Thursday 15 September 2011

Markets update - Credit - After all tomorrow is another day.

"After all tomorrow is another day", is the last line of the American Civil War novel Gone With The Wind.

Like Scarlett in Gone With the Wind, credit markets, though deeply grieved also seems to hold up, so far, under the strain. And if Gone With the Wind has a theme it is survival:

"If Gone With the Wind has a theme it is that of survival. What makes some people come through catastrophes and others, apparently just as able, strong, and brave, go under? It happens in every upheaval. Some people survive; others don't. What qualities are in those who fight their way through triumphantly that are lacking in those that go under? I only know that survivors used to call that quality 'gumption.' So I wrote about people who had gumption and people who didn't."
Margaret Mitchell, 1936

Here is the market picture for Itraxx 5 year credit indices today following the "shock and awe"(a military doctrine based on the use of overwhelming power) coordinated central banks intervention to ease dollar funding issues for European banks (we already knew about these concerns from previous posts):
Itraxx Crossover 5 year CDS index (High Yield), tighter:
Market closed at around 714 bps, 27 bps tighter.

Itraxx Financial Senior 5 year CDS index:
Cooling off as well.

Itraxx Financial Subordinate 5 year CDS index:

The liquidity picture:
The massive fall in deposits at the ECB is due to the start of a new reserve period on the 14th of September until the 11th of October.
The three-month cross-currency basis swap fell to 80.25 bps from a high of 112.6 bps on the 12th of September, thanks to central banks intervention.

So, who has what Margaret Mitchell calls "gumption" in Europe in the peripheral space?

Portugal 5 year Sovereign CDS versus Ireland 5 year Sovereign CDS:
Ireland clearly is decoupling from Portugal.

Spain 5 year Sovereign CDS versus Italy 5 year Sovereign CDS:
Spain decoupling as well. Spain sold today 3.95 billion euros of bonds maturing in 2019 and 2020 at an average yield of 5.156% compared to 5.2% in February and 5.196% on the secondary market before the auction took place.

The liquidity issues we discussed a month ago in "Macro and Markets update - It's the liquidity stupid...and why it matters again...", is not only a European problem anymore. It is as well a Russian problem:
Bloomberg - Maria Levitov and Denis Maternovsky:
"Russia is struggling to contain a cash squeeze at the nation’s banks after cutting lending rates for the first time in 15 months.
Government bond yields surged to their highest level since February, with the rate on ruble notes due in March 2014 climbing 19 basis points to 7 percent yesterday, as Bank Rossii sought to boost the amount of cash available to lenders by lowering the rate charged on repurchase loans by 25 basis points and lifting the rate earned on deposits by the same amount yesterday. The three-month MosPrime interbank rate hit an almost 19-month high.
Russia is following Brazil and Turkey in cutting borrowing costs as a way of shielding the nation’s economy from a global slowdown as the U.S. falters and the European debt crisis continues. While the refinancing rate was left on hold at 8.25 percent yesterday, the changes to the repurchase and deposit rates should “contain volatility of money market” rates, Bank Rossii said in a statement."

And why liquidity always matter, also from the same Bloomberg article:
“Economic growth must be fueled with liquidity,” Vladimir Osakovsky, chief economist for Russia at Bank of America Merrill Lynch, said by phone from Moscow yesterday. “If this doesn’t happen, growth in money market rates could stifle investment and therefore growth.”

Credit Suisse published today a review of European Banks under the title - European Banks - The lost decade.

Given ongoing liquidity constraints we discussed plaguing European banks in general, and dollar funding in particular, at this point, as the story unfolds/evolves, it is important to try to find out who has "gumption" and who hasn't in the European banking space.

