Mapping Sovereign Risk BlackRock Sovereign Risk Index BlackRock - - PowerPoint PPT Presentation

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Mapping Sovereign Risk BlackRock Sovereign Risk Index BlackRock - - PowerPoint PPT Presentation

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Mapping Sovereign Risk BlackRock Sovereign Risk Index BlackRock Investment Institute FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY Notions of safety have been rocked Implied probabilities of default Some developed market sovereigns have

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Mapping Sovereign Risk BlackRock Sovereign Risk Index

BlackRock Investment Institute

FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY

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Notions of safety have been rocked

FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY 2

Implied probabilities of default have ballooned

Source: Standard and Poor‟s and IMF staff estimates Note: For each country, the implied probabilities of default are estimated from its observed CDS spreads. The probabilities of default shown here are averages for countries whose ratings fall within specific S&P rating ranges

Some developed market sovereigns have behaved like (bad) structured credit

Source: CIRA

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Markets have been dominated by exceptional policy actions …

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Source: CIRA

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… making for a very different investing landscape (until recently)

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Interactive Version Interactive Version

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Fiscal Austerity = social unrest

FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY 5

Source: “Austerity and Anarchy: Budget Cuts and Social Unrest in Europe, 1919-2009”; Jacopo Ponticelli and Hans-Joachim Voth; Centre for Economic Policy Research Note: CHAOS is the sum of demonstrations, riots, strikes, assassinations, and attempted revolutions in a single year in each country.

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Austerity can work – IF there’s external growth

FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY 6

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Monetary policy: the path of least resistance (and effect)

16 June 2011 FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY 7

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The BlackRock Sovereign Risk Index (BSRI)

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Interactive Version

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BlackRock Sovereign Risk Index: Key Ingredients

FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY 9

Fiscal Space 40%

External Finance Position 20%

Willingness to Pay 30%

Financial Sector Health 10%

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Sovereign Risk Index : Fiscal Space

Fiscal Space (40% weight)

Proximity to Distress

  • The accumulated liabilities of a sovereign in relation to the size of its economy is a starting point, but to

determine proximity-to-distress we must also have a notion of each country‟s palatable debt limit. Idiosyncratic factors, such as reserve currency status, have a significant impact on this limit

  • Bond markets are historically less concerned by countries with higher productivity per capita, and in

contrast are likely to become uncomfortable with debt burdens at lower levels in entities with unsteady track-records for growth (and hence revenue streams), and for keeping inflation under control

  • Similarly, the „breaking point‟ can be expected to be lower in countries anticipating greater demographic

burdens, higher where sovereign debt enjoys a strong domestic base

  • Tailoring notional limits by these factors, we determine the time-to-distress at current forecasts of the burn

rate of Budget Deficits Distance from Stability

  • This measure gauges the required structural adjustment needed for the country to achieve a stable and

palatable Debt/GDP level over an arbitrary 10 year period, using consensus projections

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Sovereign Risk Index : Willingness to Pay

Willingness to Pay (30% weight)

Institutional Integrity and Stability

  • Default by regime-change, or impairments arising from fraudulent national accounts are examples of

qualitative risks that are well-reflected in quantitative ordinal data sourced to the World Bank, Euromoney and Political Risk Services Group

  • Subcomponents of our composite assess changes to bureaucracy quality, contract viability, corruption,

democratic accountability, government cohesion and stability, law and order, legislative strength, and other political risks with a monthly frequency

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Sovereign Risk Index : External Finance

External Finance Position (20% weight)

Current Account Deficit as a % of GDP

  • In very general terms, net importers of goods tend to be net issuers of liabilities. The bigger the import

ratio of a country, the more vendor financing it is likely to require, and therefore the more prone it might be to building up a large debt load External Debt vs Foreign Currency Reserves

  • Governments cannot “print money” to finance non-domestic debt, which means that it must be paid out of

FX reserves or current income at spot exchange rates. Exposure to foreign currency liabilities includes the contingent liability of net external debt issuance of the financial sector Maturity Structure of External Debt

  • The degree to which external debt must be serviced in the near-term is of particular consideration, as

rollover risk can exacerbate problems for a currency in difficulties. The interest and principal exposures

  • ver the 2 year horizon as a proportion of total external debt complements the solvency indicator above

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Sovereign Risk Index : Financial Sector Health

Financial Sector Health (10% weight)

Financial Sector Debt as a % of GDP

  • Assuming that an over-stretched domestic private sector can be a contingent liability of the state, its size

relative to the sovereign presents the scale of the potential burden Capital Adequacy Ratio,

  • The total capital of the banking system expressed as a percentage of its risk-weighted credit exposures;

based on Basel rules and including Tier 2 capital. Sourced to Fitch, the caveat that bank financial and regulatory reporting varies widely across jurisdictions is well-flagged Banking Sector Risk

  • Composite drawn from bottom-up analyses of domestic banks from Moodys and Fitch, and current non-

performing loans as a % of total loans Credit Bubble Risk

  • If the growth of domestic in recent years far-outpaces the general economic growth over the same period,

this can be indicative of overly-loose credit standards and poor lending practices

