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California’s Deadliest Wildfire Highlights Emerging Risk

Broadband Only Homes Skyrocket In 2018 Validating Top MSOs Connectivity Pivot

Street Talk Episode 40 - Digital Banks Take a Page Out of 'Mad Men'

Power Forecast Briefing: As retirements accelerate, can renewable energy fill the gap?

2019 Credit Risk Perspectives: Is The Credit Cycle Turning? A Fundamentals View

Insurance
California’s Deadliest Wildfire Highlights Emerging Risk

Dec. 05 2018 — The most destructive and deadly fire in California's history puts the spotlight on a growing threat for insurers, energy companies and investors in select catastrophe bonds.

As of Nov. 14, the Camp Fire has threatened 15,500 structures and destroyed 9,700 single residences, 118 multiple residences, 290 commercial properties and 1,750 other minor structures, according to data from CalFire.

Houses destroyed by wildfire in Paradise, Calif.
Source: Associated Press

The fire, which has ravaged more than 141,000 acres, originated in Butte County on Nov. 8. In a short period of time it burned entire neighborhoods and devastated the town of Paradise. The fire is only 40% contained as of Nov. 15 and is not expected to be fully contained until Nov. 30.

More than 60 people have been killed by the recent spate of fires burning across California, and more than 600 others are still unaccounted for.

"This is not the new normal. This is the new abnormal," California Gov. Jerry Brown said during a press conference held in the early days of the fire. The governor has asked for federal aid and declared a state of emergency for the Golden State.

Insurers react to threat

Insurance companies were introduced to this new abnormal last year when they were hit with approximately $12.8 billion in insured losses stemming from California wildfires, the bulk of which was covered by reinsurance. They also weathered millions in losses from the Mendocino Complex and Carr fires earlier this year.

Although initial estimates of insured losses related to these latest fires have not been released, modeling company Aon said earlier this week that it expects them to result in a "multibillion-dollar payout."

The rising frequency and severity of California wildfires over the past several years might have insurers starting to rethink their approach as reinsurance rates will likely continue to rise. Several insurance companies have taken steps to mitigate damage to policyholders' properties in an effort to limit claims costs from the latest blazes.

For example, Chubb Ltd.'s Wildfire Defense Services program contracts federally certified firefighters in 18 states to harden homes against wildfires. Kevin Fuhriman, catastrophe manager for Chubb Personal Risk Services, said their firefighters tend to take pre-suppression action. That includes raking away leaves, setting up sprinkler systems, bringing in generators, taping vents and spraying fire retardant on vegetation. In severe cases, they may apply gel to flammable parts of structures.

Although Fuhriman could not give an estimate for the number of Chubb firefighters active in California, he said the company has deployed roughly 15 "resources and engines" in the state.

No relief in sight

CalFire data shows a dramatic increase in the number of acres burned thus far in 2018 compared to 2017. From Jan. 1 to Nov. 12, 2017, wildfires burned 316,707 acres in California. For the same period in 2018, wildfires scorched more than double that amount, at 847,588 acres.

Persistent offshore winds and extremely dry vegetation caused the Camp Fire to spread quickly after it first sparked. Higher temperatures have also played a role in recent wildfires becoming more severe, according to Daniel Swain, a climate scientist at UCLA. Even a few degrees of average warming across multiple seasons can make fires "burn faster, more intensely, hotter and have more extreme behavior," he said.

In a "normal year," it might have rained five inches since the end of the summer, said Swain. But that part of California may have seen as little as less than half an inch of precipitation in that time frame this year. At this point, firefighters are just waiting for a "season-ending rain."

"Until we get that really widespread soaking rain, wildfire behavior is probably going to continue," Swain said, adding that there is no rain in the forecast for the next week to 10 days.

Two other wildfires are raging in Southern California. The Woolsey Fire in Ventura and Los Angeles counties has burned through 98,362 acres, destroyed at least 548 structures and killed three people, according to CalFire data. The blaze was at 62% containment as of Nov. 15.

No fatalities have been reported from Ventura County's Hill Fire, which has burned 4,531 acres and is now nearly fully contained.

