After all, in the banking space, and in this deflationary environment, it is has been all about the "survival of the unfittest".
As reported by Bill Rochelle from Bloomberg in his article "Junk, Nortel, Madoff, Hostess, A123, ResCap" published on the 30th of January, credit investors have to keep dancing until the music stops, and rest assured, at some point it will.
We therefore have to agree with David Tawil, co-founder of Maglan Capital LP which was interviewed by Bloomberg:
Not a surprise as the US leveraged loan cash price index versus its European peer picture has an uncanning resemblance with the evolution of the PMI index - source Bloomberg:
Bank of America Merrill Lynch also added in their note:
"A disorderly rotation out of bonds, into equities – where interest rates increase significantly, leading to massive outflows from high grade bond funds and much wider credit spreads – is the biggest risk to investment grade this year and the one we are getting increasingly concerned about. Thus high grade credit spreads and 10-year swap spreads share the property that significant increases in interest rates can lead to spread widening." - source BAML
The European bond picture, with Spanish 10 year yields rising towards 5.17%, whereas Italian 10 year yields below 5% hovering around 4.25% and German government yields rising towards 1.70% levels, hurting investment grade bond investors in the process with other core European bonds yields rising as well - source Bloomberg:
"Looking at non-cash intangible assets (i.e., goodwill) can be a good indicator and used as a proxy to determine the health of banks.
The significance of the write-downs on Goodwill is often presaged as rough waters ahead. These losses often take a real bite out of corporate earnings. It is therefore very important to track the level of these write-downs to gauge the risk in earnings reported for banks."
So how do goodwill impairments affects credit you might rightly ask?
A previous article from Standard &Poor's written in March 2012 dealt with this precise point - Why U.S. And European Banks’ Goodwill Assets Are Under Pressure:
"House of Pain" - Potential goodwill impairments impact, a few examples as per S&P's article as of December 2011:
To bring some solace to banks, the world's biggest mining and steel companies have already wiped out50 billion dollars off project valuations in 2012 according to Bloomberg's article "Writedowns Near $50 Billion as M&A Haunts Mine CEOs" from Thomas Biesheuvel and Jesse Riseborough on the 30th of January:
Why the change in recovery rate from 20% to 0% matters in the CDS space?
As we pointed out in "European Derecho", implied recovery rates matter enormously in relation to the determination of the payout for subordinated CDS referencing LT2 debt:
In relation to LT2, as a reminder from our September 2011 credit conversation "Credit - Crash Test for Dummies":
"Typically, in subordinated CDS single names, the bond reference is a Lower Tier 2 bond (LT2), and not Tier 1 (T1) bonds or Upper Tier 2 bonds (UT2), as coupon payments can be deferred in these structures. For Tier 1 bonds and UT2, missing a coupon does not constitute a credit event, therefore they cannot be used as a reference for a single name financial subordinate CDS, so no CDS on these bonds."
If the recovery rate for SNS LT2 subordinated bonds is zero, the significance for the European subordinated CDS market is not neutral given the assumed recovery rate factored in to calculate the value of the CDS spread is assumed to be 20% for single name subordinated CDS and 40% for senior financial CDS.
On top of that, a nationalisation, such as SNS case, is not by itself a credit event trigger. Appointing an insolvency official is.
As far as delivery of LT2 underlying subordinated bonds referenced in any CDS contract referencing SNS, you would have to ask the Dutch state for delivery (if the subordinated bonds are not simply cancelled or converted into equity...).
So what's the value of your subordinated single name CDS on SNS? Could it mean single name subordinated CDS are a "House of cards"? We wonder. Oh well...
On a final note, while goodwill impairments are bad news for European banks, as indicated by Bloomberg's recent Chart of the Day, goodwill may as well be bad news for US asset values: