From Standard & Poor’s Ratings Services
The emergence of shadow banking as a significant source of finance for infrastructure projects is thrown into sharp relief in a report published by Standard & Poor’s Ratings Services. Inside Credit: Shadow Banking Looks Set To Capture A Larger Share Of Project Financing In 2013 finds that in just two years, shadow banking finance for projects has risen from virtually zero to an estimated $20 billion. What’s more, such funding looks set to climb further this year to a projected $25 billion.
“Traditional project finance lenders–governments and the banks–are under severe economic pressure while demand for capital to fund projects is growing,” said Standard & Poor’s credit analyst Michael Wilkins. “Just less than $200 billion of funding came from the global loan market for projects in 2012, down from $214 billion in 2011.”
Because the shadow banking market is not transparent, it’s difficult to determine how much of the decline in bank finance is being replaced by alternative sources of funding.
However, we believe that about 10% of all project finance lending–$20 billion–last year came directly from alternative sources and institutional investors. This is nearly as much as the amount that came from the public bond markets, which in 2012 totaled $24 billion globally, according to Project Finance International.
We define shadow banking as the system of finance that exists outside regulated depositories, commercial banks, and publicly traded bonds.
Although alternative lending can in our view create opportunities for borrowers and lenders to obtain cheaper sources of capital with less onerous disclosure requirements, there are risks. First, we believe that more lenders participating in the project finance sector may create incentives for project companies to maximize debt leverage–a process that has led, and may lead again, to systemic defaults and downgrades. And second, construction risk in particular remains a specific source of anxiety for investors.
Despite the increasing contribution to project finance from shadow banking, we believe that funding sources for infrastructure projects need to diversify further. As we see it, the main factors holding back the shadow banking sector and other alternative funding sources from investing further in infrastructure are a lack of data, inexperience, and an unwillingness to take on construction risk.
However, we believe that these obstacles are not insurmountable, and that investment from alternative providers of funding will continue to grow in 2013 and beyond.
From Standard & Poor’s Credit Research
Sandy generated insured losses of as much as $20 billion, according to early estimates, and total economic damages of up to $50 billion. The high end of those estimates would make Sandy, in real terms, the third-costliest storm in U.S. history, after hurricanes Katrina in 2005 and Andrew in 1992.
Yet although the storm hit the nation’s most densely populated region, strong advance planning by local, state, and federal authorities helped mitigate its impact.
As such, Sandy will likely have no near-term impact on our ratings on investment-grade infrastructure, transportation, communication and local government issuers, and only a limited impact on re/insurers.
While these efforts may have curtailed the storm’s credit impact in the near term, certain issuers, both public and private, could come under pressure over time, largely because of lost revenues, or delays in reimbursements from insurance companies, federal aid, or other sources. The latter could prove especially significant for some telecom companies whose operations are directly tied to the restoration of power and whose operations are concentrated in areas hit by the storm.
See the full report ($) Sandy Blows Through The Northeast With Only A Minimal Ratings Impact
From Fitch Ratings
Enhanced risk disclosure by banks is needed to assist comparison and restore investors’ confidence, Fitch Ratings says. The Financial Stability Board published Monday a report compiled by the Enhanced Disclosure Task Force (EDTF) with recommendations which would make it much easier for investors to compare the risk profiles of major banks, and could increase the confidence of market participants in bank data.
The volume and form of public data that banks provide on many areas of risk varies significantly between institutions, making meaningful peer comparisons difficult.
While we receive additional data on a confidential basis, public disclosure would also make this more consistent. Disclosure around funding and liquidity is particularly poor.
Banks do not disclose these details on a consistent basis, and estimating them from other sources can be difficult. The recommendations in the report address this by proposing a simple table providing a breakdown of encumbered and unencumbered assets by asset type, and also by whether unencumbered assets are likely to be readily available as collateral.
See the full comment ($) Fitch: Better Disclosure Would Aid Bank Comparisons, Raise Trust
From the Financial Stability Board
In its free report Enhancing the Risk Disclosures of Banks the Enhanced Disclosure Task Force (EDTF) identified seven principles:
- Disclosures should be clear, balanced and understandable.
