Fears that the spending cuts expected as a result of US deficit reduction plans will dramatically slow economic growth are overblown, argues Oxford Analytica:
The current federal ‘debt ceiling’ debate has generated pressure from ‘tea party’ Republicans in the House of Representatives, mainstream business and financial groups, and credit rating agencies to rein-in government spending and put the US fiscal situation on a more sustainable path. Therefore, private sector analysts expect substantial fiscal consolidation in 2012-13, which would depress US GDP growth over the next couple of years.
While fiscal consolidation is likely to slow expansion in 2012-13, careful examination of OECD country experiences with fiscal consolidation over the past 40 years suggests that economic growth need not be sharply suppressed as fiscal deficits are reduced to manageable levels.
- Most cuts proposed in US ‘debt ceiling’ talks are back-loaded later in the decade, cushioning the effect on GDP growth in 2012-13.
- US and global economies will face threats to growth over the medium-term that are much more serious than mild fiscal cuts.
- With a bipartisan ‘grand bargain’ apparently now off the table, US fiscal reform this year will be mild, further reducing risks to growth.
For the full analysis, see Fiscal cuts may not be strong drag on growth (Premium)
U.S. real estate investment trusts (REITs) are initiating development projects as they seek higher returns than those available through property acquisitions, says Moody’s Investors Service in a new report.
Investment on new development will be moderate in scope for the near term, however, and represent a fraction of peak expenditures during the height of the real estate cycle a few years ago.
“As low-cost capital facilitates a run-up on acquisition prices of prime properties, development can generate stronger returns, especially for those REITs with land on their balance sheets,” says Moody’s Analyst Jane Cotroneo, who is the author of the new report on REIT development. “REITs have an edge in development as they can self-finance projects, while most private developers are dependent on banks for the limited amount of construction financing that is presently available.”
Moody’s says REITs are ahead of the development curve particularly in the multifamily sector, where fundamentals are strongest.
The full 6-page report US REITs: Modest Restart of Development Pipelines is available at the Alacra Store, along with a complimentary summary.
Moody’s says it would take an unprecedented, widespread and massive downgrade of municipalities to significantly impact a meaningful number of rated U.S. banks.
While the extended lackluster economy has resulted in budget shortfalls at both state and municipal levels of government, Moody’s-rated U.S. banks’ exposure to municipal securities is manageable, the rating agency says in a new report, with no U.S. bank’s ratings at risk solely because of these exposures.
Moody’s recent analysis of rated U.S. banks’ muni exposures drew not only on regulatory filings, but also on a survey of other exposures, including loan and credit support products and derivatives.
“We found that on a funded basis, rated U.S. banks’ muni exposure is on average just 28% of Tier 1 Common capital, while on a combined funded and unfunded basis it is still low, at 34%,” says Vice President and author of the report Gregory Frank. “Rated U.S. banks’ muni exposures therefore are not disproportionate to their capital positions.”
As part of its analysis, the agency conducted stress tests on the banks’ municipal portfolios to gauge their performance under a more adverse economic scenario. Using the conservative assumption that all unfunded commitments were fully drawn, Moody’s found that it would require a 10-notch downgrade of all the muni exposure held by rated U.S. banks before at least 25% of them would see a meaningful decline in their Tier 1 Common. To put the magnitude of a 10-notch downgrade into perspective, during 2010, a very stressful year for muni credits, less than one-half of 1 percent of public finance credits were downgraded by three or more notches.
“In other words, it would take an unprecedented, widespread and massive downgrade of municipalities to significantly impact a meaningful number of rated U.S. banks,” Frank says.
For details, see Municipal Exposures at Most Rated U.S. Banks Are Not a Cause for Alarm
The support package for Greece benefits all euro area sovereigns by containing the contagion risk that would likely have followed a disorderly payment default on existing Greek debt, says Moody’s Investors Service in a new Special Comment published today. However, the credit implications of the announcement for creditors of individual countries depend on the balance of the positive market-stabilising elements of the plan and the negative precedent set by the endorsement of distressed exchanges between Greek creditors and the sovereign.
