Thursday, 2 February 2012

Markets update - Credit - Money for Nothing

"Now, what I want is, Facts. Teach these boys and girls nothing but Facts. Facts alone are wanted in life. Plant nothing else, and root out everything else. You can only form the minds of reasoning animals upon Facts: nothing else will ever be of any service to them. This is the principle on which I bring up my own children, and this is the principle on which I bring up these children. Stick to Facts, sir!"
Charles Dickens - Hard Times - 1854

What a month in credit! The significant tightening move we have seen in credit as well as the rise in risky assets can certainly be attributed to the LTRO factor as well as the FED stepping with the FOMC decision of maintaining rates low for an extended period of time. Given markets are addicted to liquidity, the rally has been significant and could be even more significant as we await the next round of LTRO funding by the ECB.

So why our title "Money for Nothing" you might wonder? Could it simply be us referencing to one of Dire Straits most successful singles? Or just simply because the temptation of "Money for Nothing" courtesy of the ECB in their next round of LTRO operation might be an offer which might be too good to decline even for banks that doesn't even need the money? Even Nordea Bank recently said it would consider participating in the next LTRO simply as the money "looks cheap", according to CreditSights.

So, in this week special credit conversation, grab a cup of tea because in our long conversation we will go through, LTRO impact, worsening credit conditions leading to rise in Non-Performing Loans in banks balance sheet, and why the Baltic Dry Index matter for Nordic banks, more bond tenders, and Spanish Non Performing Loans and more.

First a quick credit overview.

The Credit Indices Itraxx overview - Source Bloomberg:
The SOVx Western Europe (basket of 15 European sovereign borrowers), was marginally tighter at 322 compared to Wednesday.

But comparatively to Itraxx Financial Senior representing the spreads for European banks and insurance companies, clearly indicates the impact of the unconditional support the ECB has provided to banks relative to Sovereign countries given the spread between both indexes is at a high point of 115 bps - Source Bloomberg:

The current European bond picture with Italy and Spain 10 year government yields falling still; and France receding below 3% yield for 10 years government bonds - source Bloomberg:

In relation to Spain and Italy, there is an interesting convergence between Sovereign 5 year CDS levels  between both countries - Source Bloomberg:

Ireland 5 year sovereign CDS versus Portugal 5 year sovereign CDS spread, while the absolute spread has been falling as well as government bonds, Portugal is still pretty much in the danger zone as indicated by its current 5 year CDS spread - source Bloomberg:

The liquidity picture, as per our four charts, ECB Overnight Facility, Euro 3 months Libor OIS spread, Itraxx Financial Senior 5 year index, Euro-USD basis swaps level - source Bloomberg:
From our previous conversations we have discussed liquidity at lengths and its impact credit spreads and markets.

What is interesting to note as indicated by Bloomberg is the following:
"At the end of 2011, the Italian banking system drew over 200 billion euros of gross liquidity from the ECB, just shy of 25% of its total gross lending. This reliance has grown in step with the rising sovereign auction costs in Italy, and investors are likely to want granularity on individual bank usage in forthcoming full-year results."

Bringing us to our main conversation, namely individual bank usage of "Money for Nothing", courtesy of the ECB 36 months LTRO operation. As indicated by CreditSights:

"It looks as though banks were waiting to see if capital markets opened up before deciding how much they need to use their LTRO allocation to refinance near-term maturities, or to what extent some of it might be available to fund new lending or government carry trades. Intesa for example, is reported to have taken €12 bln in the last ECB LTRO. For the stronger issuers such as the Nordic and Swiss banks, which have much easier access to funding markets, recent deals have been opportunistic."

In fact Italian bank Intesa was not the only peripheral bank making good use of previous LTRO, in its fourth quarter call according to Bloomberg, BBVA discussed how the 11 billion euro financing from the ECB covered its 2012 wholesale funding needs and that it might as well take up the second facility offered by the end of February.

But clearly Senior Unsecured markets remains open for core European banks while peripheral banks are still shut out. We argued last year that the race to funding would lead to core European banks issuing at higher cost.
It is indeed the same game we mentioned in our previous conversation "Great Expectations":

"The game is still the same, conceding consequent large premiums in the race to raise capital."

