18/4/15: Fitch Postpones Russian Ratings Review on Improved Data

As noted yesterday, both Fitch and S&P came out with (well, sort of came out in Fitch case) updated ratings for Russia. I covered S&P ratings here: http://trueeconomics.blogspot.ie/2015/04/17415-conservative-to-surprising-degree.html

Now onto Fitch.

According to the Russian Finance Minister, Anton Siluanov, Fitch postponed formal ratings review and held Russian ratings at BBB- - just a notch above junk grade. Fitch, thus, retains the only non-junk rating for Russia amongst the Big 3 agencies, with S&P at BB+ and Moody's at Ba1. According to Siluanov, the postponement reflects improved data outlook for the Russian economy.

Fitch was the first of the Big 3 to cut Russia’s rating back on January 9 (see http://www.reuters.com/article/2015/01/09/fitch-downgrades-russia-to-bbb-outlook-n-idUSFit89012120150109). Since then, Russian eurobond issue, maturing 2030 posted a 13 percent plus rise. In part, this reflects firming up of the ruble, and to a larger extent - the unprecedented levels of liquidity flowing into sovereign bonds markets worldwide. But in part, improved yields are also reflective of adjusting expectations concerning Russian economy. For example, alongside their February downgrade, Moody's estimated Russian capital outflows for 205-2016 at USD400 billion and Russian GDP was forecast to fall by 8.5%. Current consensus in the markets is that outflows will be closer to USD150-170 billion (on expected debt maturities) and the economy is likely to contract by closer to 4-4.5%.

Capital outflows figures stabilisation has been rather significant, especially given the level of debt redemptions in 1Q 2015 (see here: http://trueeconomics.blogspot.ie/2015/04/14415-russian-external-debt-redemptions.html). In 1Q 2015, estimated outflows totalled just USD32.6 billion, compared to USD77.4 billion in 4Q 2014 and with USD48 billion outflows in 1Q 2014. While banks continued to deleverage, non-financial sector was able to roll over much of maturing debt and were repatriating assets into Russia. The net result was inflow of forex into the Ruble market.

Deleveraging in the Russian economy is going at a breakneck pace: in mid-2014 Russian external debt (over 90% accounted for by private sector) stood at just over USD730 billion. By the end of 1Q 2015 estimated external debt has fallen to USD560 billion, implying net debt reductions of USD170 billion over the span of 9 months, well above my earlier estimate of net repayment of USD96.5 billion that excluded Ruble devaluation effects. The USD170 billion estimate includes devaluation of the Ruble and roll-overs when these involved conversion from forex-denominated inter-company loans and equity into Ruble-denominated ones. It is worth remembering that roughly 1/4 of Russian external debt is denominated in Rubles.

When it comes to sovereign ratings, it is also worth remembering that Russian public sector external liabilities amount to less than 10 percent of the total external debt.

Overall, Fitch decision to hold Russian ratings under review is a reflection of the recent improvements in the economic outlook, but also the fragile and early nature of these. As I noted on numerous occasions before, the situation is fragile and the risks to the downside are prominent, so Fitch's more cautious approach to ratings is probably better justified by the current environment.

17/4/15: Conservative to a Surprising Degree: S&P Russia Ratings

Two ratings agencies updated their ratings for Russia today. Here are some highlights:

S&P first (Fitch later, so stay tuned):

S&P kept Russia’s foreign-currency credit rating at BB+ or one step below investment grade with negative outlook. ""We are affirming our 'BB+/B' long- and short-term foreign currency ratings and our 'BBB-/A-3' long- and short-term local currency ratings on Russia".

The agency claimed that Russian policy makers are struggling to boost growth and the country financial system risks are increasing due to continued external funding drought caused by the sanctions. Per S&P statement, “Our base case assumes that the sanctions on Russia will remain in place over the forecast horizon, absent a resolution of the conflict in Ukraine.”

S&P first pushed Russian ratings below investment grade on January 26, based on the adverse impact of lower oil prices and ongoing sanctions.

