Finance Homework Assignment
AmazingExpert
blackrock-bsri-presentation.pdf
Mapping Sovereign Risk
BlackRock Sovereign Risk Index
BlackRock Investment Institute
FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY
Notions of safety have been rocked
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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
Markets have been dominated by exceptional policy actions …
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Source: CIRA
… making for a very different investing landscape (until recently)
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Interactive Version
Interactive Version
Fiscal Austerity = social unrest
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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.
Austerity can work – IF there’s external growth
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Monetary policy: the path of least resistance (and effect)
16 June 2011FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY 7
The BlackRock Sovereign Risk Index (BSRI)
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Interactive Version
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%
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
10
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
11
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
over the 2 year horizon as a proportion of total external debt complements the solvency indicator above
12
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
13
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)
Backtesting the BlackRock Sovereign Risk Index
FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY 15
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.
16
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
J a n -0
5
M a y -0
5
S e p -0
5
J a n -0
6
M a y -0
6
S e p -0
6
J a n -0
7
M a y -0
7
S e p -0
7
J a n -0
8
M a y -0
8
S e p -0
8
J a n -0
9
M a y -0
9
S e p -0
9
J a n -1
0
M a y -1
0
S e p -1
0
J a n -1
1
M a y -1
1
Ir e la
n d
C o
m p
o n
e n
t Z
s c o
re s
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)
0
1
2
3
4
5
6
7
8
9
10
11
12
J a
n -0
5
A p
r- 0
5
J u
l- 0
5
O c t-
0 5
J a
n -0
6
A p
r- 0
6
J u
l- 0
6
O c t-
0 6
J a
n -0
7
A p
r- 0
7
J u
l- 0
7
O c t-
0 7
J a
n -0
8
A p
r- 0
8
J u
l- 0
8
O c t-
0 8
J a
n -0
9
A p
r- 0
9
J u
l- 0
9
O c t-
0 9
J a
n -1
0
A p
r- 1
0
J u
l- 1
0
O c t-
1 0
J a
n -1
1
A p
r- 1
1
J u
l- 1
1
Ir e
la n
d A
v e
ra g
e R
a ti
n g
B u
c k
e t
-1.2
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
B la
c k
R o
c k
S o
v e
re ig
n R
is k
S c
o re
: I re
la n
d
(Z s
c o
re , In
v e
rt e
d )
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
over the backtest period.
BSRI time series: case study Ireland
Source: BlackRock Model-Based Fixed Income
17
-3.5
-3.0
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
J a n -0
5
M a y -0
5
S e p -0
5
J a n -0
6
M a y -0
6
S e p -0
6
J a n -0
7
M a y -0
7
S e p -0
7
J a n -0
8
M a y -0
8
S e p -0
8
J a n -0
9
M a y -0
9
S e p -0
9
J a n -1
0
M a y -1
0
S e p -1
0
J a n -1
1
M a y -1
1
G re
e c
e C
o m
p o
n e n
t Z
s c o
re s
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
J a
n -0
5
A p
r- 0
5
J u
l- 0
5
O c t-
0 5
J a
n -0
6
A p
r- 0
6
J u
l- 0
6
O c t-
0 6
J a
n -0
7
A p
r- 0
7
J u
l- 0
7
O c t-
0 7
J a
n -0
8
A p
r- 0
8
J u
l- 0
8
O c t-
0 8
J a
n -0
9
A p
r- 0
9
J u
l- 0
9
O c t-
0 9
J a
n -1
0
A p
r- 1
0
J u
l- 1
0
O c t-
1 0
J a
n -1
1
A p
r- 1
1
J u
l- 1
1
G re
e c
e A
v e
ra g
e R
a ti
n g
B u
c k
e t
-1.6
-1.4
-1.2
-1.0
-0.8
-0.6
-0.4
-0.2
B la
c k
R o
c k
S o
v e
re ig
n R
is k
S c
o re
: G
re e
c e
(Z s
c o
re , In
v e
rt e
d )
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
18
BSRI time series: case study USA
Over to you: Pick the mystery country (1)
FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY 19
A. United States D. Italy G. Japan
B. Argentina E. United Kingdom H. Brazil
C. South Korea F. Belgium I. Thailand
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
