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7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Faced with depressed freight rates and limited ability to fully pass through higher fuel costs to charterers, some shipping companies regularly enter into short-term financial derivatives contracts to reduce their exposure to fuel price fluctuations. Such hedging strategies, however, have proven to be tricky, as shipping companies might lock in high bunker fuel prices. At the same time, shipping companies such as MISC Berhad (A3 stable) have adopted slow-steaming to reduce fuel usage, optimize voyage planning and routing, and deploy measures to monitor vessels¡¯ performance and fuel consumption. Slow steaming refers to slowing down vessels to save fuel, while maintaining shipping schedules by adding vessels to routes. However, such savings are limited, as the extension of transit time is restricted by the time sensitivity of shipments. Furthermore, the risk of engine damage increases at extremely low steaming levels if a ship is not designed for slow steaming. Throughout the turmoil, the violent unrest has shut down key ports in Egypt and Libya for varying periods of time, disrupting loading and unloading operations for shipping operators with established routes to the region. Shipping companies such as Pacific International Lines (B1 stable), which have operations in that region, are monitoring the situation closely for possible contagion to nearby ports. Libya, unlike Tunisia and Egypt, is an oil exporter, accounting for around 2% of global production. Reports indicate more than half of this has been taken off the market since the start of the uprising. Consequently, petroleum and chemical tankers need to be redeployed elsewhere owing to the reduced output in Libya. This may be mildly positive for tanker rates as reduced oil shipments from Libya are likely to be replaced by higher output from other parts of the Middle East and West Africa, resulting in lengthened voyage distances to Europe and the US. However, the fundamental structural imbalance is still the key negative driver for the shipping industry. Besides the oversupply forecasted in the dry-bulk shipping industry,2 a similar demand and supply structural imbalance exist for liners and the tanker business over the next 12-18 months. Such pressures were evident in the weak performance of MISC Berhad¡¯s chemical, petroleum, and liner segments in its recently released fiscal third-quarter 2011 results.
2
See Moody¡¯s Special Comment: Dry-Bulk Shipping: Oversupply May Impair Performance in 2011-2012, but 2013 Could Offer a Recovery, 28 February 2011.
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MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS Banks Juan P. Lopez Associate Analyst +1.212.553.7946 juan.lopez@moodys.com
Credit Implications of recent worldwide news events
US Mortgage-Servicing Enforcement Action Will Be Credit Negative Last Tuesday, PNC Financial Services Group Inc. (A2 positive; C+/A2 positive),3 became the latest among the large US banks4 to disclose in their 2010 10-K that they are among the top 14 federally regulated mortgage servicers subject to a publicly disclosed interagency review of residential mortgage servicing operations. The review is likely to culminate in formal enforcement actions against many or all of the companies. For larger banks with sizable servicing platforms, the potential settlement cost could materially affect quarterly results. However, we note these banks have the earnings power and capital to absorb most, if not all, of these charges during a quarter. The mortgage servicing market is dominated by 14 servicers responsible for servicing more than 85% of total mortgages outstanding. At this time, it is unclear what regulators will deem an appropriate global settlement amount. Press reports based on apparent leaks from public officials have cited amounts as large as $20 billion, although how these amounts would be allocated among fines, loan writedowns, or other costs is unclear. In order to assess the potential effect on the firms, we performed the analysis shown in the exhibit below. We allocated three different possible settlement amounts across the largest mortgage servicers based on their serviced loans outstanding as of 30 June 2010, and compared it with each company¡¯s consolidated 2010 pre-provision profits.5 Although the charges will surely impact these company¡¯s financials under the various scenarios, the impact itself will not be uniform. For instance, larger banks have the ability to absorb such costs in one quarter¡¯s earnings under the various scenarios, whereas other firms, such as Ally Financial and PHH Corporation, would need at least a few quarters to ingest the costs.
3 4 5
The bank ratings shown in this article are the bank¡¯s deposit rating, its standalone bank financial strength rating mapped to the long-term scale, and the corresponding rating outlooks. PNC filed their 10-K on 1 March, US Bancorp on 28 February, and Bank of America, BB&T, Citigroup, SunTrust, and Wells Fargo on 25 February. Pre-provision income is defined as pre-tax income plus provisions minus one-time securities gains, goodwill impairment, and gains on fair value of own debt.
