Fitch Ratings says that the proposed new Solvency II regulation for European insurance companies in respect of their exposure to securitisations could discourage insurance companies from investing in highly rated and historically strongly performing securitisations.
Fitch says that the new measures, set to come into force at the beginning of 2014, could lead to disproportionately high capital charges, and in the process, restrict funding opportunities for European banks.
The proposed capital charges for securitisations are a multiple of both existing charges and those for other asset classes such as covered bonds and corporate bonds, so insurers using the standard formula will be incentivised to invest in these asset classes in preference to securitisations.
The proposed capital charges are also a multiple of the proposed Basel III capital charges for banks, largely because they are reflective of the volatility of credit spreads rather than probability of default. Under the new rules insurers, who typically would seek to hold long dated assets to match their long dated liabilities, would be incentivised to buy shorter dated assets with lower market price volatility.
“The investor base for European securitisations has been severely diminished since the onset of the global credit crisis,” says Ian Linnell, Fitch’s Global Head of Credit Ratings. “However, over the past 18 months or so there has been a gradual return of ‘real’ investors to the securitisation market. Insurers and pension funds are an important part of that investor base. If Solvency II is implemented in its current form and if, as is expected, similar regulation for pension funds follows, the recovery of the market could be put in jeopardy, with negative implications for the supply of credit and ultimately the recovery of the European economy.”
For details, see Solvency II and Securitisation: Significant Negative Impact on European Market
Standard & Poor’s Ratings Service said that while it expects European governments’ fiscal consolidation efforts to reduce net sovereign borrowing during 2012, it does not anticipate that gross medium- and long-term (MLT) commercial issuance will fall much this year (see European Sovereign Borrowing To Stabilize In 2012 At Close To All-Time High Levels).
Sovereign gross debt issuance will, under our projections, remain only slightly below 2011 levels, equivalent to 1.5x pre-crisis amounts. Sovereign refinancing needs in Europe continue to rise, leading the overall stock levels of European sovereign MLT commercial debt to reach an all-time high.
Our projections show that European sovereign medium- and long-term (MLT) debt at the end of 2012 will reach justunder €9 trillion, a rise of 50% since 2005.
As in 2011, net borrowing is likely to continue to fall. Nevertheless, our forecasts on net sovereign borrowing requirements for 2012 are subject to considerable uncertainty. Were GDP growth to be lower than we currently anticipate, the resulting fiscal slippage could push up public sector borrowing needs. Meanwhile, the one-off costs associated with financial sector recapitalization programs could also raise funding needs materially.
Last Tuesday, the International Monetary Fund (IMF) released a research paper advising policymakers to consider creating bail-in rules to deal with distressed systemically important financial institutions (SIFIs). Moody’s says the IMF’s support for cross-border bail-ins is credit negative for bondholders of SIFIs because, if implemented, a practical bail-in mechanism increases the likelihood that bondholders will receive a haircut on the debt of banks close to insolvency.
However, implementation of a credible bail-in framework for SIFIs faces significant challenges because they generally operate through a number of legal entities in different jurisdictions. We consider it unlikely that all regulators would recognise the bail-in powers of foreign peers, especially when it involves imposing losses on local bank creditors to protect a foreign SIFI.
The creation of a bail-in framework will likely receive significant public support since it aims to reduce the systemic risk caused by a SIFI’s disorderly default and restore its capital without tapping taxpayer funds. Consequently, government support to an ailing bank may be limited to providing emergency liquidity to restore market confidence. The IMF’s research paper follows a European Commission (EC) proposal outlining several options to implement a viable bail-in framework. Currently, most countries lack a detailed bail-in framework for senior unsecured bondholders, although some, including the UK, Denmark and Ireland, have legislation in place that allows bailing-in certain liabilities.
For details, see IMF Support for Bail-Ins Is Credit Negative for Bondholders of Systemically Important Financial Institutions
Western Europe’s housing markets seem to defy generalization, with some countries and cities bouncing back from the financial crisis more quickly than others, Standard & Poor’s says.