The support package incorporates the participation of private sector holders of Greek debt, who are now virtually certain to incur credit losses. If and when the debt exchanges occur, Moody’s would define this as a default by the Greek government on its public debt.
Accordingly, Moody’s has today downgraded Greece’s debt ratings from Caa1 to Ca to reflect the expected loss implied by the proposed debt exchanges. Once the distressed exchange has been completed, Moody’s will reassess Greece’s rating to ensure that it reflects the risk associated with the country’s new credit profile, including the potential for further debt restructurings. While the rating agency believes that the overall package carries a number of benefits for Greece — a slightly reduced debt trajectory, lower debt-servicing costs, as well as reduced reliance on financial markets for years to come — the impact on Greece’s debt burden is limited.
OTHER EURO AREA SOVEREIGNS
Ireland and Portugal, which currently receive support from the European Financial Stability Mechanism (EFSF), will pay lower interest rates on their borrowings going forward. Set against that, however, despite statements to the contrary, the support package sets a precedent for future restructurings should the finances of another euro area sovereign become as problematic as those of Greece. The impact of Thursday’s announcement for creditors of Ireland and Portugal is therefore likely to be credit-neutral.
As for creditors of other non-Aaa sovereigns with high debt burdens or large budget deficits, the positive elements of the announcement — including the positive short-term impact on market sentiment, the introduction of tools to help stabilise sovereign debt prices and avoid the disruptive effect of disorderly defaults and, should funding from the EFSF ever be required, the lower interest rate which would be charged — need to be weighed against the negative implications of this precedent-setting package should any country face financing challenges similar in severity to Greece’s. On balance, Moody’s says that, for creditors of such countries, the negatives will outweigh the positives and weigh on ratings in future.
For details see EU Support Package Permits Orderly Default by Greece and Buys Time, But Credit Effects Are Mixed for Other Euro Area Sovereigns (Premium)
Rather than incurring unnecessary expense, companies with superior corporate social responsibility programs appear to enjoy reduced capital costs, according to a new working paper from Harvard Business School.
Excerpts from Corporate Social Responsibility and Access to Finance, by Beiting Cheng, Ioannis Ioannou, George Serafeim (free pdf download)
In this paper, we investigate whether superior performance on corporate social responsibility (CSR) strategies leads to better access to finance. We hypothesize that better access to finance can be attributed to reduced agency costs, due to enhanced stakeholder engagement through CSR and reduced informational asymmetries, due to increased transparency through non-financial reporting.
Using a large cross-section of firms, we show that firms with better CSR performance face significantly lower capital constraints.
The results are confirmed using an instrumental variables and a simultaneous equations approach. Finally, we find that the relation is primarily driven by social and environmental performance, rather than corporate governance.
Key concepts include:
- The better a firm’s CSR performance, the fewer capital restraints it will face.
- Better CSR performance is the result of improved stakeholder engagement, which in turn reduces the likelihood of opportunistic behavior and pushes managers to adopt a long-form strategy. This introduces a more efficient form of contracting with key constituents.
- Firms with good CSR performance are likely to report their CSR activities, thus increasing their overall transparency. Higher levels of transparency ease the fears of potential investors, making them more likely to invest.
Fitch Ratings says that the commitments agreed yesterday by euro area Heads of State represent an important and positive step towards securing financial stability in the euro zone, but still considers it a “Restricted Default.”
Fitch considers the nature of private sector involvement in a new financial programme of support for Greece to constitute a Restricted Default event. However, the reduction in interest rates and extension of maturities potentially offers Greece a window of opportunity to regain solvency, despite the formidable challenges that it faces.
