Markets update - Credit - Bedtime story and the European issue of circularity

"Nothing is more frequently overlooked than the obvious."
Thomas Temple Hoyne

Volatility again today. We had a better tone in the morning in the European space credit wise, but we were back to flat at the end of the day. Following the G20, everyone expecting in a week's time big resolution coming out of the European summit. They should be bracing themselves for some disappointment.

As per Bloomberg article today by Tony Czuczka and Rainer Buergin:
"German Chancellor Angela Merkel has made it clear that “dreams that are taking hold again now that with this package everything will be solved and everything will be over on Monday won’t be able to be fulfilled,” Steffen Seibert, Merkel’s chief spokesman, said at a briefing in Berlin today. The search for an end to the crisis “surely extends well into next year.” Group of 20 finance ministers and central bankers concluded weekend talks in Paris endorsing parts of Europe’s emerging plan to avoid a Greek default, bolster banks and curb contagion. Providing a week to act, they set the Oct. 23 meeting of European leaders in Brussels as the deadline."

In this post we will have a look again at bank recapitalization, given it is still the ongoing subject, as a follow up on our previous discussion. We will also discuss the issue of circularity. We touched on the subject in our post - "Macro and Markets update - It's the liquidity stupid...and why it matters again..." in relation to European banks liquidity issues:
"The circularity issue weighting on liquidity:
In highly-indebted Euro zone countries, the issue of circularity comes from the high correlation with their sovereign creditworthiness, meaning they are experiencing very high level of stress on their current funding."

So here we go for another long conversation.

But first, a credit overview.
The Itraxx Credit Indices picture today - Source Bloomberg:

While the tone had been much positive at the open, on credit indices with at one point Itraxx Crossover 5 year index (High Yield) tightening by 23 bps, the market closed the day roughly unchanged, as equities moved from the positive territory to negative. German Finance Minister Wolfgang Schaeuble comments weighted heavily on the market by the end of European close.

Enel, Italy's largest power company came to the market with 2014 and 2015, with a new issue premium to secondary of around 50 bps for the 2014 bonds and a new issue premium of 90 bps for the longer tranche.

There was as well some resurgence in news issues in the financial space with an interesting 2 year Senior Unsecured Floating Rate note from Commerzbank, rated (A2/A/A+ outlook : stbl/neg/stbl), which priced at Euribor +158 bps. On the 12th of October SEB (Skandinaviska Enskilda Banken AB - A1 / A / A+) priced a similar note at around Euribor +120 bps.
We know from the post "Markets update - Credit - Misery loves company" that ABN Amro (Aa3 /A/A+ all stable outlook), priced a similar floater on the 30th of September at around Euribor +130 bps, as a follow up on Deutsche bank which priced at around +100 bps.

So no surprise there, new issues are not only repricing the secondary issues, but coming with big concessions given the need for banks to raise capital. It is interesting to note that apart from these 2 year Senior unsecured notes, for some prime issuers, it seems the subordinated market is still completely shut down.

In relation to flight to quality, convergence of German 10 year Government Yield and German Sovereign CDS seems to have stopped in its tracks - Source Bloomberg:

From 2.18% Yield to 2.08% on the 10 Year German Bund.

But the interesting part today was the new record set in terms of spread between the German 10 year Bond and the French 10 year Bond (OAT), which reached 95 bps - Source Bloomberg:

France still in the crosshairs of the European bond vigilantes.

The liquidity picture - Source Bloomberg:

Some improvement but nothing major so far.

And Nomura had a good comment relating to recent market action in their recent Rates Strategy Europe weekly from the 14th of October:
"Convalescence with relapse risk:
Beyond October, we are worried by the possibility of a relapse in market sentiment. There is ample scope for disappointment on the euro plan (see Euro plan: Bazooka or damp squib?). Our take is that the "bazooka" will not happen. But in a risk-on phase partly triggered by better economic sentiment, it would take a really disappointing announcement to immediately derail markets. In July, there was a very incomplete announcement in a very negative market; the background is different this time. So at this stage, we are not necessarily waiting for a major risk off, but we are aware of the risk of relapse in the aftermath. There are several triggers: (1) the PSI will be revisited with tougher terms, paving the way for a possible CDS trigger, (2) the political situation in Greece is very unstable and the Troika returns to Athens no later than end-November (assuming the next tranche is paid, the government has money only until January), and (3) it is not clear how the ECB's bond buying will continue and how the central bank will react to a GGB default (the collateral issue can be by-passed in the event of a temporary selective default; it would be more complicated with a CDS-triggering event)."
Ouch...so much for all the recent European politicians "Bedtime story"...

And Nomura to add relating to the periphery:
"The market has largely shaken off the recent euphoria over possible quick fixes to the Eurozone and sovereign spreads have come under pressure to some extent as a consequence. While many would look for a large scale solution on the horizon, from the possibility of extra IMF funds (possible with many caveats), to large scale recap of banks (obviously not a solution in and of itself), to various insurance schemes (which could come with practical and legal challenges), the likelihood of any single solution arriving imminently appears remote.

Against this backdrop we continue to believe that sovereign spreads that are unsupported by the ECB will come under pressure."

So, unfortunately, no Bazooka to be expected anytime soon.

