As humans we posited in our previous conversations that we tend to suffer from optimism bias as indicated by the work of Tali Sharot:
The adjustment of EUR 30bn of problematic assets considers that around 50% of total sector restructured loans are NPLs instead of the 37% reported at the end of 2012. In our recent report, Better today than tomorrow, we showed how total sector restructured loans at the end of 2012 were EUR 208bn, representing 14% of private sector loans, of which EUR 43bn were classified as substandard, other EUR 88bn as performing loans and the remaining EUR 77bn were not performing. The Spanish banks are reviewing these portfolios in order to apply the new and more conservative classification criteria, which will increase the non-performing and substandard restructured loans balances. If we consider as problematic assets all restructured loans, the adjusted NPL ratio will increase from 19.5% to 25.5% for May 2013. Fig. 4 shows that the Spanish financial sector adjusted NPL of 19.5% in May represents 55% of expected 2014 PDs under the OW adverse scenario." - source Nomura
the downgrades highlight the potential risks for the Spanish economy. We also consider as negative the ongoing political scandals about alleged corruption, which, considering what happened recently in Portugal, could also add more volatility and uncertainty to the country and the banking sector.
We remain negative on the Spanish banking sector. The expected continued asset quality deterioration, the potential impacts of removing mortgages floors, the additional provisions needed for restructured loans or the slowdown of LatAm economies in the case of the two large banks, are some examples of the challenging outlook for the Spanish banking sector and the potential additional negative impacts." - source Nomura
Of course we would have to agree with Nomura, in this case the trend is indeed not your friend and regardless of the "silver lining" of some credit returns, there are indeed some clouds gathering on the horizon. While the ECB has recently tweaked its collateral framework as additional policy support, as part of the intent towards re-launching the ABS market to improve SME funding conditions, we think it is too little, too late and that the credit transmission mechanism has been broken in Europe, leading to a surge in bankruptcies as well as unemployment.
As an illustration of this broken credit transmission mechanism, one can only look at the below graph from Nomura relating to loan growth in Italy to get a clear picture of the damages inflicted to the real economy:
No wonder the story separating the US economy from the European economy is a credit story. For instance we have been looking on numerous occasions on the price action of the US Leveraged Loans market versus the European Leveraged Loans market. Comparing market fundamentals between both regions from a credit perspective is paramount in order to gauge the potential growth outcome for the two regions we think. Morgan Stanley in their recent Global Leveraged Insights from the 19th of July and entitled "Game of Loans: US vs Europe" look at these differences:
In Europe, positive technicals have been much more a story of low net supply." - source Morgan Stanley
As we posited in May this year in our "Chart of the Day - Too many European banks and why the deleveraging has only just started", the impact of credit growth in Europe is seriously impaired by the on-going deleveraging leading to a vicious deflationary spiral in the European space. It is therefore not a surprise to learn from Morgan Stanley's report the importance in Europe for banks in the loan market:
Of course there are as well some quality differences:
It is notable that this difference in credit quality is almost the exact opposite of what is seen in the US and EU High Yield bond markets, where Europe has a much higher average rating. Investors should keep this quality differential in mind when comparing headline spreads and yields." - source Morgan Stanley
The growth differentiation between the US and Europe is no doubt to us a question of supply in credit:
But even for the US, every silver lining has its cloud given the fast pace of credit releveraging and surge in covenant quality trends as highlighted by Morgan Stanley in their note:
"New Issuance Trends – More Worrying in the US
However, not everything looks better in the US from a fundamental perspective. Covenant quality trends in the US have been particularly worrying. Year to date 51% of US loans have been cov-lite — a far higher share than the previous peak in 2007. Although the share of cov-lite issuance is high in Europe by historical standards, it is miles behind that of the US.
new issuance has primarily been used to refinance outstanding debt. US issuance has had a somewhat more shareholder friendly tone, with 15% of proceeds used to fund dividends or share buybacks compared to just 6 percent in Europe. New LBOs also make up a larger share in Europe, although this is predominantly a result of lower overall issuance levels." - source Morgan Stanley
For sure, the buy-back frenzy, has no doubt been more "equity" friendly and definitely more worrying from a credit investor's perspective, making the US market therefore more attractive as of late.
On a final note, "housing bubbles" thanks to cheap credit and hot inflows has no doubt been exported to Emerging Markets when one looks at the cost of housing in Columbia, so much for a post-bubble world... - gaph source Bloomberg:
Anyone presuming financial markets are in “a post-bubble world” might have a different view after looking at the cost of housing in Colombia, according to Yale University Professor Robert J. Shiller.
The CHART OF THE DAY shows how a home-price index compiled by the South American country’s central bank compares with the Standard & Poor’s/Case-Shiller price gauge for 10 U.S. cities from seven years earlier. Colombia’s index focuses on Bogota, Cali and Medellin, the three largest cities. Both indicators
have been adjusting for inflation.
“I was not expecting a bubble story when I visited Colombia last month,” Shiller wrote yesterday in a commentary posted on the Project Syndicate website. “People there told me about an ongoing real-estate bubble.”
Home prices in Colombia have increased 69 percent in real terms since 2004, according to the posting. The gain recalled a 131 percent surge in the 10-city index from its 1997 low to its 2006 peak, he wrote.
Falling inflation and interest rates largely explain the Colombian market’s strength, Shiller wrote. Consumer prices rose in February at the slowest pace since 1955. The central bank cut the overnight lending rate seven times in the past year, and the current 3.25 percent rate is Latin America’s lowest.
Shiller also cited a diminished threat from a Marxist rebel group, the Revolutionary Armed Forces of Colombia, that has been active for half a century. The government has held peace talks with the guerrillas, known as FARC, since October. “That is a good enough story to drive a housing bubble,” the New Haven, Connecticut-based economist wrote." - source Bloomberg
"Every silver lining has a cloud." - Mary Kay Ash