12
MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Potential Outcome of the Interagency Examination of Top Mortgage Servicers Pre-provision Income* Top 14 Mortgage Servicers 2010 Market Share (a) 10 (b) Loss Estimates ($ billions) 20 (c) 30 (d)
Bank of America Corporation Wells Fargo & Company JPMorgan Chase Citigroup, Inc. Ally Financial Inc. US Bancorp SunTrust Banks, Inc. PHH Corporation** OneWest Bank FSB (fka Indymac) PNC Financial Services Group, Inc. HSBC North America MetLife, Inc.** BB&T Corporation Aurora Bank FSB
38.1 34.8 41.0 39.0 1.6 8.6 2.7 0.12 1.3 6.6 3.3 3.9 3.6 0.14
27.5% 23.4% 17.5% 11.3% 4.5% 2.4% 2.3% 2.0% 2.0% 1.9% 1.5% 1.3% 1.2% 1.1% 100%
2.8 2.3 1.7 1.1 0.5 0.2 0.2 0.2 0.2 0.2 0.2 0.1 0.1 0.1 (a) x (b)
5.5 4.7 3.5 2.3 0.9 0.5 0.5 0.4 0.4 0.4 0.3 0.3 0.2 0.2 (a) x (c)
8.3 7.0 5.2 3.4 1.4 0.7 0.7 0.6 0.6 0.6 0.5 0.4 0.4 0.3 (a) x (d)
*Taken on a consolidated basis **Pre-tax income Source: The top 14 servicers ranked by amount of serviced loans outstanding as of 30 June 2010 according to Inside Mortgage Finance, 2010 10-Ks, and Moody¡¯s.
Another important consideration is the nature and timing of the settlement. Regulators can impose civil penalties that reduce earnings immediately. But we expect a portion of the settlement to lead to enhanced modification programs. In this case, the charge amount could translate into principal reduction for a number of mortgages. To the extent that a portion of any such writedowns can be absorbed through existing loan-loss reserves, rather than requiring additional provisioning, this would limit the effect on the bottom line. However, we expect that a significant portion of such writedowns would occur on loans serviced for third-parties, against which servicers generally hold little or no reserves. We anticipate that the settlement will require the servicers, not the third-party investors, to bear the costs of such modifications, adding to their servicing costs. As for timing, should the settlement take the form of monetary penalties, these would likely be recognized in earnings immediately, net of any existing litigation reserves already set aside. If the settlement results in mortgage modifications or principal reductions, then this would likely be spread over time, easing the financial burden for the firms. It would be in the best interest of both parties to agree to terms that would not only provide closure to this issue, but more importantly, reduce uncertainties in a confidence sensitive market.
13
MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Allen Tischler Vice President - Senior Credit Officer +1.212.553.4541 allen.tischler@moodys.com
SEC Investigation of Fifth Third Is Credit Negative Last Tuesday, Fifth Third Bancorp (A3 stable; C/A3 stable)6 released its 10-K and noted that the US Securities and Exchange Commission (SEC) is investigating accounting and reporting matters related to some of the bank¡¯s commercial loans. The scope of the SEC¡¯s investigation is unclear at this stage, but Fifth Third noted that it might result in fines, restatements of financials, or other penalties that are credit negative. Fifth Third¡¯s disclosures regarding the SEC¡¯s investigation have escalated since it was initially revealed last November in the following ways:
» »
November 2010: In its third-quarter 2010 10-Q, Fifth Third stated that the SEC had requested information relating to its commercial loan accounting and reporting January 2011: In the registration statements related to both Fifth Third¡¯s successful $1.7 billion common equity raise and $1.0 billion senior debt issuance that facilitated the repayment of its TARP preferred shares, the company repeated its November statement, but added that the SEC had commenced the process of seeking a formal investigation March 2011: In its 2010 10-K, Fifth Third repeated its earlier disclosures, but also noted that the SEC had issued a subpoe