a high interest coverage ratio. Your bondholders sleep soundly at night, knowing that their principal and interest is coming back to them. However, you happen to be located in a country that is not known for its fiscal conservatism, such as Argentina. If your home country is only rated BBB by S&P/Moody's, what's the best rating your company can hope for?

The sovereign ceiling says that the private sector should not be able to borrow on better terms than the government, since the government has the most senior claims on the firm's earnings (priority ahead of both debt and equity). If the government runs into economic trouble, it may be more likely to expropriate assets. Additionally, the government's problems may reflect broader economic issues that will also impact the firm. Therefore, lenders should not offer better terms to a private company than they would to its host country. The country's credit rating is a cap on all firms' credit ratings.