Will Carleton - American poet.
Back in March we wondered if in our Credit Space it would be "Plain sailing until a White Squall", and by the end of the month in our conversation relating to Spain "Spanish Denial", we started asking ourselves: "One has to ask oneself if the time has not come to start taking a few chips off the table."
The Credit Indices Itraxx overview - Source Bloomberg:
No surprise there given the bad news flow coming from Bankia. As one Index Market Maker commented:
It is particularly bound to happen as we wrote it last year given we read on Bloomberg today the following:
The "Flight to quality" picture as indicated by Germany's 10 year Government bond yields (well below 2% yield), new record low dipping below 1.55% versus 5 year Germany Sovereign CDS stable at 85 bps. It's deflation (デフレ) and "Risk-Off". - source Bloomberg:
That Japanese European feeling - 2 year German Notes evolution versus 2 making new lows versus 2 year Japanese Notes - source Bloomberg:
Moving on to the subject of Spain in general and Bankia in particular: "We do expect to see more debt to equity swaps for some weak peripheral banks".
While discussing the implications of upcoming Moody's downgrade for 114 European banks and Basel III impacts for the European financial sector ("From Hektemoroi to Seisachtheia laws?") we implied: "We think upcoming downgrades means more collateral posting and more haircuts on collateral that can be pledged for funding at the ECB and dwindling "quality assets" therefore even lower German Bund Yields..." and as our Rcube friend mentioned in the same conversation:
"This year, it appears that Spain and/or Italy are going to be the culprits of a third summer of Eurozone distress."
The latest news on Bankia was that the government has forced the removal of Bankia's management and replaced its CEO with an experienced banker (formerly with BBVA). As indicated by Barclays in their Euro area economics morning comment, it is indeed an important move:
"It is also important because Bankia is by far the largest among the problem institutions. The size of its credit portfolio is nearly EUR200bn, of which 22% is to construction and developers (the bank has a net provisioning ratio of c 43% of problem loans in this sector). The Spanish media has also indicated that the government intends to inject public funds into the institution. Some newspapers have indicated that it could be done through the use of CoCos and with the injection of (public) FROB funds for about EUR7-10bn.
In our view the key to a resolution of Bankia (and to the rest of the problem banks) is a comprehensive, prudent and transparent valuation of their assets, including the legacy real estate assets. This asset evaluation process ideally should involve an independent third party. And it should be followed by a public recapitalization plan (with burden sharing by junior bond holders). If this process is managed swiftly and transparently it could help to restore market confidence."
Bankia Stock price evolution - source Bloomberg:
As our good credit friend put it:
"According to recent news, the Spanish government intends to nationalize Bankia and to subscribe to Cocos (Contingent Capital) issued by the bank. To my view, this is definitely not the cheapest solution as the government will have to inject money that it is having already issues raising. Politically, this is not a good play while imposing harsh austerity measures with soaring unemployment. A better solution would be to force a conversion of debt to equity (In a debt-for-equity swap, a company's creditors generally agree to cancel some or all of the debt in exchange for equity in the company). Doing so will not require 7 to 10 billion funds, but would of course dilute shareholders and destroy bond holders (haircut)."
The FROB (Fondo de Reestructuracion Ordenada Bancaria - Spanish Restructuring Fund) had already dealt last year with a few ailing institutions but so far not in the size of Spanish giant Bankia. The state-funded bailout vehicle FROB has injected nearly €15bn into the banks. It injected last year 2.465 billion euro in NovaCaixa's capital with a discount of around 75 to 85% price to book. Also, CaixaBank's 1Q12 results were hit hard by real estate provisions and the bank was forced to merge with ailing Banca Cívica in 2011.
So far, the Spanish government solution has been consolidation (Savings banks reduced from 45 to 17). The set-up of a bad bank would imply price discovery and coming clean on true asset valuations. This exactly what our good credit friend mentioned in our conversation "Mutiny on the Euro Bounty" in relation to Spanish bank issues and valuations:
"Main Spanish banks have so far refused the government suggestion to create a bad bank which would carry all property toxic assets, arguing that they could manage their assets on their own. The dire reality is that the creation of such bad bank will bring transparency to asset prices, which is not what Spanish bankers want! The murkier the market, the better it is to extend and pretend..."
and we replied at the time in relation to bond tenders in the Spanish RMBS space:
"Interestingly enough, while consolidation is being underway and encouraged by Spanish authorities, this week two bond tenders caught our attention, this time in the Spanish RMBS space, from Banco de Sabadell for an aggregate principal outstanding post amortisation amount of around 1,270 million euro and Banco CAM for 5,693 million euro. The decline in prices for these securities would have been steeper if not for the tender offers..."
Of course the decline would have been steeper! Transparency in asset valuations would finally help in discovering the extent of the problems plaguing the Spanish Financial sector. The set-up of a "Bad Bank" in similar fashion to Ireland's NAMA, would indeed force price discovery and true valuations provided a third party assessor is drafted to help in the set up process as indicated above in Barclays comments.
As indicated by Deutsche Bank in their latest note on Spanish Financials - A new Royal Decree in the making:
This is clearly indicated in a recent note by Cheuvreux - Spain, too much already but still not enough:
"Banks still have a lot of bad assets to deal with, in part thanks to regulatory forbearance. The official stance of the new government in this respect is very straightforward. Its aim is to clean up some of the excessive leverage through new impairments. Supposedly, the cleaner balance sheets and lower leverage following this action would allow loans to flow to where there is demand. A clear strategy does not necessarily make it a good one. And some banks are even vocal about what's next (both Santander and CaixaBank have publicly stated that private loans will have to fall by around EUR300bn-400bn over the next few years).
We believe the private sector deleveraging poses significant challenges for the Spanish economy going forward. Going back to the surplus/deficit per sector, a private deleveraging process would need to be countered by higher public spending to compensate for the fall in GDP. This was the case in Japan in the early 90s but it is not plausible for Spain within the current EU configuration, where fiscal austerity is king. In this regard, note that the Spanish government has undertaken to reduce the budget deficit from around 8.2% in 2011 to 5.3% and 3% in 2012 and 2013, respectively (gaps of around EUR40bn and EUR55bn, respectively).
More importantly, it is unclear whether corporates are willing to borrow given:
1) high levels of debt and B/S deterioration as the price of assets fall; and 2) many companies, particularly in the property sector, are unable not only to borrow more but to even pay back their existing debt. Consequently, a number of corporates are moving into debt reduction mode as opposed to maximising profitability. This is not helped by the ongoing credit crunch, as shown by higher lending spreads. See charts below."
Spain: Spreads in New Loans (%) - source Cheuvreux - Bank of Japan:
Spain: Lending Growth - source Cheuvreux:
Money for Nothing" argument...):
"In a perfect world, the availability of an affordable (1% cost) source of medium-term (three years) funding would certainly promote lending to the private sector. There is sufficient empirical evidence to suggest, however, that neither low rates nor QE programmes foster lending to the private sector in highly leveraged economies. This has certainly been the case in Japan, the US and the UK where an enlarged monetary base did not lead to an increase in lending demand."
While the restructuring of the banking sector is a pre-condition in resuming enough credit growth to sustain economic growth, Cheuvreux estimates that the banking sector restructuring will take out 50 billion euro from taxed earnings and has clearly negative views for growth in Spain in 2011, forecasting a -2.4% print and -0.9% in 2013: