Finance
How Default Risk Triggers Credit Downgrades
As the U.S. inches closer to the June 1 deadline to avoid defaulting on our $31.4 trillion national debt, ratings agencies have already begun hinting at downgrading the nation’s credit — a move that would unleash vast consequences across commercial real estate capital markets.
Treasury Secretary Janet Yellen warned yet again this week that the U.S. won’t be able to pay its bills — specifically Treasurys, the bedrock of the global financial system — in the event Congress fails to raise the debt ceiling by the “X date” of June 1. Federal Reserve Chairman Jerome Powell said earlier this month that “no one should assume that the Fed … can really protect the economy” in the event a debt ceiling breach triggers a national default.
While reports surfaced Friday morning that President Joe Biden and House Speaker Kevin McCarthy are near a deal, it’s unclear the type of support McCarthy can gain from House conservatives on any sort of compromise. GOP Rep. Matt Gaetz of Florida has stated he and his colleagues “don’t feel like we should negotiate with our hostage,” while GOP Sen. Mike Lee of Utah has already stated his intention to potentially scuttle a deal in the Senate, which has a one-vote Democrat majority.
The big three ratings agencies — S&P Global Ratings, Moody’s and Fitch Ratings — have already taken notice of the fragile state of affairs. On Wednesday, Fitch placed the United States’ long-term foreign currency issuer default rating on watch for a downgrade, threatening to downgrade its AAA status prior to the “X date.”
“The brinkmanship over the debt ceiling, failure of the U.S. authorities to meaningfully tackle medium-term fiscal challenges that will lead to rising budget deficits, and a growing debt burden signal downside risks to U.S. creditworthiness,” Fitch said in a statement.
Moody’s warned this week that if the Treasury misses even one interest payment, then the U.S.’s stellar credit rating would be lowered a notch and that the debt-ceiling brinkmanship could “permanently” impact the creditworthiness of the government, according to The New York Times. S&P Global Ratings lowered the U.S. credit rating from AAA to AA+ in 2011, the last time Republicans used the threat of default to extract spending cuts and other concessions from a Democratic president, and has not raised it since.
“This is really, really dangerous,” said Robert Hockett, professor of corporate law and financial regulation at Cornell Law School. “A downgrade of Treasurys … heightens the possibility of a deep, deep recession that could spiral into a depression.”
The downgrade of the U.S. credit rating is intimately tied to borrowing costs and interest rates throughout the financial system. Most government debt is funded by the sale of U.S Treasurys -– T-bills, T-bonds and T-notes -– into the global economy, where investors see them as risk-free bonds that serve as the benchmark interest rate for all other forms of corporate, financial and municipal debt in the United States. If those rates are deemed a high risk — especially in the event of a mass ratings downgrade or debt default — then yields on Treasurys will spike, raising interest rates across the financial system and contracting credit at a time of increasingly tight liquidity.
Hockett said the interest rate hikes across the system would occur immediately, if not a day or two before the debt breach were to occur.
“People get quite nervous as the zero hour approaches,” he said. “You’ll see people dumping Treasurys massively, and that would cause yields to rise because that’s the only way for them to be sold.”
Thomas LaSalvia, director of economic research at Moody’s Analytics, emphasized the interconnected nature of U.S. Treasurys with the benchmark Federal Funds Rate and mortgage rates, and said that any decoupling of what is, or is not, risk-free debt will throw capital markets into turmoil.
“Anything else that causes rates to rise is just another gut punch, slap in the face for commercial real estate because it’s going to put further pressure on the capital markets side of things,” said LaSalvia. “If banks have to borrow at higher rates, then that ultimately affects what they can lend at. That means rates for consumer and commercial loans would go up as well.”
LaSalvia added that a ratings downgrade will also stoke the ongoing regional banking crisis — which has seen the second-, third- and fourth-largest bank failures in U.S. history since March — by increasing interest rates across the system and altering the balance sheets of an already weakened regional banking sector. The three biggest U.S. bank failures this year all poured capital into securities portfolios tied to long-term U.S. debt financed at low rates of interest in held-to-maturity bonds; when interest rates spiked, the value of their loan books plummeted, sending depositors running for the exits.
