Monday 6 February 2012

Markets update - Credit - Lather, rinse, repeat

Greek Calends - "To defer anything to the Greek Calends is to defer it sine die. There were no calends in the Greek months. The Romans used to pay rents, taxes, bills, etc., on the calends, and to defer paying them to the “Greek Calends” was virtually to repudiate them. (See NEVER.)" - E. Cobham Brewer 1810–1897. Dictionary of Phrase and Fable. 1898.

In our previous conversation, we reviewed the significant tightening move in credit courtesy of liquidity flushed towards the markets thanks to the ECB's LTRO and FED's FOMC decision. Given market are addicted on liquidity and depending on it, the rally has been of epic proportion. Indeed the year of Dragon has started on a very positive tone. In our conversation "The European Overdiagnosis", we argued that the Year of the Dragon should be rebranded the Year of the Central Bank given the market movement reminiscent of the 2009 rally in risky assets. So far in 2012, we have flying PIIGS with very significant tightening moves in Government peripheral yields, and Greek calends in relation to the ever ongoing discussions surrounding the Greek PSI. But, as per our usual style, we ramble again.

It is time for our credit conversation, we will look at the Greek sideshow and its "unintended consequences", some more pain for subordinated bondholders with additional Italian bond tenders making the headlines, and in extension to our previous conversation "The European Overdiagnosis", Spanish decision to enforce 50 billion euros of charges on banks given the rising growth of Non-Performing loans on banks balance sheet as we discussed in "Money for Nothing".

The Credit Indices Itraxx overview - Source Bloomberg:
Given the ongoing PSI is taking center stage again, it isn't really a surprise to see some widening today in the Credit indices albeit in quiet and thin market.

The relationship between the Eurostoxx volatility and the Itraxx Crossover 5 year index (European High Yield gauge):
As commented by one of our macro friends, after a month and half of impressive decorrelation between credit and equities volatility, spreads have finally reconnected towards the absolute level of equities and equities volatility. The 1 year implied volatility dropped by 15% in one month whereas Itraxx Crossover 5 year index (High Yield risk gauge) by more than 30%. On these levels, one should expect relative value trade to unwind given credit doesn't appear extremely cheap versus other asset classes.

As a follow up on previous post, it is interesting to note that Itraxx Financial senior 5 year index (representing 25 European banks and insurance companies), still indicate the strength of the support brought by the LTRO on their spreads compared to the SOVx 5 year Sovereign CDS index (15 countries).

In our last conversation "Money for Nothing", our friends at Rcube Global Macro Research argued the following:
"With European equity markets having rallied almost 25% since last September’s lows (mostly on expectations that the LTRO liquidity injections would ease the credit crunch), we fear that the surprise factor has just changed sides again. Now that numbers north of €1Tn are circulating for the 29/02 LTRO announcement, positive catalysts are drying up. We believe that sensitivity to European economic data has increased a notch."

We commented at the time:
"We agree with our friends at Rcube, namely that the focus should be going forward, on European economic data and rising unemployment levels."

The latest study of the correlation between the Bloomberg Industries EU Bank index and the European PMI manufacturing survey points to some interesting decoupling between EU banks and the PMI survey as indicated by Bloomberg - EU Banks More Macro Sensitive as Liquidity Concerns Abate:
"The correlation between the Bloomberg Industries EU bank index and the European PMI manufacturing survey decoupled significantly from late 2009 to early 2011, having been very strong heading into and through the banking crisis. As the ECB pours liquidity into the market, the PMI indicator is becoming more useful as the correlation returns." - source Bloomberg.

In fact it isn't the only data decoupling recently given the growing divergence between US and European PMI indexes - source Bloomberg:
US PMI versus Europe PMI from 2008 onwards.

We will not venture again in the distinction between the FED and the ECB, namely that one has been financing stock (mortgages), while the other, has been financing flows (deficits), which partially justify our negative stance on Europe, but, as reminder from our post "The law of unintended consequences":
"We do not know when European deficits will end, until a clear reduction of the deficits is seen, therefore the ECB liabilities of the ECB will have to depreciate. It is therefore not a surprise to see the ECB's current reluctance in getting a haircut on their Greek holdings in relation to the ongoing negotiations revolving around the Greek PSI."

Moving back to Greek calends, namely the never ending PSI story, CreditSights in their January Credit Review had some interesting points:
"Greece, and the obvious unsustainability of its existing debt position, has been somewhat of a sideshow to the main act of Italy and Spain for some time now. But negotiations over the restructuring still have the capacity to throw a spanner in the works."