Financial fallout

The causes of the Camp and Woolsey fires are still under investigation, but they could have been started by downed power lines. Minutes before the fire started, both Pacific Gas and Electric Co. and Southern California Edison Co. reported issues with power lines in Northern and Southern California, respectively.

If PG&E's equipment is determined to have caused the Camp Fire, the company, and its customers, could be on the hook for substantial damages. In a recent regulatory filing , the company cautioned that it could end up being found legally liable for claims that go beyond its insurance coverage and have a "material impact" on its financial position. Just days after that warning, a lawsuit was filed against PG&E, alleging that it was responsible for the fire due to, among other things, its maintenance and repair practices.

PG&E had recently renewed its liability insurance coverage for wildfire events in the amount of $1.4 billion for the period between Aug. 1, 2018, and July 31, 2019.

The energy company was forced to take a $2.5 billion charge to cover losses related to the wine country fires of October 2017. In August, the company completed a $200 million catastrophe bond that provided it with third-party liability protection against property damage caused by California wildfires. Insurance-linked securities blog Artemis said the bond was the first instrument to solely cover wildfire risks. Whether investors in the instrument will face a loss will be an open question for some time as the legal case against PG&E over the Camp Fire has just begun.

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Technology, Media & Telecom
Broadband Only Homes Skyrocket In 2018 Validating Top MSOs Connectivity Pivot

Highlights

The segment stood at an estimated 23.6 million as of Dec. 31, 2018, accounting for 24% of all wireline high-speed data homes.

The following post comes from Kagan, a research group within S&P Global Market Intelligence.

To learn more about our TMT (Technology, Media & Telecommunications) products and/or research, please request a demo.

Mar. 20 2019 — The U.S. broadband-only home segment logged its largest net adds on record in 2018, validating Comcast Corp.'s and Charter Communications Inc.'s moves to make broadband, or connectivity, the keystone of their cable communication businesses.

The size and momentum of the segment also put in perspective the recent high-profile online-video video announcements by the top two cable operators as well as AT&T Inc.'s WarnerMedia shake-up and plans to go toe-to-toe with Netflix in the subscription video-on-demand arena in the next 12 months.

We estimate that wireline broadband households not subscribing to traditional multichannel, or broadband-only homes, rose by nearly 4.3 million in 2018, topping the gains from the previous year by roughly 22%. Overall, the segment stood at an estimated 23.6 million as of Dec. 31, 2018, accounting for 24% of all wireline high-speed data homes.

For perspective, broadband-only homes stood at an estimated 11.3 million a mere four years ago, accounting for 13% of residential cable and telco broadband subscribers.

The once all-powerful, must-have live linear TV model, which individuals and families essentially treated as a utility upon moving into a new residence, increasingly is viewed as too expensive and unwieldy in the era of affordable, nimble internet-based video alternatives. This has resulted in a sizable drop in penetration of occupied households.

As a result, continued legacy cord cutting is baked in and broadband-only homes are expected to continue to rise at a fast clip, with the segment's momentum in the next few years compounded by Comcast's, Charter's and AT&T's ambitious moves into online-video territory.

Note: we revised historical broadband-only home estimates as part of our fourth-quarter 2018, following restatements of historical telco broadband subscriber figures and residential traditional multichannel subscriber adjustments.

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Listen: Street Talk Episode 40 - Digital Banks Take a Page Out of 'Mad Men'

Mar. 20 2019 — Some fintech companies are making hay with digital platforms that tout their differences with banks, even though they are often offering virtually the same products. In the episode, we discuss with colleagues Rachel Stone and Kiah Haslett the deposit strategies employed by the likes of Chime, Aspiration and other incumbent players such as Ally Financial, Discover and Capital One. Those efforts conjure up memories of a Don Draper pitch in Mad Men and likely will enjoy continued success.

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Watch: Power Forecast Briefing: As retirements accelerate, can renewable energy fill the gap?

Mar. 19 2019 — Steve Piper shares the outlook for U.S. power markets, discussing capacity retirements and whether continued development of wind and solar power plants may mitigate the generation shortfall.

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Credit Analysis
2019 Credit Risk Perspectives: Is The Credit Cycle Turning? A Fundamentals View

Mar. 15 2019 — On November 20, 2018, a joint event hosted by S&P Global Market Intelligence and S&P Global Ratings took place in London, focusing on credit risk and 2019 perspectives.

