'Falling angels' could hit $260 billion of emerging market debt

LONDON - After a golden decade of improvement, credit ratings for a swathe of developing economies risk falling back to "junk", with huge potential costs for up to a tenth of outstanding emerging market bonds.

Many mainstream investment and pension funds have rules preventing them from holding debt unless it is classified as investment grade by at least two of the big ratings agencies, and a number of countries are at risk due to problems ranging from tumbling commodity export prices to political instability.

Russia this week became the first of the major economies to lose its investment grade status from Standard & Poor's, falling out off the top ratings category for credits deemed to have a low risk of default for the first time in a decade.

If Moody's and Fitch follow, conservative investors barred from owning junk securities must sell their holdings. JPMorgan estimates this means they may ditch $6 billion in Russian government rouble and dollar debt.

Russia may have company. Almost $260 billion worth of sovereign and corporate bonds - nearly a tenth of outstanding emerging market (EM) debt - is in danger of being relegated to junk, according to David Spegel, head of emerging debt at BNP Paribas, who calls such credits "falling angels".

What's more, almost $1 trillion of debt is rated BBB or BBB minus - the two lowest investment grade ranks after which junk or "high yield" status awaits.

"After a year of political upheaval and collapsing commodity prices, the sky is alight with EM falling angels," Spegel said.

TABLE of emerging markets ratings.

In 2010, for the first time, a majority of bonds in the EMBI Global index of emerging market debt became investment grade 11EML. But now a fifth of emerging market governments rated by S&P carry negative outlooks; the agency calls emerging markets the "weak link" in the global ratings picture.

If there is a series of downgrades, the entire index could shift lower again, Spegel warned, adding: "The EM benchmark index is at risk of becoming a falling angel."

Ratings models compiled by analysts at Bank of America/Merrill Lynch show downgrade risks in Brazil, Russia, Turkey, South Africa and Indonesia.

Some of these, such as energy importers which benefit from falling oil prices and countries making economic reforms, may avoid relegation.

However, ratings tend to move up and down in tandem, BofA noted. It cited negative credit revisions in the 1980s, upgrades in the early 1990s, downgrades in the late 1990s and another round of upgrades this century. Two-thirds of emerging economies are investment grade, up from 42 percent a decade ago, it added.

"Investors may well view initial downgrades not as isolated events but as the beginning of a new trend," BofA said.

INDEX EJECTION RISK

Russian, Turkish, Brazilian and South African local bonds - among the handful of emerging market names included in the Barclays Global Aggregate index - risk ejection from the $2 trillion benchmark if they are downgraded.

Falling angels which lapse into junk status will also drop out of the investment grade portion of the EMBIG index which has up to $7 billion benchmarked, JPMorgan says.

"The big worry is for countries in the low investment grade range, such as Russia and Brazil. Falling into the junk bond range cuts you off from the largest segment of bond buyers," said Peter Marber, head of emerging debt at Loomis Sayles.

That's especially so in the case of big insurers and banks which are extremely sensitive to ratings due to tighter regulations on capital reserves and asset quality, he noted.

Also, company ratings tend to be constrained by the sovereign, Marber said, adding: "So if we see countries downgraded into high-yield status, it may trigger automatic corporate downgrades which would dramatically restrict access to international capital."

All this will raise capital costs for borrowers, adding to pressures caused by the possibility of higher U.S. interest rates and Treasury yields which will suck funds out of emerging markets.

Exactly how much emerging bond yields will rise is impossible to calculate. But BofA/Merrill reckons a one-notch downgrade to junk tends to produce a 40-60 basis point increase in yield and credit default swap spreads.

BNP's Spegel calculates that for every 10 falling angels, spreads over U.S. treasury bond yields on the CEMBI EM corporate debt index will widen by 125 basis points and sovereign spreads will blow out 241 bps.

On the plus side, though, some risk is already priced in. Russian and Kazakh bonds for instance trade as though they were several notches into junk.

Also ratings don't much matter to dedicated emerging market funds and increasingly to some institutional investors who may base allocations on asset managers' analysis, rather than solely on ratings.

Wayne Bowers, EMEA and Asia chief investment officer at Northern Trust, says many big investors have built in the flexibility to hold different kinds of emerging assets in recent years. Also, he notes, while some countries' outlook has darkened, others will benefit from reforms and cheaper oil.

