The shadow banking system in the United States might not be as large today as regulators and market participants feared, according to a new quarterly index introduced today by the Deloitte Center for Financial Services. However, with regulatory changes and financial innovation looming, the shadow banking system could creep back very quickly, the Deloitte research group cautions.
The Deloitte Shadow Banking Index shows the volatile shadow banking system totaled $9.53 trillion at the end of 2011 ‒ more than 50 percent below its peak in 2008 ‒ and a figure considerably lower than many estimates.
“With other size estimates ranging from $10 to $60 trillion, we think shadow banking is a concept continuing to look for a better definition,” said Adam Schneider, the executive director of the Deloitte Center for Financial Services.
The Deloitte Shadow Banking Index value differs from other market estimates. For instance, Deloitte estimates that shadow banking assets were over $10 trillion in 2010, compared to the $24 trillion estimated by the FSB.
The FSB estimate differs greatly from Deloitte’s estimates. Most importantly, the FSB’s use of “other financial intermediaries” as a proxy for shadow banking includes activities that are not contained in Deloitte’s definition, including non-MMMF investment funds, finance companies, and “others.”
Other estimates vary as well. For example, researchers at the Federal Reserve Bank of New York (Pozsar, et al.), puts the size of the U.S. shadow banking system at $20 trillion in 2008 and $15 trillion in 2010. Similarly researchers at the International Monetary Fund (IMF) opined that the shadow banking liabilities in the U.S. were as high as $18 trillion in 2010.
Key Index findings include:
- Shadow banking in the U.S. reached a peak value of $20.73 trillion in the first quarter of 2008.
- Also during the first quarter of 2008 the traditional banking sector’s assets were only about $15 trillion — 28 percent less than shadow banking.
- At the end of 2011, however, the comparison reversed with assets in the traditional banking sector $8 trillion higher than shadow banking.
- Dramatic growth of the sector occurred between late 2004 (the Index’s starting point) and early 2008, increasing nearly two-thirds in size.
- There have been dramatic changes to a number of the Index’s components, including money market mutual funds and activities relating to the government-sponsored enterprises. Securities lending is the only activity that is twice the volume today compared to the Index’s baseline eight years ago.
The investment potential for offshore wind through this decade is immense, says Standard & Poor’s in a new report Strong Growth Of Global Offshore Wind Power Provides Big Opportunities For Project Finance (available as a complimentary download via the Alacra Store).
Many countries expect wind power to account for a large share of their renewable-energy investment to meet energy and climate goals. The new capacity by 2020 envisioned by the U.K. (16 gigawatts [GW]) and Germany (10 GW) alone would require about €91 billion ($117 billion) to €104 billion ($133 billion). China’s current five-year plan envisioning 30 GW of offshore capacity by 2020 would involve even more investment.
Most European offshore wind projects have to date been sponsored by utilities and funded on their balance sheets. Only utilities could put together funding on reasonable terms to pay for these capital-intensive projects. In addition, utilities are motivated by strategic objectives and regulatory incentives.
After construction and commissioning are complete, some utilities sell the project or part of it to long-term investors. But some rated utilities have limited headroom at their current ratings to accommodate the increase in financial risk inherent in the substantial upfront investments required. This will likely increase the incentive for utilities to develop the projects off their balance sheets through single-asset project financing and shared equity stakes with infrastructure or financial investors.
We think utility funding will remain the predominant source for projects in the early stages of development for the next few years, then gradually decline as offshore wind technology evolves and investors are better able to quantify construction and commissioning risks.
Despite the good match of long-term assets with institutional investors’ long-term investment horizons, investors have so far shown little interest in these projects until they have established operations and are generating a profit. Institutional investors are typically reluctant to assume construction risk and instead focus on yield. But this is beginning to change. In 2008, a private investor group led by Blackstone Group L.P. began to develop the 288 MW Meerwind project in Germany, the first offshore wind project to be sponsored privately. This €1.2 billion project is in construction and funded with private equity and debt.
The complete report Strong Growth Of Global Offshore Wind Power Provides Big Opportunities For Project Finance has been made available free of charge to ResearchRecap users for 30 days by special arrangement with Standard & Poor’s, an Alacra content partner. After 30 days, the report will revert to its regular AlacraStore price of $500.
Related research from S&P:
U.S. Offshore Wind Investment Needs More Than A Short-Term Production Tax Credit Fix
Support For Renewable Energy Inches Ahead While Global Energy Demand Grows By Leaps And Bounds
Renewable Energy Requires Renewable–And Plentiful–Funding To Meet Global Policy Goals
For additional reports from Standard & Poor’s visit the Alacra Store.
A new working paper from Harvard Business School finds that companies with progressive environmental and social policies significantly outperform their counterparts over the long-term, both in terms of stock market and accounting performance.
Excerpts from The Impact of a Corporate Culture of Sustainability on Corporate Behavior and Performance (free pdf download) by Robert G. Eccles (HBS) Ioannis Ioannou (London Business School) and George Serafeim (HBS).