Pascal Hartwig, Credit Product Specialist, and I provided a review of the latest trends observed across non-financial corporate firms through the lens of S&P Global Market Intelligence’s statistical models.1 In particular, Pascal focused on the outputs produced by a statistical model that uses market information to estimate credit risk of public companies; if you want to know more, you can visit here.

I focused on an analysis of how different Brexit scenarios may impact the credit risk of European Union (EU) private companies that are included on S&P Capital IQ platform.

Before, this, I looked at the evolution of their credit risk profile from 2013 to 2017, as shown in Figure 1. Scores were generated via Credit Analytics’ PD Model Fundamentals Private, a statistical model that uses company financials and other socio-economic factors to estimate the PD of private companies globally. Credit scores are mapped to PD values, which are based on/derived from S&P Global Ratings Observed Default Rates.

Figure 1: EU private company scores generated by PD Model Fundamentals Private, between 2013 and 2017.

Source: S&P Global Market Intelligence.2 As of October 2018.

For any given year, the distribution of credit scores of EU private companies is concentrated below the ‘a’ level, due to the large number of small revenue and unrated firms on the S&P Capital IQ platform. An overall improvement of the risk profile is visible, with the score distribution moving leftwards between 2013 and 2017. A similar picture is visible when comparing companies by country or industry sector,3 confirming that there were no clear signs of a turning point in the credit cycle of private companies in any EU country or industry sector. However, this view is backward looking and does not take into account the potential effects of an imminent and major political and economic event in the (short) history of the EU: Brexit.

To this purpose, S&P Global Market Intelligence has developed a statistical model: the Credit Analytics Macro-scenario model enables users to study how potential future macroeconomic scenarios may affect the evolution of the credit risk profile of EU private companies. This model was developed by looking at the historical evolution of S&P Global Ratings’ rated companies under different macroeconomic conditions, and can be applied to smaller companies after the PD is mapped to a S&P Global Market Intelligence credit score.

“Soft Brexit” (Figure 2): This scenario is based on the baseline forecast made by economists at S&P Global Ratings and is characterized by a gentle slow-down of economic growth, a progressive monetary policy tightening, and low yet volatile stock-market growth.4

Figure 2: “Soft Brexit” macro scenario.5

Source: S&P Global Ratings Economists. As of October 2018.

Applying the Macro-scenario model, we analyze the evolution of the credit risk profile of EU companies over a three-year period from 2018 to 2020, by industry sector and by country:

  • Sector Analysis (Figure 3):
    • The median credit risk score within specific industry sectors (Aerospace & Defense, Pharmaceuticals, Telecoms, Utilities, and Real Estate) shows a good degree of resilience, rising by less than half a notch by 2020 and remaining comfortably below the ‘b+’ threshold.
    • The median credit score of the Retail and Consumer Products sectors, however, is severely impacted, breaching the high risk threshold (here defined at the ‘b-’ level).
    • The remaining industry sectors show various dynamics, but essentially remain within the intermediate risk band (here defined between the ‘b+’ and the ‘b-’ level).

Figure 3: “Soft Brexit” impact on the median credit risk level of EU private companies, by industry.

Source: S&P Global Market Intelligence. As of October 2018.

  • Country Analysis (Figure 4):
    • Although the median credit risk score may not change significantly in certain countries, the associated default rates need to be adjusted for the impact of the credit cycle.6 The “spider-web plot” shows the median PD values for private companies within EU countries, adjusted for the credit cycle. Here we include only countries with a minimum number of private companies within the Credit Analytics pre-scored database, to ensure a robust statistical analysis.
    • Countries are ordered by increasing level of median PD, moving clock-wise from Netherlands to Greece.
    • Under a soft Brexit scenario, the PD of UK private companies increases between 2018 and 2020, but still remains below the yellow threshold (corresponding to a ‘b+’ level).
    • Interestingly, Italian private companies suffer more than their Spanish peers, albeit starting from a slightly lower PD level in 2017.

Figure 4: “Soft Brexit” impact on the median credit risk level of EU private companies, by country.

Source: S&P Global Market Intelligence. As of October 2018.

