Excerpted from Moody’s Special Comment: Sovereign Credit Risk in Eurozone Countries Under Stress
The Eurozone as a whole continues to be characterized by significant financial strength, as represented by the Aaa ratings assigned to its multilateral institutions and many of its members, including its two largest. Importantly, this financial strength benefits all Eurozone member states as we expect that policymakers will do whatever is necessary to prevent a sovereign default during this period of financial turbulence.
Moody’s recently downgraded Ireland to Baa1. In addition, we have placed the ratings of Spain, Portugal and Greece under review, following downgrades earlier in 2010. Having said that, Spain’s rating is expected to remain in the Aa rating category, indicating extremely low credit risk, on par with many other strong sovereigns; Portugal’s rating will also remain firmly placed within the investment-grade range; and to the extent that Greece’s rating is repositioned, it will remain at a level consistent with a base-line expectation that Greece will not default over the next five years.
Aside from concerns over the current market liquidity problems that pose refinancing risks for governments and banks and the uncertainty surrounding support arrangements over the longer term, the key factors weighing against the economic and financial strength of these sovereigns include:
i) a significant deterioration in public finances and a sharp rise in public debt;
ii) banking system problems potentially requiring government financial support;
iii) an uncertain outlook for economic growth and long-term debt sustainability under current policy parameters; and
iv) large external imbalances and economy-wide risks from heavy foreign borrowing.
The ability of these and other sovereigns to regain and retain market confidence will depend on their success in completing the austerity programmes needed to generate primary surpluses and begin the process of reducing their debt burdens. That in turn is likely to rest on economic recovery supporting the reduction in expenditures and the recovery in tax revenues. In the meantime, the collective willingness of the Euro zone to support weaker members through the provision of liquidity will remain an important element of investor protection and something Moody’s will continue to reflect as supporting access to financial resources within its sovereign methodology.
See also: Moody’s puts Portugal’s A1/P-1 ratings on review for possible downgrade Read the rest of this entry »
The Moody’s/REAL National – All Property Type Aggregate Index measured a 1.3% increase in commercial real estate prices in October. This is the second consecutive month to record an increase in the CPPI.
The National – All Property Type Aggregate Index currently stands at 111.41, an increase of 3.2% from a year ago. Prices are down 34.4% in the past two years and have declined 41.9% since the peak, which occurred in October 2007.
For details, see Moody’s/REAL Commercial Property Price Indices, December 2010
Moody’s today downgraded Ireland’s foreign- and local-currency government bond ratings by five notches to Baa1 from Aa2, thereby concluding the review for possible downgrade initiated on 5 October 2010. The outlook on the Baa1 rating is negative.
The rating action is in line with the guidance Moody’s gave in a comment published on 22 November 2010, in which Moody’s indicated that the most likely outcome of the rating review would be a multi-notch downgrade that would leave Ireland’s rating within the investment-grade category.
The key drivers for the decision to downgrade Ireland’s government bond ratings are as follows:
- the crystallization of bank-related contingent liabilities;
- the increased uncertainty regarding the country’s economic outlook; and
- the decline in the Irish government’s financial strength.
Moody’s negative outlook on the ratings of the government of Ireland is based on our forward looking view on the risk that the Irish government’s financial strength could decline further if economic growth were to be weaker than currently projected or the costs of stabilizing the banking system turn out to be higher than currently forecast.
Moody’s has also downgraded Ireland’s short-term issuer rating to Prime-2 (commensurate with a Baa1 debt rating) from Prime-1. Ireland falls under the Eurozone’s Aaa regional ceilings for bonds and bank deposits, which are unaffected by the Irish government’s downgrade.
In reaching this decision Moody’s notes that the economy’s competitiveness and its business-friendly tax environment are credit-positive. The labour market’s flexibility is reflected by the considerable wage adjustment that occurred in the course of the crisis. Moreover, recent economic information, in particular healthy export data are factored into our conclusion.
For details, see Key Drivers of Moody’s Decision to Downgrade Ireland to Baa1 from Aa2.
Loss severities on distressed U.S. residential mortgage loans are likely to increase an additional 5-10% from current levels due to higher loss mitigation and foreclosure expenses and weakening home values, according to the latest RMBS Performance Metrics results from Fitch Ratings.
The anticipated increases for each sector’s average loss severities are expected to be as follows:
- Prime loans: currently 44%, increasing to 49%-54%;
- Alt-A loans: currently 59%, increasing to 64%-69%;
- Subprime loans: currently 75%, increasing to 80%-85%.
Prior to the recent negative trends, loss severities had remained stable for over a year. Beginning in second quarter-2009 (2Q’09), recovery values had been supported by an improvement in home prices brought on by low mortgage rates, homebuyer tax credits and government directed loan-modification programs. From 2Q’09 though 2Q’10, home prices jumped approximately 6% nationally and almost 12% in California according to the Case-Shiller Index.