Money for nothing, ECB net lending falling to Euro Area Credit institutions falling but ECB deposits rising - source Bloomberg:

We mean "Money for Nothing" given our friends at Rcube Global Macro, in their latest study of the ECB quarterly bank lending survey indicate a significant worsening of the credit crunch in Europe, meaning plenty of liquidity impact for banks but confirming our 2011 fears of credit contraction for corporates and households ("Money for nothing and the Casino Chips for free..." - Macronomics):

"The ECB has just released its quarterly bank lending survey. Given that it was conducted right after the LTRO announcement, it should have captured part of the macro improvement based on the liquidity injection. Considering this, we think that the results are particularly alarming.
It seems that the LTRO has eased the stress on the sovereign side but did not impact the credit channel to the private sector positively."

As indicated by our friends at Rcube Global Macro Research:

"The credit crunch has intensified further. All lending standards (Firms, Households) have tightened aggressively. Credit to firms in the last quarter has been drastically reduced."
"A net 42% of the 124 banks surveyed have tightened their lending standards to large firms. This is the highest figure since the Lehman bust." - source Rcube Global Macro Research.

"Even more worryingly, the net effect of liquidity position on credit to firms (which historically has a small lead on the actual change in terms of credit) is at an all-time high, hinting at further net tightening in Q1." - source Rcube Global Macro Research:

"The large number of reasons mentioned to justify the tightening of credit availability makes a substantial improvement in coming months significantly less likely. The expectation of general economic activity has massively deteriorated. Similarly, access to market financing, banks’ liquidity position and cost related to banks’ capital position have all experienced stress." - source Rcube Global Macro Research:

"On the household front, we notice that demand for loans has crashed, while banks are now aggressively restraining credit for house purchases. This clearly hints at a much weaker consumption ahead in Europe.
On the positive side, it seems that German banks have remained far more accommodating than their European peers. Ironically, German corporates are also the most self-sufficient in terms of financing..." - source Rcube Global Macro Research:

"As a result, Eurozone growth expectations look way too optimistic.
The survey clearly points towards renewed Eurozone economic momentum weakness.
While this morning’s PMIs were a pleasant surprise, we don’t think it can be repeated. French PMI will slowly move to the mid-30s (please refer to past documents on France for further details), and this will potentially trigger another leg down for global risky assets." - source Rcube Global Macro Research:

And my friends at Rcube to conclude:
"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."

In the continuation to our previous conversation, we agree with our friends at Rcube, namely that the focus should be going forward, on European economic data and rising unemployment levels:
"Unemployment expectations in the euro zone have worsened significantly over 2H11, breaching the 10% level of late November. France has the highest forecast level (outside of Spain and Ireland), and with GDP expectations falling, it is increasingly likely that bad debt formation will exceed current estimates, reversing recent trends." - source Bloomberg.

Although LTRO provides cheap funding to European banks, rising unemployment levels and deteriorating credit conditions should consequently lead to a significant rise in Non Performing Loans (NPLs) on banks balance sheet.

As indicated by Bloomberg:
"IMF data show that while the median NPL ratio for the European banks at FY10 was 4%, by 1H11 it was rising for Ireland and Denmark. Bad debt coverage ratios will fall should the stock of non-performing loans rise, as unemployment grows, economic recovery stalls and the associated lower profitability slows retained earnings growth."
NPLs on the rise in Europe - source Bloomberg.

In the meantime, many pundits have been arguing about the importance of the Baltic Dry Index as a leading indicator. For us, it is just another indicator in the deterioration of credit and for tracking NPLs for the Danish banking sector given, as indicated by Bloomberg:
"Nordea highlighted the weak economic environment in Denmark and decreasing collateral values in the shipping industry as key drivers of the 134% increase in loan losses since 3Q. These trends will likely hurt peers Danske Bank (27% share of total Danish lending) and DNB Bank (11% share in syndicated shipping loans)."

If it was only shipping plaguing our Danish Friends...
"Denmark’s biggest lender, Danske Bank A/S, probably returned to profit in the fourth quarter after reporting its first loss since 2009 in the previous period, according to analyst estimates compiled by Bloomberg.
Banks in the worst-performing Nordic economy face more losses on farming loans as that industry struggles to pay down its obligations, Noedgaard said. Agricultural debt swelled 2.6 percent to 359 billion kroner ($63 billion) in 2010, the Danish Agriculture and Food Council estimates. Commercial farms have lost as much as half their value in some parts of Denmark, leaving 6 percent of the industry technically insolvent, according to the council. “We have an agricultural sector that is somewhat challenged by very high levels of debt and a poor performance currently,” Noedgaard said.
Loans to farming, construction and real estate made up 26 percent of total lending at the end of 2010 at banks with less than 50 billion kroner in working capital, according to a May report by the central bank. For the biggest banks, the corresponding figure was 16 percent.
‘Not Looking Good’
At the end of 2011, loans to farms made up 11 percent of banks’ corporate lending and 23 percent of commercial mortgage lending, the Danish Bankers Association estimates.
Danish banks also face growing losses on loans to small-and medium-sized enterprises, which are struggling to survive the fallout of a faltering domestic economy, Noedgaard said." - source Bloomberg - Frances Schwartzkopff - 31st of January - "Denmark’s Bank Crisis Worsening, More Failures Loom, FSA Warns".