“We really don’t want to go down this path. It signals the wrong message to the global economy at a time when the U.S. is being questioned as a global center of banking,” LaSalvia said. “If we end up actually defaulting, then I don’t know where those ratings will go, but … if we end up defaulting, then all bets are off.”
A May report by Moody’s Analytics argued that a downgrade of Treasury debt “would set off a cascade of credit implications and downgrades on the debt of many other financial institutions, nonfinancial corporations, municipalities, infrastructure providers, structured finance transactions, and other debt issuers,” and create financing complications at institutions backed by the U.S. debt, namely Fannie Mae, Freddie Mac and the Federal Home Loan Banks, which would all suffer ratings downgrades, as well.
A national credit ratings downgrade carries implications for the currency, too. Tomasz Piskorski, professor of real estate finance at Columbia Business School, said that a ratings downgrade weakens the dollar, and a weakened dollar puts upward pressure on the price of imports.
“Which means it could make fighting inflation harder, which would mean the Fed would have a harder time lowering interest rates to circumvent the rise in prices,” he said. “It could contribute to the increasing interest rates across the system and thus increase the recession risk.”
Piskorski noted that the yield on 10-year Treasury notes — the base and benchmark for 10-year loans and short-term CRE loans — stands at 3.8 percent as of May 25, more than double its 1.8 percent yield of May 25, 2021.
“That ’s how commercial mortgage loans are quoted. Spreads are widening, too, because of the risk, reflecting the default risk,” he said. “In two years, the cost of debt doubled. This is not a good thing.”
Perhaps most alarming for the real estate system is the threat a ratings downgrade poses for the housing market, due to the sensitivity of housing prices to interest rate movements. Because of the levered nature of most home mortgages, lower interest rates increase the value of homes, and vice versa. So in the event interest rates rise following a ratings downgrade, home values will plummet on a national scale, according to professor Hockett.
“You’re gonna see sudden diminution of housing stock value — basically people’s homes will suddenly be worth much less,” he said. “So what we’re faced with is the prospect of swarms of American households being underwater on their home mortgage loans.”
Hockett said the situation could quickly mirror the problems that set off the 2007-2008 housing collapse, which ushered in the Global Financial Crisis, one that seriously damaged the U.S. economy and froze commercial real estate capital markets for much of 2009 and 2010.
“If you see a Treasury downgrade, you get it from two ends: You see people with lower net worth in virtue of home values plummeting and people having less net worth in their securities portfolios, 401Ks, pension plans, and Roth IRAs,” Hockett said.
“This is exceedingly ominous,” he added. “This is a potential calamity for the middle class.”
Brian Pascus can be reached at bpascus@commercialobserver.com
SHEPHERDSTOWN, W. Va., November 15, 2024–(BUSINESS WIRE)–JSB Financial Inc. (OTCPink: JFWV) reported net income of $2.0 million for the quarter ended September 30, 2024, representing an increase of $1.3 million when compared to $643 thousand for the quarter ended September 30, 2023. Basic and diluted earnings per common share were $7.64 and $2.33 for the third quarter of 2024 and 2023, respectively. The third quarter results include the recognition of an interest recovery totaling $1.3 million, a recovery to the allowance for credit losses on loans totaling $252 thousand and a recovery of legal fees totaling $17 thousand on prior nonperforming loans. Excluding the impact of these notable items, pre-tax income of $959 thousand for the third quarter of 2024 was $187 thousand more than the same period in 2023.
Net income for the nine months ended September 30, 2024 totaled $3.4 million, representing an increase of $1.1 million when compared to $2.3 million for the same period in 2023. Basic and diluted earnings per common share were $13.33 and $8.46 for the nine months ended September 30, 2024 and 2023, respectively. Annualized return on average assets and average equity for September 30, 2024 was 0.87% and 17.65%, respectively, and 0.66% and 13.17%, respectively, for September 30, 2023. Excluding the impact of the notable items in the third quarter of 2024, pre-tax income of $2.7 million for the nine months ended September 30, 2024 was $96 thousand lower than the same period in 2023.