However, the positive momentum in home prices is not sustainable, according to Managing Director Grant Bailey. ‘With the tax credits expired and a high inventory of distressed properties remaining to be sold, the housing market faces significant challenges in 2011,’ said Bailey. ‘The higher the glut of unsold properties on the market, the more adverse of an effect it will have on home prices.’
As such, Fitch is projecting a further 5-10% decline in home values nationally next year.
For details, see Fitch: U.S. RMBS Loss Severities to Rise 5-10% on Rising Costs & Weakening Home Values.
Standard & Poor’s Ratings Services today raised its long-term foreign and local currency sovereign credit ratings on the People’s Republic of China to ‘AA-’ from ‘A+’. The outlook on the long-term ratings is stable. At the same time, Standard & Poor’s affirmed its short-term ratings at ‘A-1+’ and revised its transfer and convertibility assessment on China to ‘AA-’ from ‘A+’.
- A positive revision in Standard & Poor’s assessment of the risks to China’s macroeconomic and financial stability supports the upgrade.
- We raised our long-term sovereign credit ratings on the People’s Republic of China to ‘AA-’ from ‘A+’ and affirmed our short-term rating of ‘A-1+’.
- The stable outlook reflects our view of China’s strong capacity to absorb potential balance sheet losses, given its substantial foreign reserves
and strong fiscal position.
As a result S&P upgraded the credit ratings of eight China-based and five Hong Kong-based companies, including BNP Paribas (China) Ltd., China Life Insurance Co. Ltd., China Mobile Ltd., China National Offshore Oil Corp., China Petroleum & Chemical Corp., CNOOC Finance Corp. Ltd., CNOOC Ltd., and Hang Seng Bank (China) Limited.
For details see Research Update: Long-Term Ratings On China Raised To ‘AA-’ On Assessment Of Improved Financial And Economic Stability; Outlook Stable.
Moody’s today placed Spain’s Aa1 local and foreign currency government bond ratings on review for possible downgrade, but said it will most likely conclude that Spain’s rating will remain in the Aa range.
The main triggers for placing the rating on review for possible downgrade are:
- Spain’s vulnerability to funding stress given its high refinancing needs in 2011. This vulnerability has recently been amplified by fragile market confidence.
- A potential further increase in the public debt ratio should the cost of bank recapitalisation prove to be higher than expected so far, whether to meet higher-than-expected asset impairments or simply to retain the confidence of the wholesale markets.
- Increased concerns over the ability of the Spanish government to achieve the required sustainable and structural improvement in general government finances given the limits of central government control over the regional governments’ finances.
Moody’s has also placed the Aa1 rating of Spain’s Fondo de Reestructuración Ordenada Bancaria (FROB) on review for possible downgrade as the FROB’s debt is fully and unconditionally guaranteed by the government of Spain. No further ratings or outlooks have been changed as part of today’s rating action.
“Moody’s believes that the above-mentioned downside risks warrant putting Spain’s rating under review for downgrade”, says Ms Muehlbronner, Moody’s Vice President and lead analyst for Spain. “However, Moody’s also wants to stress that it continues to view Spain as a much stronger credit than other stressed Euro zone countries. This is reflected in the significantly higher rating for the Spanish sovereign. Moody’s review will therefore most likely conclude that Spain’s rating will remain in the Aa range.”
For details see Moody’s puts Spain’s Aa1 ratings on review for possible downgrade
See also: European Risk Report: Risk Metrics Rise as Credit Markets Focus on Spain (Capital Markets Research) and Banking System Outlook: Spain.
Moody’s says the tax and unemployment benefits package agreed between President and Obama and Republican leaders should boost economic growth but raises the risk of a downgrade of the US Aaa credit rating in the next two years.
Excerpts from US Tax Package Is Negative for US Credit, but Positive for Economic Growth
If the tax and unemployment-benefit package agreed to on 6 December by President Obama and congressional Republican leaders becomes law, it will boost economic growth in the next two years, but adversely affect the federal government budget deficit and debt level. From a credit perspective, the negative effects on government finance are likely to outweigh the positive effects of higher economic growth.
Unless there are offsetting measures, the package will be credit negative for the US and increase the likelihood of a negative outlook on the US government’s Aaa rating during the next two years.
The net cost of the proposed package of tax-cut extensions, payroll-tax reductions, unemployment benefits, and some other measures may be $700-$900 billion, raising the debt ratio to 72%-73%, depending on the effects on nominal economic growth. The government’s ratio of debt to revenue, instead of declining rather steeply over the two years from about 420% at the end of fiscal year 2010, would decline considerably less to somewhere just under 400%. This is a very high ratio compared with both history and other highly rated sovereigns.