In this lengthy report, Credit Suisse analysts tell us:
"Whilst many observers may see these two events as separate, we see them as part of the same process which ultimately, we believe, may force banks to deleverage and restructure in a much more significant way. Further, as a result of the current crisis, given European banks have only reduced about half of their original sub prime exposures according to our estimates, we could again see losses related to these assets come through the P&L.
Overall, based on our analysis we see that whilst overall losses associated with credit market assets are c.€184bn so far, European banks effectively ‘raised and retained’ a much higher amount to reach a tangible equity position of €811bn last reported. We note that the additional capital has also been part of higher capital requirements mandated under Basel III and is an important indication that European banks are in a better position in terms of capital going into the sovereign crisis. It has also however, been a drag on profitability.
We compare these losses with the potential losses from the current sovereign crisis. On our estimates, assuming an accelerated sovereign shock scenario, we could see a further €213bn of losses i.e. higher than the losses experienced thus far with credit market assets.
This includes:
(i) further losses on sub prime assets (€52bn); (ii) sovereign losses of €125bn and (iii) one year of higher funding costs of €37bn. If we were to include risk weighting for sovereign exposure of €22bn then the total would be €235bn."

 And Credit Suisse to add:
"Estimating the capital shortfall for the sector
Going into this crisis, given higher regulatory capital demands and funding markets requiring larger capital cushions, our base case suggests the sector will still have a €165bn capital deficit at year end 2012E. In the core scenario that we present we estimate the sector would have a total recapitalisation requirement of c.€400bn (Figure 3) compared to the current market cap of €541bn."

Clearly Europe needs a European TARP. Could that be the message that Treasury Secretary Timothy Geithner will convey to European finance ministers in Poland?

We know from my post "Macro and Markets update - It's the liquidity stupid...and why it matters again..." that the lack of disclosure of the LCR (Liquidity Coverage Ratio), which unfortunately is not published by the majority of banks is an issue as Credit Suisse put it in their report: "A more significant market dislocation in terms of bank failure e.g., Lehman in the sub prime crisis,would make a liquidity coverage ratio (LCR) analysis more relevant, as it highlights the vulnerability of funding on a 30-day basis."

Unfortunately as we previously discussed, lessons have not been learn from the 2008 onslaught and the lack of disclosure and transparency for the majority of European banks does not really allow for a proper "gumption" assesment process under very adverse liquidity conditions. But a good point Credit Suisse points out in their report is as follows:
"European banks have effectively ‘raised’ a much higher amount—of €835bn—since 2007 i.e. five times the losses incurred. We note that the additional capital is also part of higher capital requirements mandated under Basel III but it is an important indicator that highlights that European banks are in an improving position in terms of capital going into the sovereign ‘sub-prime’ crisis. This is why tangible equity for the European banks has almost doubled from the level at the start of 2007."

Sweden is also bracing for impact should it happen:
Source Bloomberg - Johan Carlstrom - 14th of September:
“There will be facilities in place to support banks that may have problems,” Reinfeldt said in an interview today in Stockholm.

Sweden has a good first hand experience of financial crisis:
"Sweden, which suffered through a banking crisis in the early 1990s and then again in 2008 and 2009, chose to inject capital into struggling banks only in return for equity to avoid raising deficits and burdening taxpayers. The government in 2008 set up a financial stability fund by charging banks an annual fee and enacted various crisis-management measures including a bank guarantee program to help support lending.
The fund will grow to 2.5 percent of gross domestic product by 2023 and stood at 35 billion kronor ($5.2 billion) at the end of 2010, including shares in Nordea Bank AB, according to the Swedish National Debt Office.

On another note, Bloomberg Chart of the day shows that the currency ugly contest is well alive and kicking between the Euro and the Dollar:

And finally, to end up on a less somber note this what I think Ben Bernanke could have said after today's coordinated intervention: I know what you're thinking. "Did the FED fire six shots or only five?" Well, to tell you the truth, in all this excitement I kind of lost track myself. But being this is the FED, the most powerful central bank in the world, and would blow your head clean off, you've got to ask yourself one question: Does the ECB feel lucky? Well, do they, punk?

Stay tuned!

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