“We are pleased with our performance for the third quarter, which includes one-time recoveries on nonperforming loans totaling $1.5 million. Additionally, our team continued to create, deepen and expand our customer relationships which resulted in an increase in total deposits of 10% when compared to the second quarter and 17% year-over-year,” said President and Chief Executive Officer, Cindy Kitner. “During the third quarter, we saw stable loan growth, which was funded through loan maturities and deposit growth, and we continue to have strong credit quality metrics including past dues, nonaccruals, charge offs and nonperforming loans, all of which remained at historically low levels.”
Finance
Interested In Manulife Financial’s (TSE:MFC) Upcoming CA$0.40 Dividend? You Have Four Days Left
Regular readers will know that we love our dividends at Simply Wall St, which is why it’s exciting to see Manulife Financial Corporation (TSE:MFC) is about to trade ex-dividend in the next 4 days. The ex-dividend date is usually set to be one business day before the record date which is the cut-off date on which you must be present on the company’s books as a shareholder in order to receive the dividend. It is important to be aware of the ex-dividend date because any trade on the stock needs to have been settled on or before the record date. Accordingly, Manulife Financial investors that purchase the stock on or after the 20th of November will not receive the dividend, which will be paid on the 19th of December.
The company’s next dividend payment will be CA$0.40 per share. Last year, in total, the company distributed CA$1.60 to shareholders. Looking at the last 12 months of distributions, Manulife Financial has a trailing yield of approximately 3.5% on its current stock price of CA$46.23. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. So we need to investigate whether Manulife Financial can afford its dividend, and if the dividend could grow.
View our latest analysis for Manulife Financial
If a company pays out more in dividends than it earned, then the dividend might become unsustainable – hardly an ideal situation. Manulife Financial paid out more than half (55%) of its earnings last year, which is a regular payout ratio for most companies.
When a company paid out less in dividends than it earned in profit, this generally suggests its dividend is affordable. The lower the % of its profit that it pays out, the greater the margin of safety for the dividend if the business enters a downturn.
Click here to see the company’s payout ratio, plus analyst estimates of its future dividends.
Companies with consistently growing earnings per share generally make the best dividend stocks, as they usually find it easier to grow dividends per share. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. With that in mind, we’re encouraged by the steady growth at Manulife Financial, with earnings per share up 4.5% on average over the last five years.
Another key way to measure a company’s dividend prospects is by measuring its historical rate of dividend growth. In the past 10 years, Manulife Financial has increased its dividend at approximately 12% a year on average. It’s encouraging to see the company lifting dividends while earnings are growing, suggesting at least some corporate interest in rewarding shareholders.
Finance
Solving the Adaptation Finance Gap: Plans are in Place, but Funding Falls Short – Climate 411
The UN climate talks, COP29, is well underway, and countries have entered final negotiations on the New Collective Quantified Goal (NCQG), a new climate finance goal to boost funding for climate action in developing countries. Reaching agreement on the goal may be difficult in the face of the U.S election results, but it remains an urgent priority.
One glaring finance gap that we need to address in the new goal is finance for climate adaptation. Adaptation is how governments and communities prepare for and adjust to the impacts of climate change. It’s about making changes to reduce or prevent the harm caused by climate impacts like rising sea levels, more frequent storms, and hotter temperatures.
According to a new report from the United Nations Environment Programme (UNEP), adaptation needs are not being met worldwide. Developing countries will need $215 billion per year over the next decade for their adaptation priorities, from building climate resilient infrastructure to restoring ecosystems. Yet international finance flows for adaptation were just $28 billion in 2022 – an increase over prior years, but nowhere near enough.