With a recession looming, though, any rebound may be running out of steam.
France’s real estate market has perhaps been the biggest surprise. After a short slump in the wake of the most recent economic recession, prices have again reached historic highs. Much of this is attributable to a stark imbalance in supply and demand. With the French population growing by an annual 370,000 per year, on average, and the number of people who live alone increasing, the country will need 400,000-500,000 new dwellings in the coming decade, according to the French housing authority.
For more see Western Europe’s Housing Markets Brace For Recession
Strong refi-driven mortgage banking results and a rebound in capital markets business drove surprisingly solid revenue growth for the large U.S. banks, according to Fitch Ratings.
Though revenues were generally higher for most banks, spread income was flat or down given the prolonged low interest rate environment. The uneven economic recovery produced modest organic loan growth in 1Q12. Banks reported more normalized levels of C&I loan growth (down from the robust activity reported last quarter), which was offset by lower consumer balances and continued CRE runoff.
Based on new regulatory guidance related to second liens, several institutions reported an increase in home equity nonperforming balances. Excluding this increase, nonaccruing loans were lower on a sequential basis. Fitch does not view this as a material shift in the performance of these loans or the reserving methodology.
Fitch would probably revisit its loss estimates on second lien loans if there is a sufficient increase in principal modification activity.
Exposure to home equity loans remains of Fitch’s top concerns for U.S. banks, particularly for the largest institutions where most of these loans are concentrated. While Fitch believes there is a possibility that losses in these portfolios could be material, current ratings reflect Fitch’s assumption that losses will remain above historical levels for several years.
For details, see the full Fitch report U.S. Banking Quarterly Comment: 1Q12
US investment-grade debt issuers have accelerated their share repurchase programs, generally leading to weakening credit profiles and limiting financial flexibility should market conditions weaken, according to a Fitch Ratings report.
Since the beginning of 2011, Fitch has taken negative rating actions on 12 issuers due in part to share repurchases. This compares with just three negative actions taken in 2010. All but one of the 12 issuers was rated investment grade, and most of the affected companies were in the ‘A’ and ‘BBB’ categories.
The growing levels of share repurchases were financed not only with free-cash-flow, but also with a larger dose of borrowings.
The increase in share repurchase activity reflects a willingness on the part of management teams to move down the credit scale, as well as the favorable market conditions.
Fitch notes that these actions leave companies with less flexibility in the event of another economic downturn, brought on, for example, by a deepening euro zone crisis or an oil price shock.
Fitch expects further aggressive share repurchase activity in 2012 as borrowing rates continue to move lower, even as stock prices have recovered from October 2011 lows. This will likely continue until economic growth accelerates, prompting companies to shift resources toward growth initiatives or M&A activity.
For details, see Buybacks Up, Ratings Down
The growing scale and importance of capital flows in the global economy indicates that such flows are set to experience a significant long-term rise, according to Oxford Analytica.
Global foreign direct investment (FDI) outflows rose by 16.5% last year, to $1.66 trillion dollars, the UN Conference on Trade and Development (UNCTAD) reported on April 12.
While portfolio diversification of rising personal wealth will be one reason for this growth in international capital flows, FDI will play its part. It will be driven by:
- established international businesses in the developed world seeking to further develop sales and operations in the leading emerging markets;
- and major companies in the emerging market economies likewise stepping up their investments abroad in order to foster trade and technical exchanges but also enable them to become global players in their own right.
This means that by 2020, based on the best case scenario for global growth and international investment, FDI flows could be worth as much as 9 trillion dollars (4-5% of GDP versus just over 2% today). The share of emerging markets in these outflows is also expected to rise — possibly reaching 50-60% by the end of this decade.
Given the high level of confidence in the scope for further fast economic growth, trade and capital market development across the emerging markets, these countries will attract inflows from both the developed and developing world. Furthermore, FDI will be a key driver of M&A activity in the advanced economies, and add to greenfield investments, as leading emerging-market companies seek to expand their networks. International investments look set to form a larger share of total global investment over the next decade.