The rating came in as expected, though negative outlook might be a touch gloomy for some observers. The reason is that since January, Ruble gained significant ground in value, while capital outflows projections for 2015 improved (in 2014 Russia experienced capital outflows of USD154 billion, and 2015 latest forecast is for outflows of USD90 billion). Ruble trade at 68.0 to USD back on the day of S&P previous decision, today it is around 52 mark. Growth outlook is stabilising, albeit remains highly challenging. Inflation is matching S&P previous expectations, but against lower CBR rates. Ukrainian conflict drags on, for sure, but there is at least a fragile pause in place and if in January new sanctions were looming, today there appears to be no momentum for their introduction. Finally, oil was at around USD48 pb then, at USD55 pb now. Russian authorities have said this week that they may return to foreign borrowing markets in 2016, while expectation in January was that the earliest date we might see Russian issuance in international markets is 2017.

On the higher risks side, March consumer demand appears to have worsened despite improved Ruble exchange rate as preliminary retail sales data shows a 8.7% drop y/y and consumer sentiment index down 14 percentage points on Q4 2014. Economy is expected to post a contraction of 2-4 percent in 1Q 2015. Preliminary data suggests investment declined 5.3% y/y and industrial production is down 0.6%. Inflation is running at 16.8% annualised rate, but that is, actually, a slowdown from over 18% earlier this year.

Still, at 2-4 percent, things in 1Q 2015 are not as bad, and certainly not worse, that full year consensus forecast of 4.1 percent this year. And capital outflows eased significantly in 1Q 2015 to USD32.6 billion from USD77.4 billion in 4Q 2014.

So it is a mixed bag, but crucially, the economy is performing close to previous expectations, with no significant downside surprise between January and today. Which means that it is rather unclear which part of expectations forward warrants 'negative' outlook, given there is already a 'negative' outlook reflected in the affirmed ratings?

S&P tries to explain: “The outlook remains negative, reflecting our view that we could downgrade Russia if external and fiscal buffers deteriorate over the next 12 months faster than we currently expect. We could also lower the ratings if Russia’s monetary policy flexibility were to diminish further.”

But contrasting this, is S&P own outlook published in recent weeks covering key sectors and economic activity. In April 13 note, S&P estimated that 5 largest Russian banking groups have lost USD4-5 billion in 2014 (ca 20-25% of their aggregate operating income) due to their exposure to Ukrainian assets. But forward outlook is not exactly any worse, as S&P said that 2015 losses from the same can be about the same. More significantly, S&P said that they "…estimate that Russian banking groups face aggregated Ukraine-related risks of less than 3% of their aggregated assets…. We nevertheless believe that Russian banks can withstand such costs, and that there will therefore be no rating impact for rated Russian financial groups."

And more. On April 7th, S&P itself upgraded outlook for the Russian economy: S&P own forecasts now expect 2016 growth of 1.9% (as opposed to 0.5% consensus forecasts) and a recession of 2.7% in 2015, as opposed to January 2015 forecast of 0.5% growth in 2015 and zero percent growth in 2016 and against the consensus forecasts cited above.

S&P is not the only research outfit upgrading Russian growth forecasts: JPMorgan revised recently its 2015 forecast from -5% to -4%. Russian official forecasts are also 'stabilising': Ministry of Economic Development forecasts +2.3% for 2016 and +2.5% over 2017 and 2018. CBR forecasts a drop of 3.5–4% in 2015 and growth of +1–1.6% in 2016, rising to 5.5–6.3% in 2017.

The bizarre nature of ratings agencies analysis - including inherent own-contradictions and lags - is one of the reasons why the CBR recently said they are considering gradually abandoning Big 3 agencies ratings for the country banking sector. The move would involve developing internal ratings system and, potentially, relying on other agencies in the mix.

Conclusion: altogether S&P latest ratings make some, but very limited sense and are conservative. So let them be. Russian bonds have been rallying recently and as long as oil stays firm-ish and Ruble does not experience another run, this rally will continue in the medium term. Any adverse repricing of bonds on foot of today's S&P action (and potential downgrade by Fitch) can actually create opportunities for distressed debt buyers, which will firm up prices again. Globally, there is too much money chasing too few bonds, so spike in yields in the short run can be seen by some speculators as an opportunity to pile into Russian paper. 