Transformational adaptation requires closing the finance gap and maximizing the impact of every dollar.
Where is the world falling behind on adaptation?
Many developing countries are particularly vulnerable to climate change impacts, and the good news is that they are prioritizing efforts to build resilience. UNEP’s Adaptation Gap Report found that 87% of countries have at least one national adaptation planning instrument in place, compared to around just 50% a decade ago. These instruments include National Adaptation Plans (NAPs) and other strategies or policies that guide adaptation.
Now time for the bad news: although planning has improved, there is a growing gap in implementation as countries lack the necessary finance to meet their objectives. Adaptation has consistently been underfunded compared to mitigation, and while developed countries are working to double adaptation finance, the current $28 billion in annual flows represents just 13% of the $215 billion needed annually.
[Source: UNEP Adaptation Gap Report 2024]
The lack of finance for adaptation has serious implications for many developing countries, especially small island states which urgently need international support to strengthen resilience. For example, the Caribbean nation of Dominica is installing early warning systems to improve preparedness and reduce the impact of future hurricanes, but by 2023 they had only installed three systems and need 50 more to adequately cover the island. Without sufficient adaptation finance, the country will remain highly exposed to sudden climate shocks.
This finance gap is further complicated by limited private sector engagement in adaptation. UNEP finds that many transformational adaptation projects are seen as risky by private investors, due to their longer time frame for benefits and less clear return on investment. Private finance does flow to projects in infrastructure and commercial agriculture, but often not without efforts by the public sector to de-risk investments.
It is not surprising that two-thirds of adaptation financing needs are anticipated to be financed by the public sector. But the quality of public finance for adaptation has room for improvement as well. 62% of public finance for adaptation is delivered through loans, of which 25% are non-concessional, or at market rate with no favorable terms. And the use of non-concessional loans for adaptation in most vulnerable countries has actually increased in recent years. These tools have the potential to drive up the debt burden in developing nations which are already struggling to pay the bills. Expanding grant and concessional finance will be important to mitigate these challenges.
How do we unlock quality adaptation finance?
The Adaptation Gap Report suggests that filling the finance gap will require several enabling factors that can unlock new finance flows. Notably, in EDF’s new report ‘Quality Matters: Strengthening Climate Finance to Drive Climate Action,’ we identify similar strategies as we call for structural reforms within the international climate finance system. Three key recommendations overlap in both reports.
First, countries need to mainstream their climate objectives and adaptation goals within national planning and budgeting processes. This integration should be paired with robust stakeholder engagement that systematically includes subnational authorities, marginalized groups and potential implementing entities in the planning process. Doing so will better align adaptation activities with other national priorities and create more fundable projects. Moreover, planning processes should emphasize project evaluation and evidence gathering to better understand what interventions are most impactful and maximize the potential of climate resources.
Second, countries should adopt investment planning approaches to climate action. Specifically, they should work to develop a pipeline of bankable projects that can meet the objectives within their NAPs and other planning instruments. This can help attract investors to projects and ensure successful implementation of adaptation plans.
Third, multilateral financial institutions including multilateral development banks (MDBs) and climate funds need to undergo structural reform to improve the quality of finance. The MDBs are currently pursuing reforms to become better fit-for-purpose for addressing the climate crisis, and at COP29 they jointly announced that their collective climate finance will reach $120 billion by 2030 – though only $42 billion will be dedicated for adaptation. Improving the balance between mitigation and adaptation finance will be important to ensure that developing countries’ priorities don’t go unfunded. Additional actions these institutions can take include strengthening the concessionality of terms for adaptation projects to alleviate debt burdens and spark new blended finance opportunities, and leveraging innovative instruments like adaptation swaps which can foster positive adaptation outcomes in exchange for forgiving debt.
The NCQG is an important milestone which has the potential to advance action on these reforms and strengthen adaptation finance flows. Alongside supporting a strong quantitative goal, countries should call for improvements in the quality of finance, to ensure that finance for adaptation projects is available, accessible, concessional, and impactful.
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