CreditSights, in relation to the Collective Action Clause which Germany proposed to introduce into all Eurozone Government bonds, which could lead to a supermajority of bondholders (66%) to impose the same terms on all holders made the following interesting point:
"Greece, and the obvious unsustainability of its existing debt position, has been somewhat of a sideshow to the main act of Italy and Spain for some time now. But negotiations over the restructuring still have the capacity to throw a spanner in the works. For example, introducing a CAC into Greek law won't, by itself trigger the CDS. But if the CACs are used to impose a restructuring on all bondholders, it is difficult to see how that won't trigger any CDS written before the clause was introduced into Greek law (see Sovereign CDS: Collective Action Complications). We believe the primary reason for avoiding triggering the CDS has been to avoid the known unknown of how it will affect other Eurozone governments rather than worries about the cost of payouts to European banks. One concern is that triggering the CDS may encourage leveraged speculation against Spain or Italy. In other words, if sovereign CDS are demonstrated to be an effective hedge against bond default, then there should be a link between the bond spreads and CDS spreads. If speculators are able to drive CDS spreads wider by selling protection on relatively light volumes, then the bond yields may also be pushed up to potentially unsustainable levels.
Secondly, if Greece can't negotiate a restructuring with bondholders, then it will be faced with the choice of either defaulting or repaying the €14.4 billion in bonds (all domestic-law bonds) that come due in March(the debt that matures before March is all bills). A disorderly default has plenty of scope to undermine investors' confidence in Eurozone governments and repaying any holdouts from the bond restructuring in full will make future negotiations much harder and is sure to prompt the kind of political rhetoric that has previously proved so destabilising."

A case study in the making...

While Greece is taking center stage again, it is interesting to see Spain 5 year Sovereign CDS moving closer to Italy's 5 year sovereign CDS level - source Bloomberg.

While Italian banks have risen thanks to an opportune change of bond buy back rules, Spanish banks have been asked to face the music and will bear 50 billion euros of charges, as Spain is forcing banks to take more losses on the 175 billion euros of real estate assets. On the 1st of February according to Bloomberg:

"The Italian central bank’s new regulations meet European buyback rules on hybrid securities. Banks won’t have to simultaneously issue new instruments to replace those being repurchased and don’t need the approval of Italy’s stock market regulator, the Bank of Italy said on its website.
The Bank of Italy will authorize banks to buy back securities that qualify as regulatory capital as long as their financial position isn’t put at risk, it said."

So go ahead, buy back, the ECB's got your back. And, true to form, this is exactly what has happened following the tweak in the rule book, given, Banco Popolare Società Cooperativa (BPIM) is doing a bond tender for Tier 1 bonds and LT2 bonds, while Intesa, as well, announced today tender offers for 3 Series of Subordinated Tier 1 Notes with a face amount outstanding of EUR 3.75bn:

"The invitation on the Subordinated Notes has the objective to strengthen and optimise the regulatory capital composition of Intesa Sanpaolo and the Group, while at the same time offering Holders the possibility to realise their investment in the Subordinated Notes at a price higher than the prevailing market price immediately prior to anouncement."

Buying the 9.50% Perp. Subordinated Notes (XS0545782020) €1,000,000,000 at 70% of par on the 19th of January, given the bond tender is offered at 90%, would have landed a 20 points gain on the bond, a rapid 28% gain for the brave punter and a 10 points loss for the subordinated buy and hold bondholder.

We touched the subject of rising Non-Performing loans in Europe and in Spain in particular recently. By accelerating the realisation of losses, the new Economy Minister Luis de Guindos is trying to overhaul Spain's crippled financial sector and dealing with its "zombie" banks as indicated by Charles Penty and Emma Ross-Thomas in their Bloomberg article - Spain Coaxes Banks to Merge as Extra Time Given to Purge Losses:
"The government will make banks increase the ratio of provisions set aside for urban and rural land to 80 percent from 31 percent, de Guindos said. For unfinished developments, the provisioning level will rise to 65 percent from 27 percent and to 35 percent for other so-called “troubled” assets including finished developments and houses."

The new 50 billion euros charge according to Bloomberg: "compares with 66 billion euros of provisions taken by banks between 2008 and June 2011 to cover specific loan risks, according to the ministry."

So carrot for Italian banks, and just stick for Spanish banks.

It appears to us that given the ongoing surge in Non-performing loans, if the European recession deepens and unemployment rises, non-financial corporates will suffer as well:
Source - SocGen Sees 4 New Worrying Signs In Italy - Business Insider.

Given the ongoing deleveraging, in the light of the recent Sovereign CDS convergence between Italy and Spain, we might be viewed as contrarian but given the ongoing deleveraging process and the sectorial composition of debt as a percentage of GDP, Spain appears to us as being in a less favorable position particularly given its housing hangover:

On a final note and in relation to the ongoing Greek PSI case study and given Portugal's recent widening in both bonds and CDS, please find below Bloomberg Chart of the day indicating the value of English law when it comes to sovereign debt:
"Portugal’s bonds show how investors concerned about losses being imposed on them are willing to pay up for the extra protection given by English law.
The CHART OF THE DAY shows the prices of Portugal’s $100 million of floating-rate notes and 7.8 billion euros ($10.2 billion) of 3.6 percent bonds, both due in 2014. While the dollar notes are governed by English law and have covenants restricting the issuer’s ability to act against lenders’interests, the euro-denominated securities are issued under local law and lack those protections.
Portugal’s bondholders are concerned the nation will follow the example of Greece, which is negotiating a debt exchange to cut the value of its notes by more than half. The Greek government said it may pass a law to insert so-called collective action clauses into the terms of its domestic-law bonds to force holdouts to accept a writedown."

When the game changes, change the rules...

Stay tuned!

"You can't expect to solve a problem with the same thinking that created it". - Albert Einstein

1 comment:

  1. Here's the latest update: I can't believe this continues to drag on. Europe is so afraid of Greece failing that they are continuing to throw money at them. Anyone recognize this quote: "If you owe your banker a thousand pounds, you are at his mercy. If you owe your banker a million pounds, he is at your mercy."


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