We investigate the effect of a corporate culture of sustainability on multiple facets of corporate behavior and performance outcomes. Using a matched sample of 180 companies, we find that corporations that voluntarily adopted environmental and social policies by 1993 – termed as High Sustainability companies – exhibit fundamentally different characteristics from a matched sample of firms that adopted almost none of these policies – termed as Low Sustainability companies.
In particular, we find that the boards of directors of these companies are more likely to be responsible for sustainability and top executive incentives are more likely to be a function of sustainability metrics. Moreover, they are more likely to have organized procedures for stakeholder engagement, to be more long-term oriented, and to exhibit more measurement and disclosure of nonfinancial information.
Finally, we provide evidence that High Sustainability companies significantly outperform their counterparts over the long-term, both in terms of stock market and accounting performance.
The outperformance is stronger in sectors where the customers are individual consumers, companies compete on the basis of brands and reputation, and in sectors where companies’ products significantly depend upon extracting large amounts of natural resources.
See also Doing Well by Doing Good: Corporate Social Responsibility Lowers Capital Costs
Oxford Analytica believes that fears that US political leaders may precipitate renewed recession by allowing a fiscal crunch or voluntary debt default late this year are wildly overblown.
Congress will raise the statutory debt ceiling and reduce the severity of scheduled fiscal consolidation regardless of the outcome of November’s elections — though the debate may spill into the next Congress, unnerving markets.
Republican leader John Boehner vowed that the House of Representatives would not vote to increase the debt limit beyond the current threshold of 16.39 trillion dollars unless there were offsetting cuts in spending or unspecified “reforms” — raising the spectre of another destabilising standoff over fiscal policy. The United States might hit the ceiling before the end of the year, adding to market anxiety about Congress’s ability to avert the 8 trillion dollar fiscal consolidation crunch scheduled to hit under current law by January 1, 2013. Unless there is legislative action to avoid overly rapid consolidation, many economists view this cocktail of tax increases and heavy spending cuts (’taxageddon’) as lethal to US growth.
However, OxAn says:
- The elections will determine the nature (cuts vs revenue increases) of fiscal consolidation; it will occur regardless who is in office.
- Even if ‘tea party’ influence grows, it will not be sufficient to stymie the process or block a debt ceiling increase and fiscal deal.
- Even if lawmakers engage in further political brinkmanship, the hit to confidence will be less than during the August 2011 debt debacle.
For details see UNITED STATES: Fear of a fiscal debacle is excessive
Fitch says the election of the Socialist party candidate, Francois Hollande, as President of the French Republic does not have implications for France’s ‘AAA’ rating, currently on Negative Outlook.
Nonetheless, his electoral victory marks an important change in the leadership of France and Europe.
The new President faces the same challenges as his predecessor: strengthening fiscal credibility; boosting France’s medium-term growth potential; and dealing with the eurozone crisis.
Fitch affirmed France’s ‘AAA’ sovereign rating on 16 December 2011 and revised the rating Outlook to Negative. In the absence of material shocks, the Outlook is unlikely to be resolved until 2013. Fitch’s review of France’s sovereign credit fundamentals will incorporate developments in the eurozone crisis and the economic and public finance risks it poses to France, as well as its latest assessment of the economic outlook and prospects for reducing public debt over the medium term.
For more see France – The Challenges Ahead
Increased financial statement disclosure and transparency can provide early warnings of trouble spots in corporate earnings and/or cash flow for US corporate issuers, according to Fitch Ratings.
Fitch does not expect the recently implemented accounting standards to have a material effect on corporate financial statements or be the sole cause of rating changes.
Fitch’s third annual review of corporate accounting issues evaluates recent accounting guidance, including enhanced footnote disclosures for multi-employer pensions and fair value. Changes in guidance for goodwill, changes in presentation for comprehensive income, as well as topical issues regarding pensions, taxes, and convergence are also discussed. Additionally, the report contains an appendix summarizing common accounting ‘red flags’ that may signal aggressive accounting practices.
The most informative recent enhancements to footnote disclosure relate to employers’ financial obligations to multi-employer pension and postretirement plans (MEPPs). The new disclosures go a long way toward revealing better estimates of a company’s share of its MEPP liabilities and potential impact on future cash flow.
Pension liabilities generally increased during 2011, driven by the decline in discount rates. Also, the weak equity returns in 2011 were not able to offset the increase in liabilities, causing the funding gaps to widen. This problem is likely to be most pronounced for lower-rated companies with materially underfunded pension plans and increased funding requirements. Proposed pension legislation would allow companies to use a higher discount rate for funding purposes, likely resulting in lower required contributions and potentially exacerbating funding problems in the future.
For details, see the full Fitch report Scrutinizing Topical Accounting Issues
Alacra has released the beta version of a tool to keep track of bank regulation and compliance in a clear and understandable format. Presented as a Periodic Table, the beta version includes 76 “elements” representing major regulations and regulators. No doubt some more will be added based on feedback.
The entries date back to 1863, when the Office of the Comptroller of the Currency was formed, and includes summaries of pending regulations resulting from the Dodd-Frank Act and Basel III, for example. Each entry includes a summary, key facts, and links to more information.
We had a hand it putting together the content, so if you spot any errors or omissions or have any suggestions for improvements, please send them to email@example.com.
