Tag: defaults

Public Pensions: Double-Check Those ‘Shadow Banker’ Investments

Mary Pat Campbell

Link:https://www.governing.com/finance/public-pensions-double-check-those-shadow-banker-investments

Excerpt:

For almost a decade leading up to 2021, bond yields were suppressed by low inflation and central bank stimulus. To make up for scanty interest rates on their bond investments, many public pension funds followed the lead of their consultants and shifted some of their portfolios into private credit funds. These “shadow bankers” have taken market share from traditional lenders, seeking higher interest rates by lending to non-prime borrowers.

Even during the pandemic, this strategy worked pretty well, but now skeptics are warning that a tipping point may be coming if double-digit borrowing costs trigger defaults. It’s time for pension trustees and staff to double-check what’s under the hood.

For the most part, the worst that many will find is some headline risk with private lending funds that underwrite the riskiest loans in this industry. Even for the weakest of those, however, the problem will not likely be as severe as the underwater mortgages that got sliced, diced and rolled up into worthless paper going into the global financial crisis of 2008. And until and unless the economy actually enters a full-blown recession, many of the underwater players will still have time to work out their positions.

The point here is not to sound a false alarm or besmirch the private credit industry. Rather, it’s highlighting what could eventually become soft spots in some pension portfolios in time to avoid doubling down into higher risks and to encourage pre-emptive staff work to demonstrate and document vigilant portfolio oversight.

Author(s):Girard Miller

Publication Date: 8 Aug 2023

Publication Site: Governing

Private Overborrowing Under Sovereign Risk

Mary Pat Campbell

Link: https://www.chicagofed.org/publications/working-papers/2022/2022-17

Graphic:

Abstract:

This paper proposes a quantitative theory of the interaction between private and public debt in an open economy. Excessive private debt increases the frequency of financial crises. During such crises the government provides fiscal bailouts financed with risky public debt. This response may cause a sovereign debt crisis, which is characterized by a higher probability of a sovereign default. The model is quantitatively consistent with the evolution of private debt, public debt, and sovereign spreads in Spain from 1999 to 2015, and provides an estimate of the degree of overborrowing, its effect on the spreads, and the optimal macroprudential policy.

Author(s): Fernando Arce

Publication Date: May 2022

Publication Site: Chicago Fed

US CMBS Loan Defaults Leveled Off in 2021 with Pandemic Recovery

Mary Pat Campbell

Link: https://www.fitchratings.com/research/structured-finance/us-cmbs-loan-defaults-leveled-off-in-2021-with-pandemic-recovery-17-05-2022

Graphic:

Excerpt:

US CMBS loan defaults declined significantly in 2021 compared with 2020, as the resumption of economic activity supported a recovery in asset performance and property cash flows from their pandemic lows, says Fitch Ratings in its US CMBS 2021 Loan Default Study. The total annual default rate for Fitch-rated CMBS transactions declined to 0.4% in 2021, down from 3.3% in 2020.

Author(s): Stephanie Duski, Melissa Che, Everett Bruer, Sarah Repucci

Publication Date: 17 May 2022

Publication Site: Fitch Ratings

How Vulnerable Are Insurance Companies to a Downturn in the Municipal Bond Market?

Mary Pat Campbell

Link: https://www.chicagofed.org/publications/chicago-fed-letter/2021/451

Excerpt:

The potential impact of Covid-19 on the municipal bond market

The coronavirus pandemic and the related economic slowdown are expected to cause a persistent drag on state and municipal tax revenues, which may apply pressure to the municipal bond market. Current estimates from the Brookings Institution suggest that, relative to 2019 tax receipts, state and local general revenues will decrease by $155 billion in 2020, $167 billion in 2021, and $145 billion in 2022—or by about 5.5%, 5.7%, and 4.7%, respectively.3 These estimated declines are in line with those experienced during the Great Recession of 2008–09, which averaged 5.8%.4 States face additional budgetary pressures from increased expenditures related to the pandemic, particularly from increased payouts of unemployment insurance (UI) benefits. Between March and October 2020, states paid a record $125.1 billion in UI benefits. The UI benefits paid thus far in 2020 are 30% more than the $96.3 billion in benefits states paid in all of 2009.5 However, states are better positioned to weather these budget stresses than they were prior to the Great Recession due to the increase in state revenue stabilization funds, commonly referred to as “rainy day funds.” At the start of 2020, the median state rainy day fund was equal to 7.8% of state general revenues, compared with 4.6% at the start of 2008.6 This should provide some cushion for the expected decline in revenues due to Covid-19.7 And the second Covid-19 stimulus package signed into law at the close of 2020 is expected to help stabilize state and local budgets and ease stress on municipal bond markets, although direct aid to states and municipalities was removed from the final bill. The bill does provide direct payments to individuals of up to $600, paycheck protection loans for businesses, extended federal UI benefits, $30 billion for vaccine distribution and testing, $54.3 billion for K–12 schools, $22.7 billion for higher education, and $45 billion for transportation-related relief spending. President Joe Biden is proposing $1.9 trillion in additional stimulus spending focused on vaccine distribution, aid to states, and direct benefits to individuals. However, this plan has yet to be enacted and is therefore subject to change. In summary, states and localities are likely to experience significant variation in Covid-19-related revenue declines, and their budgetary strength also varies. As such, certain muni bonds may face downgrades and default.

Authors: Andy Polacek , Shanthi Ramnath

Publication Date: February 2021

Publication Site: Chicago Fed