And that leads us to the issue of circularity we previously mentioned. And, in relation to bank recapitalization, don't expect wizards, fairy tales and magic tricks in our "Bedtime story".
The issue of circularity we mentioned earlier again cannot be clearer than the graph realised by Martin Sibileau in his latest post - "The EU must not recapitalize banks":

And as indicated by Martin Sibileau:
"The circular reasoning therefore resides in that the recapitalization of banks by their sovereigns increases the sovereign deficits, lowering the value of their liabilities, generating further losses to the same banks, which would again need more capital."

To illustrate further the issue of circularity, here is a table from Bloomberg displaying Greek debt ownership:

The 6 top owners of Greek debt are 6 Greek banks.

And I have to agree with Martin Sibileau's view:
"What would be a solution for the EU? We have repeatedly said it: Either full fiscal union or monetization of the sovereign debts. Anything in between is an intellectual exercise of dubious utility."

And the clear difference between the ECB and the FED in relation to bond purchases is as follows, as pointed out by Martin Sibileau:
“…The Fed was financing what we call in Economics a “stock”, i.e.( mortgages) “…a variable that is measured at one specific time, and represents a quantity existing at that point in time, which may have accumulated in the past…”
"The ECB is financing “flows”, deficits, or “…a variable that is measured over an interval of time…” Therefore, by definition, we cannot know that variable until the interval of time ends…When will deficits end? Exactly!! Nobody knows! Thus, it is naïve to ask more clarity on this issue from the ECB. The only thing that is clear here is that the Euro, i.e. the liabilities of the ECB will necessarily have to depreciate as long as that interval of time exists, until a clear reduction in the deficits is seen…”
Stock and flows:
"Economics, business, accounting, and related fields often distinguish between quantities that are stocks and those that are flows. These differ in their units of measurement. A stock variable is measured at one specific time, and represents a quantity existing at that point in time (say, December 31, 2004), which may have accumulated in the past. A flow variable is measured over an interval of time. Therefore a flow would be measured per unit of time (say a year). Flow is roughly analogous to rate or speed in this sense."

And following the circularity, let's discuss current recapitalization issues as there were some interesting developments today namely involving subordinated Tier 1 debt.

BPCE, the French bank decided to launch a tender and offered to buy back subordinated bonds as much as 1.8 billion Euros of four subordinated hybrid securities:

Why so? Given we know that "access to capital is depending on growth outlooks", a cheaper way for a bank to beef up its Core Tier 1 capital is to buy back at a discount its Hybrid Subordinated perpetual bonds in the secondary market.

We discussed this very subject in the post "Markets update - Credit - Crash Test for Dummies":
"In 2009, the game was for weakly capitalised banks to quietly retire bonds at distressed levels to create/boost Core Tier 1 capital, which was precious as long as they could finance the purchase with term debt.

If a financial entity is able to buy back its LT2 debt below par, it generates earnings (the beauty of FAS 159, on that subject see my post "Statement 159 - Debt Valuation Adjustments - Déjà Vu 2008.") and then Core Tier 1 capital. It's a kind of magic...because this way a bank's total capital base goes down (by retiring LT2 debt) and given regulators care most about the Core Tier 1 ratio, everyone is happy (probably note the subordinate bondholder)."

and bingo! French bank BPCE strikes today!

And a market maker to comment following the BPCE tender:
"Very big moves in T1 space mainly driven by BPCE T1 tender which came approximately 13 points above secondary (for the low coupons bonds). The market rapidly drew the conclusion that similar moves would be coming on in French names - with a particular focus on low-cash, step-up bonds."

BPCE Tier 1 subordinated perpetual bonds indicative round up:
BPCEGP 4.625% 07/15 (call date) cash price - 61/64 +13.75 points
BPCEGP 5.25% 07/14 (call date) cash price - 62/65 +11 points
BPCEGP 6.117% 10/17 (call date) cash price 61/64 +9 points
BPCEGP 9% 03/15 (call date) cash price 78/80 +4 points
BPCE 9.25% 04/15 (call date) cash price 76/79 -

BPCEGP 5.25% 07/14 (call date) - Source Bloomberg

BPCE commented on its tender:
"The Tender Offer is being undertaken in order to further enhance the quality and efficiency of the Company's capital base."
Of course it is!

On a side note, FAS 159 is fashionable again in the banking space:
DVA/CVA in earnings:
UBS = 1.6 billion USD
JP Morgan = 1.9 billion USD
Citi = 1.9 billion USD
To be continued...(Bank of America, Goldman Sachs, Morgan Stanley, etc.).

And on a final note I leave you with Bloomberg chart of the day, showing that Asian stocks are yet to reach bear-market floors:

According to Bloomberg:
"Stocks in Asia excluding Japan may extend a bear-market rally for “several” weeks before resuming declines that could send them to new lows next year, according to Mizuho Securities Asia Ltd. The MSCI All Country Asia excluding Japan Index rebounded 13 percent in the six days through Oct. 13, following a 31 percent plunge from its April 28 intraday high. In the four previous periods when the Asian gauge dropped more than 30 percent from peak to trough closing levels since records began in 1988, all were interrupted by rallies of between 14 and 45 percent, before the routs resumed. A minimum drop of 20 percent from a peak signals to some investors a bear market."

"There cannot be a crisis next week. My schedule is already full."
Henry A. Kissinger

Stay tuned!