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Initial Work on the BlackRock Sovereign Risk Index

FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY 14

Source: BlackRock, CDS from Bloomberg (18th June 2011)

Comparison With Sovereign CDS highlighted a strong cross-sectional relationship Italy’s BSRI Profile (06/2011) “Taking these points into consideration, we believe that Italy may be a case where markets are too sanguine about sovereign risks, and would be inclined to be defensive on this market within an index.” Introducing the BlackRock Sovereign Risk Index, (June 2011)

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Backtesting the BlackRock Sovereign Risk Index

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Eurozone Periphery1, Ratings vs BSRI Eurozone Periphery1, CDS vs BSRI

Source: BlackRock, Standard & Poor‟s, Moody‟s, Fitch (1) Eurozone „periphery‟ includes Greece, Ireland, Portugal, Italy and Spain Source: BlackRock, Bloomberg Note: Backtest only uses unrevised data that was available at the time.

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16

  • 2.5
  • 2.0
  • 1.5
  • 1.0
  • 0.5

0.0 0.5 1.0 1.5 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Ireland Component Zscores Fiscal Space Score Health of External Finance Score Financial Sector Health Score Willingness to Pay Score

Average rating bucket calculated mapping ratings to an ordinal structure, (e.g. AAA = 1; AA1 = 2 ; AA2 = 3; through to 25)

1 2 3 4 5 6 7 8 9 10 11 12 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Ireland Average Rating Bucket

  • 1.2
  • 1.0
  • 0.8
  • 0.6
  • 0.4
  • 0.2

0.0 0.2 0.4 0.6 0.8 BlackRock Sovereign Risk Score : Ireland (Zscore, Inverted) Ireland Average Rating Bucket BlackRock Sovereign Risk Score : Ireland Agency From To Date S&P AAA AA+ Mar-2009 Fitch AAA AA+ Apr-2009 S&P AA+ AA Jun-2009 Moodys AAA AA1 Jul-2009 Fitch AA+ AA- Nov-2009 Moodys AA1 AA2 Jul-2010 S&P AA AA- Aug-2010 Fitch AA- A+ Oct-2010 S&P AA- A Nov-2010 Fitch A+ BBB+ Dec-2010 Moodys AA2 BAA1 Dec-2010 S&P A A- Feb-2011 S&P A- BBB+ Apr-2011 Moodys BAA1 BAA3 Apr-2011 Moodys BAA3 BA1 Jul-2011

The contingent liabilities represented by the credit bubble in Ireland take pole position in December 2008, an early warning from banking metrics available at the time, of what would later follow. While Ireland’s distress is characterised by its banking weakness, the other components of the index also deteriorated

  • ver the backtest period.

BSRI time series: case study Ireland

Source: BlackRock Model-Based Fixed Income

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17

  • 3.5
  • 3.0
  • 2.5
  • 2.0
  • 1.5
  • 1.0
  • 0.5

0.0 0.5 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Greece Component Zscores Fiscal Space Score Health of External Finance Score Financial Sector Health Score Willingness to Pay Score

Average rating bucket calculated mapping ratings to an ordinal structure, (e.g. AAA = 1; AA1 = 2 ; AA2 = 3; through to 25)

5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Greece Average Rating Bucket

  • 1.6
  • 1.4
  • 1.2
  • 1.0
  • 0.8
  • 0.6
  • 0.4
  • 0.2

BlackRock Sovereign Risk Score : Greece (Zscore, Inverted) Greece Average Rating Bucket BlackRock Sovereign Risk Score : Greece Agency From To Date S&P A A- Jan-2009 Fitch A A- Oct-2009 Fitch A- BBB+ Dec-2009 S&P A- BBB+ Dec-2009 Moodys A1 A2 Dec-2009 Fitch BBB+ BBB- Apr-2010 Moodys A2 A3 Apr-2010 S&P BBB+ BB+ Apr-2010 Moodys A3 BA1 Jun-2010 Fitch BBB- BB+ Jan-2011 Agency From To Date Moodys BA1 B1 Mar-2011 S&P BB+ BB- Mar-2011 S&P BB- B May-2011 Fitch BB+ B+ May-2011 Moodys B1 CAA1 Jun-2011 S&P B CCC Jun-2011 Fitch B+ CCC Jul-2011 Moodys CAA1 CA Jul-2011 S&P CCC CC Jul-2011

The BSRI backtest only uses macroeconomic figures that were available at the time – even on the basis of Greece’s fraudulent government accounting the Fiscal Space has clearly been deteriorating since November 2007 Current Account weakness characterized the Health Of External Finance dip during the Financial Crisis

BSRI time series: case study Greece

Source: BlackRock Model-Based Fixed Income

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18

BSRI time series: case study USA

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Over to you: Pick the mystery country (1)

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A. United States D. Italy G. Japan B. Argentina E. United Kingdom H. Brazil C. South Korea F. Belgium I. Thailand

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Over to you: Pick the mystery country (2)

FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY 20

A. United States D. Italy G. Japan B. Argentina E. United Kingdom H. Brazil C. South Korea F. Belgium I. Thailand