“Hard Brexit” (Figure 5): This scenario is extracted from the 2018 Stress-Testing exercise of the European Banking Authority (EBA) and the Bank of England.7 Under this scenario, both the EU and UK may go into a recession similar to the 2008 global crisis. Arguably, this may seem a harsh scenario for the whole of the EU, but a recent report by the Bank of England warned that a disorderly Brexit may trigger a UK crisis worse than 2008.8

Figure 5: “Hard Brexit” macro scenario.9

Sources:”2018 EU-wide stress test – methodological note” (European Banking Authority, November 2017) and “Stress Testing the UK Banking system: 2018 guidance for participating banks and building societies“ (Bank of England, March 2018).

Also in this case, we apply the Macro-scenario model to analyze the evolution of the credit risk profile of EU companies over the same three-year period, by industry sector and by country:

  • Sector Analysis (Figure 6):
    • Despite all industry sectors being severely impacted, the Pharmaceuticals and Utilities sectors remain below the ‘b+’ level (yellow threshold).
    • Conversely, the Airlines and Energy sectors join Retail and Consumer Products in the “danger zone” above the ‘b-’ level (red threshold).
    • The remaining industry sectors will either move into or remain within the intermediate risk band (here defined between the ‘b+’ and the ‘b-’ level).

Figure 6: “Hard Brexit” impact on the median credit risk level of EU private companies, by industry.

Source: S&P Global Market Intelligence. As of October 2018.

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  • Country Analysis (Figure 7):
    • Under a hard Brexit scenario, the PD of UK private companies increases between 2017 and 2020, entering the intermediate risk band and suffering even more than its Irish peers.
    • Notably, by 2020 the French private sector may suffer more than the Italian private sector, reaching the attention threshold (here shown as a red circle, and corresponding to a ‘b-’ level).
    • While it is hard to do an exact like-for-like comparison, it is worth noting that our conclusions are broadly aligned with the findings from the 48 banks participating in the 2018 stress-testing exercise, as recently published by the EBA:10 the major share of 2018-2020 new credit risk losses in the stressed scenario will concentrate among counterparties in the UK, Italy, France, Spain, and Germany (leaving aside the usual suspects, such as Greece, Portugal, etc.).

Figure 7: “Hard Brexit” impact on the median credit risk level of EU private companies, by country.

Source: S&P Global Market Intelligence. As of October 2018.

In conclusion: In Europe, the private companies’ credit risk landscape does not yet signal a distinct turning point, however Brexit may act as a pivot point and a catalyst for a credit cycle inversion, with an intensity that will be dependent on the Brexit type of landing (i.e., soft versus hard).

1 S&P Global Ratings does not contribute to or participate in the creation of credit scores generated by S&P Global Market Intelligence.
2 Lowercase nomenclature is used to differentiate S&P Global Market Intelligence credit scores from the credit ratings issued by S&P Global Ratings.
3 Not shown here.
4 Measured via Gross Domestic Product (GDP) Growth, Long-term / Short-term (L/S) European Central Bank Interest Rate Spread, and FTSE100 or STOXX50 stock market growth, respectively.
5 Macroeconomic forecast for 2018-2020 (end of year) by economists at S&P Global Ratings; the baseline case assumes the UK and the EU will reach a Brexit deal (e.g. a “soft Brexit”).
6 When the credit cycle deteriorates (improves), default rates are expected to increase (decrease).
7 Source: “2018 EU-wide stress test – methodological note” (EBA, November 2017) and “Stress Testing the UK Banking system: 2018 guidance for participating banks and building societies”. (Bank of England, March 2018).
8 Source: “EU withdrawal scenarios and monetary and financial stability – A response to the House of Commons Treasury Committee”. (Bank of England, November 2018).
9 As a hard Brexit scenario, we adopt the stressed scenario included in the 2018 stress testing exercise and defined by the EBA and the Bank of England.
10 See, for example, Figure 18 in “2018 EU-Wide Stress Test Result” (EBA November 2018), found at:https://eba.europa.eu/documents/10180/2419200/2018-EU-wide-stress-test-Results.pdf

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2019 Credit Risk Perspectives: Is The Credit Cycle Turning? A Market-Driven View

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