Greece is the canary. Europe is the coal mine. One voice calling it yellow and black.
Harsh but true words on Greece, the Euro
Reply
Category Archives: credit risk
Fitch downgrades outlook for South Africa
Aside
Fitch downgrades outlook for South Africa to “negative”. Ferial Haffajee highlights a difference in reasons given by Treasury (blame the international economy) and Fitch (unemployment).
Competing European interests
The BBC has a great overview of competing European interests, demonstrating exactly how far they are from a deal. In my mind, this is half of the reason markets are going to punish European bonds soon. The other half is that the proposed deal is rubbish. It doesn’t fix the causes but tries to ban the symptoms.
What is best practice for matching annuities in Greece in 2012?
Best practice for matching non-profit annuities in most countries, certainly from a risk perspective, is still to cash flow match (or at the very least, match key durations) using government bonds.
The theory is that the insurer isn’t then exposed to changes in the term structure on interest rates, only exposed to illiqudity/reinvestment risk to the extent of mortality fluctuations, isn’t exposed to currency risk and certainly isn’t exposed to credit risk. Without complex margining requirements like some swaps and without the need to roll cash investments over, government bonds should allow ALM teams to sleep well.
Now, Solvency II is likely to adopt a swap yield curve rather than bond yield curve. There are some good reasons here, including arguably fewer distortions from temporary supply and demand imbalances, improved liquidity and so on. The same yield curve is used for liquid liabilities so the allowance for an illiquidity premium over and above the swap curve at some times, in some ways and for some products is still under debate.
But what should Greek insurers do in the meantime?
Frankly, Greek government bonds don’t remove credit risk and the huge credit spreads on these instruments will create huge funding gaps and variability in earnings unless a Greek govi yield curve is used to value liabilities as well. It’s not clear at all that Greece will stay part of the Euro, so German government bonds don’t remove currency risk. German government bonds in any case are show signs of nervousness as yields creep up.
The swap market is exposed to the same Euro break-up risks as bonds. Which banks will survive, what happens to currencies in the meantime and what does that do to long-term Euro swaps? What about Euro-Sterling swaps issued by Greek banks (I’m not sure if these even exist though).
All in all, it’s good to be involved in ALM in South Africa, and even the Middle East just at the moment.
Italy’s yields head towards 8%
Aside
Italy’s yields are heading towards 8%, which is about the same as South Africa. And South African inflation is flirting with 6% while Eurozone inflation is looking more like 1%.
Europe is in serious trouble and very few South Africans have yet woken up to exactly how serious this trouble is.
[update: intrade betting has it more likely than not that at least one country will leave the Euro by December 2014. If one goes, it's likely more than one will.]
Nearer the edge than ever before
I wouldn’t want anything to do with any bank that has much at all to do with European banks or European sovereign debt. The old South African Rand is seeming like a safer relative bet than at pretty much any other time in the last decade.
Greek default?
So European politicians have more or less agreed a deal which may, more or less, push some of their problems to one side for a period. Yes, I’m not madly optimistic about this as a cure-all. This is not the end of the Euro problems.
Part of the deal is a “50% loss for private investors”. Which is part true and part nonsense but will be an effective Greek default when enacted / agreed. (I don’t care how “voluntary” it may be, it’s a default and almost all definitions of default include restructuring of debt in any way that isn’t what was originally promised.)
Why is it only partly true? Well it’s not necessarily a “loss” for private investors. The probability of default on Greek bonds has been just about 100% for a while now. This probability of default is derived from market prices for Greek bonds and market spreads on Greek Credit Default Swaps (CDS) and an assumed Loss Given Default or Recovery Rate for investors when the bonds do default. Actual Recovery Rates vary widely, but often analysts plug in the average Recovery Rate over most of this century on unsecured debt which is around 40%.
So if market prices for Greek bonds assumed 100% default probability and a 40% recovery, then a 50% recovery doesn’t sound so bad. The potential downside is that Greece may still (need to) default on these written-down bonds at some point in the next two decades.
So the real question is what will the new probability of default be? Then we will know whether investors “took a loss” and perhaps gain the market’s view on how successful the deal really will be.
Swazi King not sure he wants the conditions attached to the loan
This is really fantastic news. The Swazi King is apparently reluctant to accept the loan from South Africa because of the conditions imposed in the agreement. I was quite harsh in criticising the granting of the loan with only conditions for improvement far down the line. (I still believe the first condition should be an immediate unbanning of political parties.)
Hearing that the conditions are sufficiently onerous that the borrower may not want it is great news. At the very least this reflects a balanced package rather than one heavily in favour of the undemocratic absolute monarchy of our neighbour.
I wonder how many of these conditions were added or modified after the initial public announcement. Cosatu, amongst other powerful groups, has also been very outspoken against the loan.