Moody’s anticipates more bankruptcy filings and bond defaults by California cities, but expects the total number to be relatively low. Across the-board ratings downgrades are a possibility.
Excerpts from Why Some California Cities Are Choosing Bankruptcy
We expect more bankruptcy filings and bond defaults among California cities reflecting the increased risk to bondholders as investors are asked to contribute to plans for closing budget gaps, however, we expect the number of filings and defaults will be low relative to the 93 Moody’s rated and 389 unrated city credits in California.
Given the deepening financial stress of many California cities, the home rule, “hands off” approach of the state as it relates to the fiscal challenges of the cities, the application of state’s new laws and access to bankruptcy, we are considering the following:
- Potential across the board adjustments of debt ratings for California cities to reflect the new fiscal realities and the governmental practices in addressing them;
- Potential for downgrades for particularly economically and fiscally distressed California localities, including counties, school districts, and special districts; and,
- Potential for additional downgrades for bonds other than GOs and special tax bonds.
Following the actions of legislators with a direct or indirect interest in firms in their constituencies could be a promising investment strategy, according to a new working paper from Harvard Business School.
Excerpts from Legislating Stock Prices
By observing the actions of legislators whose constituents are firms affected by legislation, the authors gather insights into the likely impact of government legislation on firms. Specifically, the authors demonstrate that legislation has a simple yet previously undetected impact on firm prices.
A long-short portfolio based on these legislators’ views earns abnormal returns of over 90 basis points per month following the passage of legislation.
- Focusing attention on the legislators who have the largest vested interests in firms affected by a given piece of legislation gives a powerful lens into the impact of that legislation on the firms in question.
- Legislators who have a direct interest in firms often vote quite differently than other, uninterested legislators on legislation that impacts the firms in question.
- The more complex the legislation, the more difficulty the market has in assessing the impact of these bills.
- The effect the authors document has been becoming stronger over time.
The Federal Housing Finance Agency (FHFA) is playing a major role in frustrating government attempts to address the housing crisis, and broader initiatives being explored by cities, municipalities, and states to alleviate household distress and promote recovery, according to Oxford Analytica.
Excerpts from Efforts to reduce mortgage crisis fail
The Federal Housing Finance Agency (FHFA) announced on August 8 that it may take action against any states or municipalities that use eminent domain powers to seize and refinance ‘underwater mortgages’ (ie, where the outstanding mortgage exceeds the property’s current value).
The failure of the federal government to enact an effective policy that would allow borrowers to refinance underwater mortgages continues to impose a significant drag on US economic performance.
Many borrowers remain locked into their current (high interest) mortgages, unable to take advantage of low interest rates, because lenders are not willing to refinance loans for more than current assessed valuations.
Eminent domain proposals have been floated before, but FHFA officials and Treasury Secretary Timothy Geithner have been publicly critical. Through its oversight role over Fannie Mae and Freddie Mac, FHFA has considerable power over housing markets, and could choose to punish entities that might use eminent domain, by, for example, making it more difficult to take out or refinance GSE-backed loans in those locations.
These efforts might be buttressed by credit rating agencies, which could threaten to downgrade the debt of any city, state, or municipality that enacts such a policy. Moreover, the Securities Industry and Financial Markets Association (SIFMA), a leading industry trade group, has threatened to exclude mortgages exposed to eminent domain risk from mortgage-backed securities pools. This threat, at least in theory, could increase the costs, and reduce availability, of mortgage loans in these jurisdictions.
FHFA and the opposition of the administration of President Barack Obama will, for now, prevent states and localities from using eminent domain power to seize underwater mortgages, allowing borrowers to refinance at lower rates. This is good news for banks and mortgage-backed securities holders, who do not want to realise losses on their portfolios, but bad news for economic growth. However, there could be further state and local government efforts to compel loan modification.
The US banking sector remains riskier than its peer group on most measurements, according to Standard & Poor’s.
Excerpts from Banking Industry Country Risk Assessment (BICRA): U.S.
We have reviewed the banking sector of the United States of America (AA+/Negative/A-1+) following the recent affirmation of the U.S. sovereign rating. We rank the U.S. in BICRA group ‘3′, along with countries such as South Korea, Denmark, Chile, New Zealand, and the U.K.
Our criteria define the BICRA framework as one “designed to evaluate and compare global banking systems.” A BICRA analysis for a country covers rated and unrated financial institutions that take deposits, extend credit, or engage in both activities. The analysis covers the entire financial system of a country while considering the relationship of the banking industry to the financial system as a whole. A BICRA is scored on a scale from 1 to 10, ranging from what Standard & Poor’s views as the lowest-risk banking systems (group ‘1′) to the highest-risk (group ‘10′).
The BICRA comprises two main areas of analysis–economic risk and industry risk–on which the U.S. scores ‘3′ and ‘4′, respectively.
Our economic risk score of ‘3′ reflects our opinion that the U.S. has “very low risk” in “economic resilience” and “intermediate risk” in terms of “economic imbalances” and “credit risk in the economy,” as our criteria describe those terms.
Our industry risk score of ‘4′ for the U.S. is based on our opinion that the country faces “intermediate risk” in its “institutional framework,” “high risk” in its “competitive dynamics,” and “very low risk” in “systemwide funding.”
With another half-year of performance in the books, current data is pointing to a continued slow and uneven improvement for U.S. commercial real estate according to Fitch Ratings in its latest U.S. Structured Finance Snapshot.
Performance across CMBS property types has been dependent on the property type in question. ‘Office properties will likely continue to see net operating income declines unless the property is in a core market such as New York,’ said Managing Director and CMBS group head Huxley Somerville. Multifamily and hotels, in contrast, will likely see average net operating income close in on historic peaks as 2012 comes to a close.
Fitch expects loan delinquencies to remain relatively flat for the remainder of 2012, with only office properties expected to climb. The same holds true for defaults. Loans on office properties contributed 47% of all defaults for the first six months of this year.
Another asset type that Fitch has been and will be paying particular attention to is retail. Recent consumer spending declines make retail properties a continued focal point. This has been especially true with respect to new deals where retail loans have been making up a large proportion of the newly securitized collateral.
Additional information is available here.
The recent moves toward bankruptcy by the California cities of Stockton and San Bernardino do not presage a wave of defaults by state and local governments, according to a new report from Standard & Poor’s.
Excerpts from U.S. Public Finance Economic And Credit Conditions Forecast: Overall Improvement Will Likely Slow With Some Exceptions
A downward revision to S&P’s baseline economic outlook for the remainder of 2012 and 2013 . . . suggests that most governments will not enjoy the organic fiscal relief that rising revenues from an accelerating economic recovery would bring.
Financial management can mitigate the negative pressures on credit quality that difficult economic conditions can bring about or intensify. However, governments with limited tax-raising ability and high fixed costs may be less able to respond to underperforming revenues. Examples of this have arisen in Stockton and San Bernardino.
. . . expenditure management (by localities) underscores our frequent refrain that the vast majority of government obligors will navigate the difficult conditions now and on the horizon.
While we avoid generalizing credits, certain traits can make governments more susceptible to credit deterioration than others. In our view, these include jurisdictions with the following characteristics:
- Low per capita incomes and higher rates of unemployment than the U.S.;
- A tax base that has undergone a relatively more exaggerated boom-bust housing market experience; and
- Low revenue-raising flexibility combined with inflexible expenditure budgets — especially where this has led to a reliance on unsustainable budget maneuvers to fund operations.
The forecast reinforces that governments with the above factors may be susceptible to fiscal pressure.
See also Moody’s view.