(Please, do not confuse this with an investment advice, as usual, for I do not do that sort of thing).

Economics 25/8/10: S&P & the horrific cost of banks bailouts

As you all know, Standard & Poor (S&P) downgraded Irish sovereign debt to AA- from AA with a negative outlook. The downgrade was mainly motivated by the fact that the cost of the Irish banking bailout has increased significantly over previous expectations. S&P now estimate the cost of recapitalising the Irish financial system at €45-50bn, up from €30-35bn.

In my view, this is still behind the news curve in terms of estimated total costs.

My projections for total losses are as follows:

• Nama - net loss of (mid-range) €12bn, rising to €19bn in the worst case scenario (although I have not redone estimates for this scenario for some time and they reflect 55% haircut applied on Tranche 1);
  
• Anglo - €33bn in mid-range case, rising to €38.6bn in the worst case scenario (another update is due once the bank reports its results in the next few weeks);
  
• INBS - €6bn, no range as we have little clarity as to their balance sheets details;
• AIB - €7bn mid-range, assuming successful disposal of M&T and BZBWK, worst case scenario €9bn;
  
• BofI - €2bn.

So the total expected banks losses are €50-55.6bn in my estimates.

Importantly, S&P's negative outlook allows for the possibility that the rating could be cut
further if the Government fails to deliver on promised fiscal stabilization. This can occur either due to significant continued deterioration in underlying economic conditions or due to the failure of the Government to actually implement planned cuts, or both.

S&P's current position rates Ireland at the same level as Fitch and one notch below Moody’s, but both of these are keeping Ireland on a stable outlook.

S&P latest estimate is for Ireland net government debt / gross GDP ratio reaching 113% in 2012. Forever cheerful folks at DofF projected this ratio to be 83.9% in 2012 in their Budget 2010 figures. This shows just how much can change in 8 months time. S&P's estimate for debt implies Ireland is facing greater debt mountain than similar rated Belgium and Spain.

But here comes a tricky part. Remember that our debt is currently yielding in excess of 5.5% for 10 year notes. This implies that in 2012, we can expect to pay out 6.215% of our GDP in interest payments alone, or 7.52% of our domestic economy total income. The bill will be €10,241 million - using DofF forecasts - or 20.5% of the total current expenditure planned by the Government. All in, even by rosy projections from DofF for tax revenue, our interest bill alone will be swallowing every third euro revenue will bring in.

This puts into perspective recent ECB research that concluded that debt levels above 90-100% of GDP are, "on average, harmful for growth" and that porblems could arise at the debt levels of as low as 70% of GDP. ECB currently projects that euroarea-wide average debt levels will reach 88.5% in 2011. Does anyone believe anymore that Ireland can run 2.5-3% annual growth rate in the current conditions as projected by the IMF? Or 4.5-4.3% (2012-2013) real GDP growth as projected by DofF?

Economics 26/01/2010: S&P Note on Irish Banks

Standard & Poor's has finally thrown in the towel and after having to “periodically increase” their “credit loss assumptions over the course of the current economic cycle” concluded “that Irish banks' asset quality and earnings will, in general, likely remain under significant pressure over the medium term”.

Anyone surprised so far?

“We have considered the implications for each rated Irish bank and lowered the ratings on some of them.” But even after that action, “the ratings on all Irish banks are currently uplifted because of our view of high systemic importance to Ireland and related government support, or their relationship with a higher-rated parent.”

We never would have guessed that if not for the State guarantee plus 11 billion worth of public capital, plus Nama’s countless billions of pledged support, the banks bonds would be junk. Wait, some of them actually would be ‘high risk junk’ as one Russian fund manager once described to me his own bonds (I ran away as fast as I could).

How junk? Take a load of honesty from S&P (with my emphasis added):

“We have lowered the ratings on Allied Irish Banks PLC (A-/Negative/A-2) by a notch. This reflects our view that the environment will remain challenging over the medium term, leading to high credit losses, and a weakened revenue base. We consider AIB to be of high systemic importance and the Irish government to have made a strong statement of support, as a result of which we have incorporated five notches of support into the ratings. The negative outlook reflects our view that AIB's anticipated recapitalization may not fully occur in 2010, and may be of an insufficient size to support an 'A-' rating, as well downside risk to our earnings expectations arising from the weak environment.”