Full report available here.
Municipal borrowers rated ‘A’ and below with a significant amount of outstanding variable-rate debt face a growing credit risk from expiring bank facilities in 2011 and 2012, according to Fitch Ratings.
Bank facility expirations for issuers with variable-rate demand obligations (VRDOs) are a growing credit risk, as large levels of bank facilities expire in 2011 and 2012. This is a by product of the auction-rate securities (ARS)/bond insurance meltdown in 2008 and shift to VRDOs. Fitch Ratings is concerned that bank capacity for renewals will be constrained due to bank consolidation, a contraction of facility providers, and uncertainties regarding Basel III capital/liquidity requirements. In addition, Fitch expects that available liquidity support capacity will become increasingly expensive.
If issuers are unable to secure replacement facilities to support their VRDOs or are unable to refinance or convert their VRDOs with instruments not requiring such support, the VRDOs would face a mandatory tender. The draw on the liquidity facility in most cases would then have an accelerated principal repayment schedule (generally three to five years) to the bank.
Also, many issuers have fixed payer swaps linked to the VRDOs that would be costly to terminate. However, given historic low long-term interest rates, absorbing the termination cost and fixing out can be a prudent action for many issuers, which many have done to date.
Fitch has always considered in its analysis the ability of municipal issuers to manage their exposure to variable-rate demand debt. However, with the heightened concern regarding the availability of liquidity providers, Fitch believes lower rated credits are more exposed, as they generally have fewer opportunities for obtaining bank liquidity or could face difficulties in refinancing their VRDOs with fixed-rated obligations and terminating swaps. The inability of an issuer to renew expiring facilities, find alternative sources of liquidity, or effectuate a timely refinancing could yield negative rating pressure.
For the full analysis see Changing Dynamics of Bank Facilities Market Heighten the Risk Profile for Some Municipal Borrowers.
Shipments of tablet devices such as Apple’s iPad are forecast to outstrip sales of desktop computers by 2013, while smartphone sales will exceed total computer sales, according to a special report on Wireless Communications from iSuppli.
Although many devices have been labeled as convergent from a consumer’s perspective, we believe the driving force for convergent mobile O/S has been devices like the iPad. Tablets are unique in that they truly have brought once-disparate industries together and as direct competitors. Despite the current upsurge of smart phone players trying to extend their platforms to tablets, many of them lack competent O/S as well as competitive device commerce/content ecosystems to handle a wider range of uses.
We believe creation tablets will create both a larger market opportunity and more PC cannibalization than others forecast today.
Our departure from conventional thinking stems from our belief that tablets (2-4 years out) not only will be able to retain their form factor advantages, but also possess notebook-like content creation capabilities when equipped with a competent O/S and a wireless keyboard/mouse.
Tablets are an early step in a larger CE revolution, where devices increasingly get smarter and possess greater commonality, empowered by a unifying O/S and more shared chipsets. Thus, hardware and software similarity will exist in devices that previously had none. We believe that TVs (by bringing them under a converged mobile O/S with relevant and new apps) are probably the next important catalyst in this evolution.
Full report available here (Premium).
New accounting rules for financial instruments under U.S. GAAP likely will have a greater focus on amortized cost and less on fair value accounting than what is presently proposed, according to Moody’s.
This spring the FASB issued an exposure draft proposing changes that would require banks, insurers, and other financial institutions to carry significantly more financial assets at fair value on the balance sheet, rather than at amortized cost.
The largely negative response from constituents, however, means that the board will probably move closer to the approach of the International Accounting Standards Board, which emphasizes amortized cost basis reporting.
Respondents’ main objections were that the use of fair value in determining the carrying value of illiquid assets and liabilities on financial statements does not reflect the true economic value of such instruments and can be pro-cyclical, forcing firms to sell assets in illiquid markets, and further depressing prices.
Whatever the form of the final rules, Moody’s will continue to consider both fair value and amortized cost in its analysis of financial institutions’ creditworthiness.
“Fair value is relevant in assessing a firm’s liquidity position and provides an indication of the market’s view of the quality of an asset,” says analyst Wallace Enman. “Conversely, amortized cost less impairment speaks to expected losses on a security, which is a better indication of the economic value of an asset. Amortized cost is therefore a useful indicator of a firm’s long-term capital adequacy.”
If the final rules do favor amortized cost as the appropriate measure for loans and debt instruments, Moody’s believes that full disclosure of the fair value of such instruments should nonetheless be included in an institution’s financial statements to facilitate investor access to such information, and to ensure that such values are subject to a similar level of audit rigor.
For details, see FASB Likely to Heed Market Concerns on Fair Value