"People usually understand EM is not a low-risk asset class." Bowers said. "You will find the return profile of the broader indexes can offset the negatives... It's not just focused on countries that are fragile but also those that benefit from falling oil prices."

source: interaksyon.com

Britain loses AAA-rating in Moody's downgrade

WASHINGTON - Rating agency Moody's cut Britain's debt rating Friday by one notch from the top-grade AAA to Aa1, citing slow growth and a rising debt burden.

Moody's also cut its AAA rating for the country's central bank, the Bank of England, by one step, also to Aa1.

The main driver for the sovereign downgrade, Moody's said, "is the increasing clarity that, despite considerable structural economic strengths, the UK's economic growth will remain sluggish over the next few years."

The British economy is constrained both by the turgid global economy, Moody's said, and the drag from businesses and the British government slashing their debt burdens.

Moody's said the country's recovery has proven to be significantly slower than previous rebounds from recession, and Moody's said it did not expect the situation to change.

"Moreover, while the government's recent Funding for Lending Scheme has the potential to support a surge in growth, Moody's believes the risks to the growth outlook remain skewed to the downside."

Moody's said that slow growth would retard a projected rise in tax revenues and make progress difficult for the government's fiscal consolidation program, "which will now extend well into the next parliament."

Meanwhile, the government's growing debt load would reduce the shock-absorption capacity of government finances at least into 2016.

Moody's projected that government debt would continue to rise and peak at 96 percent of gross domestic product in 2016, much later than previous projections.

"After it was elected in 2010, the government outlined a fiscal consolidation program that would run through this parliament's five-year term and place the net public-sector debt-to-GDP ratio on a declining trajectory by the 2015-16 financial year," ratings agency said.

"Now, however, the government has announced that fiscal consolidation will extend into the next parliament, which necessarily makes their implementation less certain."

Moody's however put Britain on a stable outlook, guardedly confident that political will combined with some medium-term fundamental economic strengths "will, in time, allow the government to implement its fiscal consolidation plan and reverse the UK's debt trajectory."

source: interaksyon.com

Moody's says PNB, Allied Bank to benefit from BPI acquisition

MANILA – A merger between the Ayala group’s Bank of the Philippine Islands on the one hand and Philippine National Bank and Allied Banking Corp on the other would improve the credit score of the latter two Lucio Tan-owned lenders, according to Moody’s Investors Service.

“BPI’s acquisition of PNB is credit positive for PNB and [Allied Bank] because BPI is fundamentally stronger than the other two banks, and as such will be able to improve their credit profiles,” Moody’s said in a statement.

“Because BPI is the strongest among the three in terms of asset quality and risk-adjusted profitability, we expect the merger to have a positive effect on PNB’s and [Allied Bank’s] respective financial metrics,” the credit rating firm said.

Last week, BPI and PNB announced that they were in discussions for the former's acquisition of the latter. The talks come as PNB has yet to complete its own merger with Allied Bank.

Moody’s maintains a “Ba1” rating on BPI, a “Ba2” rating on PNB, and a “Ba3” rating on Allied Bank. Outlooks for the three lenders are “stable,” which means no change in their ratings is expected in the near term.

“PNB and [Allied Bank] rank lowly among our rated Philippine banks in key credit performance measures despite improvements over the past three years. Both maintain substantial legacy bad loans that continue to weigh on their asset quality,” Moody’s said.

“In addition, both exhibit high credit risk concentration to large borrowers relative to their core capital base, which exposes them to significant credit losses,” the rating firm said.

“Moreover, the boards of directors at both banks are dominated by a controlling shareholder and lack adequate representation by independent directors, both of which threaten their corporate governance,” Moody’s said, referring to Tan.

The rating firm said the absence of financial details on the transaction prevents it from providing a definitive assessment on the credit implication on BPI.

“However, our preliminary assessment is that the transaction would not entail a significant burden on BPI’s credit profile. Assuming that BPI pays two times PNB’s and [Allied Bank’s] book value for Tan’s stakes in both banks, and funds the acquisition through a share swap based on the last traded share price prior to the announcement of the acquisition, we estimate BPI’s Tier 1 capital ratio would increase to 16 percent from 14.5 percent, based on September 2012 financials,” Moody’s said.

“In another scenario in which BPI pays for the acquisition using a 50-50 mix of cash and newly issued equities, we estimate BPI’s Tier 1 capital ratio would decrease to 11 percent,” the rating firm said.

At end-June, BPI was the third-largest bank by assets in the Philippines, while PNB was seventh and Allied Bank, 13th. A merger would catapult the surviving entity to the top spot, with an estimated market share of 19 percent of system assets.

source: interaksyon.com