For details, see FDI flows point to long-term confidence
Adopting International Financial Reporting Standards (IFRS) should benefit capital markets by reducing insiders’ ability to exploit private information, according to a new working paper published by Harvard Business School.
The study examines whether mandatory adoption of International Financial Reporting Standards (IFRS) leads to capital market benefits through enhanced financial statement comparability.
UK domestic standards are considered very similar to IFRS (Bae et al. 2008), suggesting any capital market benefits observed for UK-domiciled firms are more likely attributable to improvements in comparability (i.e., better precision of across-firm information) than to changes in information quality specific to the firm (i.e., core information quality). If IFRS adoption improves financial statement comparability, we predict this should reduce insiders’ ability to benefit from private information.
Consistent with these expectations, we find that abnormal returns to insider purchases―used to proxy for private information―are reduced following IFRS adoption.
Similar results are derived across numerous subsamples and proxies used to isolate IFRS effects attributable to comparability. Together, the findings are consistent with mandatory IFRS adoption improving comparability and thus leading to capital market benefits by reducing insiders’ ability to exploit private information.
Excerpted from Mandatory IFRS Adoption and Financial Statement Comparability by Francois Brochet, Alan D. Jagolinzer and Edward J. Riedl
US CMBS delinquencies rose in March for the first time since last summer, according to the latest index results from Fitch Ratings.
Late-pays climbed 13 basis points (bps) to 8.43% from 8.30% a month earlier. Helping to drive the increase was the continued underperformance of the $360 million Solana loan, now officially classified as 60-days delinquent.
Prior to March, overall delinquencies had declined every month after hitting a high water mark of 9.01% in July of last year.
Office loan delinquencies, as expected, are continuing their steady upward trajectory following a 31 bp increase to 7.99%. Late-pays on industrial CMBS also rose (37 bps) and are now the second-highest delinquency rate among all property types (behind multifamily) at 10.91%.
In contrast, performance for hotel CMBS is continuing to turn for the better, with delinquencies falling another 40 bps to 10.35%.
Current and prior month delinquency rates for each of the major property types are as follows:
–Multifamily: 12.61% (from 13.30% in February); –Industrial: 10.91% (from 10.54%); –Hotel: 10.35% (from 10.75%); –Office: 7.99% (from 7.68%); –Retail: 7.23% (from 7.15%).
Additional information is available in Fitch’s weekly e-newsletter, U.S. CMBS Market Trends, which also contains recent rating actions and an overview of newly released CMBS research.
The large US aerospace and defense companies have fallen further behind in their funding of burgeoning pension liabilities, says Moody’s Investors Service in a new report.
In 2011 the funding gap for the eight largest contractors rose by about $15 billion to $51 billion, and the average level of funding dropped five percentage points from the end of 2010, to 77%.
The defense contractors are able to bill the US government for pension costs, which helps to mitigate the risk such liabilities pose for credit quality, says Moody’s. But the billing must be done on future contracts, and US fiscal pressures could lead to payment delays or more stringent rules being imposed on plan sponsors.
The $51 billion figure for combined pension benefit liabilities (net of plan assets) is for the plans sponsored by Boeing, Lockheed Martin, Northrop Grumman, United Technologies, Honeywell, Raytheon, General Dynamics and Textron — eight of the largest Aerospace & Defense companies with some of the biggest defined benefit pension programs.
Moody’s expects the rising pension liabilities only to pressure ratings of the defense companies at their margins.
“While key credit metrics, especially leverage, look decidedly worse for some companies, we do not expect rating changes solely as a result of the growing pension burden,” says Russell Solomon, a Moody’s Senior Vice President. “Still, companies with outsized funding gaps could face growing downward rating pressure to the extent that liquidity is strained as funding requirements inevitably grow.”
For details see the Moody’s Special Comment Top Defense Contractors See Pension Deficits Widen