Click here to open the Periodic Table of Bank Regulation and Compliance, then click on individual elements for details.
A number of recent U.S. economic data releases, as well as management comments during earnings season, continue to support Fitch Ratings’ view that companies are proceeding cautiously when considering expanded investment in plant and equipment.
We see little evidence that a significant ramp up in capital expenditures is at hand, despite some positive signs regarding a modest pick up in manufacturing activity in the April Institute for Supply Management (ISM) survey.
The weaker preliminary read on U.S. GDP growth of 2.2% for the first quarter was driven in large part by a decline in nonresidential fixed investment, which contracted at a 2.1% annualized rate (compared with growth of 5.2% in the fourth quarter of 2011). March durable goods orders also showed weakness, down 1.1% in the month after excluding volatile orders for transportation equipment.
This tracks closely with our expectations for 2012 U.S. corporate capex, which appears to be lagging following a pull-forward of some corporate investment into late 2011.
Corporate capex grew last year, but that growth partly reflected an acceleration of some investment to take advantage of expiring bonus depreciation tax benefits. Heavy investment in the energy sector, which accounts for approximately 30% of total corporate capex, also helped drive 2011 growth. Energy companies remain outliers in early 2012, with aggressive capex plans still on track in light of high oil prices.
The hangover effects of accelerated 2011 spending, persistent concerns about the global demand outlook, and the absence of production capacity constraints are all holding back investment growth. Most management teams across a range of industries remain concerned about potential economic ripple effects from the European debt crisis and a slowdown in emerging market growth this year.
Many U.S. manufacturers have indicated that stronger relative demand conditions in the U.S. and Latin America are offsetting weakness in Europe as well as slowing growth in China. To the extent that companies are heavily exposed to those more challenging markets, the outlook for capex growth in the second half of the year is likely to remain cautious.
For more see Fitch: U.S. Corporate Investment Caution Evident in 1Q Reports
Public Sector Credit Solutions and PF2 Securities Evaluations have released a quantitative open source tool to provide an alternative or supplement to the more qualitative approach to analyzing government debt used by established ratings agencies such as Fitch, Moody’s and Standard & Poor’s.
Excerpts from the Press Release:
PF2’s Public Sector Credit Framework (PSCF) avoids several of the pitfalls facing traditional public finance methodologies used by credit rating agencies. It relies on a multi-year budget simulation that estimates annual default probabilities based on the likelihood of exceeding a user-specified fiscal threshold in any given year. These default probabilities are then converted to ratings.
“Rating agency sovereign and muni bond groups do not take advantage of the power and objectivity of quantitative techniques, leaving their methodologies vulnerable to bias and inconsistency,” said PF2 Consultant Marc Joffe, who previously researched and co-authored Kroll Bond Rating Agency’s Municipal Bond Default Study. PF2 is an independent consulting firm founded by a group of former Moody’s analysts.
The approach of using stochastic budget projections to estimate government credit risk is a natural and appealing approach to an important problem.- Ronald Lee, Director of the Center on the Economics and Demography of Aging at UC Berkeley
Programmers and analysts can review the tool’s source code and adapt it to fit their needs. PF2 has posted the software along with sample models for the US and California at http://www.publicsectorcredit.org/pscf.html and the source code on GitHub, a popular open source repository, at https://github.com/joffemd/pscf .
The California sample provided uses as a default point the ratio of interest and pension expenses to total revenue. Budget projections in this analysis rely on a range of population, economic growth, inflation, interest rate and policy scenarios. While these modeling choices may be appropriate for California, the framework accommodates a wide variety of threshold choices and budget simulation methods.
Anthony Randazzo, Director of Economic Research at The Reason Foundation, commented, “An open source tool like PSCF is a great answer to complaints about rating agency transparency. By linking a government’s projected debt burden to its risk, the framework sends the right signal both to bondholders and policymakers.”
FT Alphaville provides some additional analysis here.
Standard & Poor’s Ratings Services’ base-case outlook for global auto sales in 2012 is for sharper differences between regions than in 2011. The mixed outlook for passenger vehicle sales reflects an economic outlook that varies by region and so the outlook for credit quality also varies. The mixture of regional exposures is a key aspect of credit quality in 2012.
Our forecast for 2012 US sales of 14.2 million units means sales may climb comfortably above estimated replacements of 13 million for the first time since 2008.
And the first three months of 2012 have seen annualized rates of sales in excess of our 2012 forecast. Still, we remain cautious about potential weakness in the economic recovery because of challenges in Europe, the impact of slower growth in China, and the potential for U.S. fiscal showdowns late in 2012.
In Europe our base-case outlook assumes that light-vehicle sales will decline more significantly in 2012 than in 2011 (the fourth consecutive year of European decline). In Japan, new vehicle sales during the first three months of 2012 jumped by 47.5% compared with the same period in 2011; we expect improved supply conditions and the government’s new eco-car subsidy program to boost new vehicles sales. In the important markets of China and Brazil our base case is for slower, but still positive growth.
More from S&P Credit Research
Industry Report Card: Mixed Regional Sales Outlooks Equals Mixed Prospects Among Global Automakers