Excerpts from Fitch Comments on Euro Area Summit and Rating Implications of Greek Debt Plan (Premium)
A more unified and coherent policy response to the Greek crisis and broader financial instability across the euro zone eases near-term pressure on sovereign credit profiles and ratings across the region. However, until there is a sustained and broad-based economic recovery across the region, allied with continued progress on reducing outsized government budget deficits and structural reforms to enhance long-term potential growth, further episodes of financial market volatility cannot be discounted and downward pressure on sovereign ratings will persist.
In line with the rating approach outlined by the agency on 6 June 2011, Fitch will place the Greek sovereign (issuer) rating into ‘Restricted Default’ and assign ‘Default’ ratings to the affected Greek government bonds on the date that the offer period for the proposed debt exchange closes.
Fitch will assign new post-default ratings to Greece and to the new debt instruments once the default event is cured with the issue of new securities to participating bondholders. Along with other relevant factors, the extended maturity structure and reduction in the net present value of the Greek public debt stock will be reflected in the new post-default sovereign rating that will be assigned to Greece and its debt instruments on completion of the exchange. The new ratings will likely be low speculative-grade.
The impact of the credit crunch is likely to be seen on corporate balance sheets for some time, says Oxford Analytica.
Excerpts from Corporate caution hampers investment (Premium)
While recovery from the financial crisis has been slow in most advanced economies, and recovery in employment has lagged even further, corporate balance sheets are more robust. Sitting on cash (or liquid assets) reported at close to 2 trillion dollars in the United States alone, the corporate sector has potential to boost investment, job creation and growth.
Uncertainty about the speed of recovery, concerns over liabilities and potential for credit markets to freeze again mean that firms in advanced economies probably will maintain a cautious stance. Thus investment is likely to be restrained — except in the most dynamic sectors of the economy.
However, in emerging markets, while efforts to rein in credit may over the short-run encourage companies to build up cash balances to fund investment, in the longer term the development of financial markets should reduce their need to hold cash.
Standard & Poor’s says it may cut the US debt rating as soon as August even if the debt ceiling is increased, if the government fails to also approve a credible agreement to reduce debt.
Excerpts from The U.S. Debt Ceiling Standoff Could Reverberate Around The Globe–With Or Without A Deal (Premium)
From a creditworthiness perspective, we believe that failure to formulate a fiscal consolidation plan, even if the president and Congress were to agree to raise the debt ceiling in time to avert a potential default, would be materially less optimal than hypothetical scenario 1 (Agreement To Raise The Debt Ceiling And Reduce Debt). Such a partial solution would essentially put before American voters in the 2012 presidential and congressional election the spending vs. revenue debate. Meanwhile, debt would continue to mount and the results of the election might not, in any event, resolve the issue.
Under this scenario, we might lower the U.S. sovereign rating to ‘AA+/A-1+’ with a negative outlook within three months and potentially as soon as early August.
We expect that the U.S. transfer and convertibility assessment would likely remain ‘AAA’. We assume that under this scenario we would see a moderate rise in long-term interest rates (25-50 basis points), despite an accommodative Fed, due to an ebbing of market confidence, as well as some slowing of economic growth (25-50 basis points on GDP growth) amid an increase in consumer and business caution.
Agreement on raising the debt ceiling without making any tough budget decisions would not be shocking, in our view, given the number of times Congress has done so in the past. And while such a move might modestly raise borrowing costs for the federal government, we view it as relatively benign for public finance issuers. Maintaining the status quo on federal outlays–for the year, anyway–would help alleviate some fiscal stress in the public finance sector, and reduce the prospect of widespread downgrades until and unless a larger solution was reached that cut federal outlays significantly.
While banks and broker-dealers wouldn’t likely suffer any immediate ratings downgrades, we would downgrade the debt of Fannie Mae, Freddie Mac, the ‘AAA’ rated Federal Home Loan Banks, and the ‘AAA’ rated Federal Farm Credit System Banks to correspond with the U.S. sovereign rating. We would also lower the ratings on ‘AAA’ rated U.S. insurance groups, as per our criteria that correlates insurers’ and sovereigns’ ratings.