We already know "Misery loves company", it was of no surprise to learn the Spanish origin of our latest subordinated bond tenders likely to generate some upcoming haircuts. Banco Popular Espanol launched a tender for Subordinated bonds as well as Asset Backed Securities, for 3 subordinated Lower Tier 2 bonds and 13 tranches of ABS with an aggregate amount outstanding of 1.14 billion euros. The capped face amount being bought back is up to 250 million euros for the LT2 securities and up to 125 million euros of the ABS (via modified Dutch Auction).

In relation to the evolving Spanish situation, from our previous conversation we know that Spanish unemployment has reached 22.9%. It is not surprising to read that Spanish banking giant Santander took a 1.8 billion euros provision against its Spanish real estate exposure last quarter, bringing its coverage ratio to 50% according to Bloomberg:
"With an estimated 170 billion euros of troubled assets outstanding, real estate NPLs reached 28.6% in Spain in 4Q."

Probably a wise move by Santander unlike BBVA, who hasn't so far adjusted its coverage level. While in our conversation "The European Principle of Indifference", we discussed BBVA's accounting gymnastic relating to its Goodwill impairment. We already know the impact Goodwill impairments can have on bank earnings (see "Goodwill Hunting Redux"). It wasn't a surprise to see BBVA having a fourth quarter loss of 139 million euros, (against a profit of 939 million euros in Q4 2010).
From MarketWatch - "Analysts polled by Dow Jones Newswires were forecasting a profit of €152 million, but apparently not all analysts had included that writedown in their forecasts."

What analysts should be concerned about is that BBVA’s bad loans as a proportion of total lending has remained little changed at 4.07 percent in the fourth quarter given according to Bloomberg:
"The bank reported 15.3 billion euros of assets linked to real-estate development in September, of which 4 billion euros was land and 2.8 billion euros was unfinished buildings. BBVA had 6.63 billion euros of foreclosed or acquired real-estate assets on its books, with provisions to cover 33 percent of that amount."

They also should be concerned as well that its Chief Operating Officer Angel Cano said in April 2010 that asset quality was probably going to be “stable from now on.”

According to Dow Jones Newswire - Christopher Bjork:
"The bad debt ratio of Spain's banking sector rose for the eight consecutive month in November to a new 17-year high, while deposits and loans shrunk further as the country edged towards a double-dip recession, data released Wednesday by the Bank of Spain showed.
According to the data, 7.51% of loans held by banks were more than three months overdue for repayment in November, up from 7.42% in October. It is the highest percentage recorded since November 1994, and contrasts with bad debt levels below 1% of all loans in the years prior to the country's 2008 property bust.
High unemployment, falling house prices and the sluggish economy likely will cause bad loans to continue to rise throughout this year and into 2013, said Goncalo Guarda Garcia, an analyst at Portuguese brokerage BPI."

Christopher Bjork also commenting:
"The November data showed banks had cut lending by 2.54% on the year, while the pool of deposits shrunk at an annual rate of 2.14%.
The new Spanish government said earlier this month that after stalling in the third quarter, the economy had contracted in the fourth quarter of 2011 and is set to shrink further this quarter.
Overall, EUR134.1 billion in loans were non-performing in November, up from EUR131.9 billion in October and EUR104.7 billion a year earlier. Banks had set aside a total of EUR73.82 billion to cover these soured loans at the end of November, up from EUR62.2 billion a year earlier. The amount of provisioning will likely rise sharply next month, as many of the country's lenders are expected to set aside a large chunk of their earnings to cover loan losses.
As of November, Spain's banks had total of EUR1.79 trillion in loans outstanding, down from EUR1.84 trillion a year earlier."

"There is a wisdom of the Head, and ... there is a wisdom of the Heart."
Charles Dickens - Hard Times - 1854

Stay Tuned!

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