- Disclosures should be comprehensive and include all of the bank’s key activities and risks.
- Disclosures should present relevant information.
- Disclosures should reflect how the bank manages its risks.
- Disclosures should be consistent over time.
- Disclosures should be comparable among banks.
- Disclosures should be provided on a timely basis.
Firms with lower disclosure on their anticorruption efforts may make more sales in corrupt countries than their high-disclosure peers, but they are likely to make less money from them, according to a new working paper from Harvard Business School.
The study examines 480 of the world’s largest companies, using ratings by Transparency International of firms’ public disclosures of strategy, policies, and management systems for combatting corruption. Professors Paul Healy and George Serafeim find that firm disclosures are related to enforcement and monitoring costs, such as home country enforcement, US listing, big four auditors, and prior enforcement actions. Disclosures also reflect industry and country corruption risks. Meanwhile the financial implications of fighting disclosure are more nuanced. Key concepts include:
- While firm-level research on corruption is still at the formative stage, findings suggest that disclosure is more than cheap talk.
- Firms with high disclosure on their anticorruption efforts are committed to fighting corruption. The policies and enforcement actions reflected in their disclosures help to protect their public reputation and profitability, but at the cost of slower sales growth in high corruption risk markets.
- Firms with abnormally low disclosure have roughly 15 percent higher sales growth in corrupt country markets than their high disclosure peers. But this higher growth is accompanied by lower profit margins and return on equity.
- Firms with abnormally high anticorruption ratings have a lower frequency of subsequent allegations of corruption in the media, suggesting that disclosures reflect their commitment to fighting corruption.
- Future research could examine (among other issues) what factors, other than monitoring/enforcement costs and risk exposures, explain the differences in firms’ level of disclosure and commitment to fight corruption.
Fore details, see Causes and Consequences of Firm Disclosures of Anticorruption Efforts
Standard & Poor’s expects continued austerity in fiscal 2013 budgets for US states, which nevertheless will mostly retain their strong credit status:
Our credit outlook for the sector at the start of 2011 focused on the difficult transition to a post-stimulus budget environment. By all accounts, states have made the often-difficult decisions necessary to transition their budgets. For most, the solutions were structural, with less reliance on non-recurring resources and debt issuance and more focus on spending reductions and, to a lesser extent, revenue enhancement.
We believe that this focus on structural solutions in fiscal 2012 will translate to a more favorable budget picture heading into fiscal 2013.
Despite a steady pace of economic recovery for most states through the first two quarters of fiscal 2012, we believe that economic prospects and federal fiscal consolidation present significant uncertainty that could translate into continued budget austerity.
Despite these challenges, we expect the sector as a whole to retain its strong credit profile. In contrast to the federal government and many other governments across the globe, most U.S. states are required by statute or their constitution to adopt a balanced budget. In our opinion, this requirement tends to force budgetary discipline, corrective action on identified budget gaps, and lower leverage.
For details and a state-by-state analysis, see:
For U.S. State Budgets, Austerity Is Here To Stay
More from S&P Credit Research
Standard & Poor’s says infrastructure and other project financing is holding up well despite weak economic conditions.
The current trend in project finance demonstrates demand for this type of transaction to support infrastructure and renewable energy projects, among others. The ratings on some sectors were pressured because of offtaker or monoline issues, and while we have downgraded a few projects to noninvestment grade from the investment-grade category, the majority of U.S. projects are still in the investment grade. Overall, this asset type, because of its long-term contractual nature remains strong and resistant to some economic pressures.
Currently, 61% of U.S. projects are investment grade, up about 14% for the same period last year. Seventy percent of rated U.S. projects have a stable outlook, 12 have a positive outlook, and 54 have a negative outlook.
While we expect some ratings to remain under pressure until an economic recovery takes hold, we expect most ratings to to show some resiliency through the recession.
For the full report, see Industry Report Card: Global Project Finance Presses On Steadfastly Despite Economic Conditions.
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