S&P analysts have considered three hypothetical scenarios that could emerge, and is publishing articles today detailing itsviews on the potential effects of each on the financial services industry, corporate borrowers, structured finance, public finance borrowers, as well as economies and markets around the world.
Visit the S&P page on the Alacra Store to access these reports, including:
What If Analysis: The Potential Impact To Structured Finance Securities Of The U.S. Debt Ceiling Standoff
Where U.S. Public Finance Ratings Could Head In The Wake Of The Federal Fiscal Crisis
Fitch Ratings has launched new Viability Ratings on financial institutions around the globe, representing “Fitch’s primary assessment of the intrinsic creditworthiness of these institutions.”
Fitch’s Viability Ratings are assigned on the familiar 19-point long-term rating scale, although using the lower case (’aaa’, ‘aa+’ etc). Details of the rationale driving the introduction of Viability Ratings, their definitions, the circumstances under which Fitch assigns them and how they function in Fitch’s overall FI rating framework are captured in the newly published report Viability Ratings: An Introductory Primer (Premium).
In addition, spreadsheets with lists of rated entities by region and their corresponding ratings are available in Viability Ratings for Global Financial Institutions- Excel file (Premium).
Fitch emphasises that this is not a fundamental change in its approach to bank ratings or a change in opinion on the creditworthiness of the entities covered. The Long-term Issuer Default Rating (IDR) will remain the primary issuer rating for financial institutions and is driven by an issuer’s Viability Rating and its Support Rating.
The Viability Rating reflects the same core risks as the legacy Individual Rating but with greater granularity and on a more familiar rating scale.
Specific benefits of this shift include increased transparency regarding the key drivers of a bank’s IDR; greater consistency with traditional market-familiar credit rating scales; more granularity in Fitch’s opinion on the intrinsic risk of a bank; enhanced visibility on the specific benefits of support; enhanced consistency with the approach that Fitch has already taken with its Support Rating Floors, which are expressed on the ‘AAA’ scale; greater clarity on the baseline from which debt issues not expected to benefit from sovereign support are notched (e.g., hybrid and other regulatory capital securities);and greater consistency with current regulatory parlance around the subject of ‘viability’ and ‘non-viability.’
To facilitate an orderly transition from Individual Ratings to Viability Ratings Fitch will, with limited exceptions, maintain the two ratings on a parallel basis until 31 December 2011, after which all Individual Ratings will be withdrawn. Fitch will only assign Viability Ratings where it deems these appropriate.
Moody’s has issued a spreadsheet comparing the European Banking Authority stress tests with Moody’s own assessments of individual banks. It can be purchased at the Alacra Store.
Moody’s said the test results and disclosures from the EBA were broadly consistent with its expectations, and its preliminary assessment is that the test revealed no information that changes Moody’s view of the credit strength of any of the 80 Moody’s-rated banks included in the test. Of the eight banks that failed the EBA test, Moody’s publicly rates six, and all are rated D/Ba2 The EBA stress test is a step towards strengthening European banks’ ability to cope with very challenging conditions. However, it is not the quantum leap that a tougher test with concurrently announced capital-strengthening measures would have been.
. . . we believe the test has several credit positive effects for banks, including (1) vastly improving transparency with detailed, consistent disclosures on capital and credit exposures, especially to sovereigns, and (2) incentivizing banks to strengthen capital both before and after the test.
Moody’s noted two negative surprises. The first is that the EBA did not announce any new capital-strengthening measures for banks that failed the test; instead, weak banks will be asked to provide capital plans within three months. The second negative surprise is that the EBA identified just €2.5 billion of capital needed for the eight banks (out of 90) reported to have failed the test.
See also European Bank Stress Test Brings Wealth of Disclosure, but Defers Capital-Strengthening Measures (Premium)