Most risky sovereign debt remains in eurozone as gap with safe assets widens

Half of most risky sovereign credits are in the eurozone, says OTC data provider CMA. IMF data shows continued volatility in the region’s sovereigns and a growing gap between safe and risky assets.

Portugal and Cyprus are the riskiest sovereign credits, both with five-year default probabilities above 60%, reports CMA, the over-the-counter market data provider.

Cyprus, a new entry, went straight to the top of the table. Spain is also a new entrant in the list of most risky sovereigns ranked at 10 with a five-year cumulative probability of default (CPD) of 32.1%.

CPD is calculated based on credit default swap (CDS) prices and recovery assumption using proprietary data from CMA Datavision.

Greece has been removed from the risk report following its default. However, despite the restructuring, CMA still considers its sovereign bonds at risk.

Norway retains its position as the least risky sovereign with a five-year CPD of 2%. The US retains number two position at 2.7%, followed by Switzerland with 3.6% and Sweden, the first EU and eurozone member in the top 10, maintaining fourth position. All four retain CMA’s implied AAA rating.

The UK has had a good quarter, moving up three positions to sixth place. Germany remains at 10th, gaining it a CDP of 6.4%. Its position is linked to continuing concerns about fellow eurozone members Portugal and Spain, states CMA.

Chile and Australia are the other new entrants to the top 10 least risky sovereign credits, with default probabilities of 6.3% and 6.2% respectively.

Another review of sovereign risk names US, German and Japanese government bonds as more of a ‘safe asset’ than those of less stable economies, according to the IMF’s latest Global Financial Stability Report. The IMF identifies $10.5 trillion gross consolidated debt in the eurozone, compared with $9.3 trillion in the US.

The report shows that post-2008 volatility levels are significantly different between Europe, Japan and the US. This was true for the relative volatility of corporate debt  but more so for government bonds which the IMF classes as its highest level of ‘safe asset’.

Volatility of excess returns in US debt instruments fell from 1.65% before December 2007 to 1.5% between January 2008 to October 2011. The equivalent figure in Japan fell from 3.75% to 3.55%. Across a sample of European countries, volatility increased from 3% to around 5% in the highest spread countries.

“The evolution of the volatility of debt returns also confirms that the differentiation between safer and riskier debt instruments increased considerably as a result of the crisis,” says the IMF report.

This is an important consideration for banks calculating capital ratios under Basel III. The report throws light on best practice of banks’ assessment of sovereign debt holdings.

Because many banks use 0% risk weighting for sovereign debt, there could be an upward bias in banks’ capital adequacy ratios, says the IMF. Exposure at default and recovery rate are also factors that need to be taken into account when assessing sovereign debt and credit risk.

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