Absent state support, AIB should be BB/Negative/C+. Errr, that is squarely in the junk bonds category.

“We have also lowered the ratings on Bank of Ireland (A-/Stable/A-2) by a notch. This reflects our view that the environment will remain challenging over the medium term and BOI's financial profile will be weaker than we had previously expected, with capital expected to be only adequate by our measures and BOI continuing to make losses through 2011. We consider BOI to be of high systemic importance and the Irish government to have made a strong statement of support, as a result of which we have incorporated four notches of support into the ratings. The stable outlook reflects our expectation that the government will remain highly supportive of BOI, BOI's core Irish banking franchise will remain materially intact, and it will raise significant equity capital in 2010, from the market or the government or both.”

So absent support, BofI would be at BB+/Negative/BB-. Junk status as well.

“The ratings on Irish Life & Permanent PLC (ILP; BBB+/Stable/A-2) are unchanged. In our view, ILP faces continuing uncertainty around its strategic direction and desired business profile, in addition to the near-term pressure on the banking operations from weak earnings prospects and difficult wholesale funding conditions. Nevertheless, the ratings continue to benefit from the relative strength of the ILP group's life assurance operations. They also incorporate two notches of government support, reflecting our view of ILP's high systemic importance and our expectation that the Irish government would provide further support if required. The expectation of government support also underpins the stable outlook."

Absent state aid IL&P would be, then, at BBB-/Negative/B. Barely above water line.

Please, be mindful – S&P expects (and prices in) that the Irish state will be likely to buy equity in the banks. So we all can become investors in junk bonds-issuing institutions.


Very good, although bland, outlook statement:

“We consider the current operating conditions for the Irish banking industry to be weak, and expect that any recovery in earnings prospects will prove to be sluggish. In the coming year, we anticipate that many of the Irish banks may undergo operational and financial restructuring, which will likely lead to consolidation in the sector. Our overall assessment of the sector incorporates our opinions reflected in the following key points:

• The recovery in Irish economic performance appears likely to be gradual, with growth only consistently established in late 2010 at the earliest;
• Loan losses will likely be elevated between 2009-2011 and will likely peak in 2010; Wholesale funding conditions appear likely to remain pressurized, with strong competition for retail deposits...

"Under our base case, we expect loan losses on bank lending to the Irish private sector to peak at about 4.6% or EUR16 billion in 2010, and to total about 10.7% or EUR37 billion over the period from 2009 to 2011."

In country rankings analysis, S&P highlights that they expect the need for significant deleveraging by the banks in the future, reflective, presumably, of the lack thereof so far in the crisis – a risk I warned about consistently over time.

“The impact of the continuing challenging economic environment, which we view as weakening asset quality and earnings prospects” – presumably the S&P is on the same note as the rest of sane analysts: poor economy will drag banks down. Which means that Government logic – restore banks and see economy recover – is out of the window.


Next – a gem: “We have additionally revised our assessment of Gross Problematic Assets (GPAs) in the system to 15%-30% from 10%-20%. GPAs are our estimation of a country's potential problem loans to the private sector and nonfinancial public enterprises in a severe economic downturn, such as that being experienced in Ireland, and includes restructured and foreclosed assets, as well as overdue loans, and nonperforming loans sold to special-purpose vehicles.”

Oh yes – up to 30% GPA means that we can expect 45-50% of the loans to be stressed one way or the other at some point in time – some defaulting, some skipping couple of payments, some restructuring with various haircuts. That is, potentially, up to €200 billion in loans in various forms of distress for the 6 guaranteed banks alone.


With this sort of an outlook, not surprisingly, AIB's CDSs are now at around 650bps, BofI's at 250bps and virtually no action is taking place in bonds. Which, of course, does hint at the market reading Irish banks' bonds as being in effect a purely speculative bet on one probability - that of survival...

The share prices are yet to follow the same path of logic.