Macro and Credit - The fourth wall

"It is only with the heart that one can see rightly; what is essential is invisible to the eye." - Antoine de Saint-Exupery, French pilot and writer

While enjoying the festive season in Paris, we watched with interest a couple of interesting credit and market events that made us think about a theatrical reference which we decided to use as our title analogy. The fourth wall is the imaginary "wall" at the front of the stage in a traditional three-walled box set in a proscenium theatre, through which the audience sees the action in the world of the play (or markets). Speaking directly to, otherwise acknowledging or doing something to the audience through this imaginary wall – or, in film and television, through a camera – is known as "breaking the fourth wall" (think Ferris Bueller's day off...). The fourth wall being an established convention and given our disregard for conventions (us being contrarian), we will, therefore, in this first of the year conversation "break the fourth wall". The acceptance of the transparency of the fourth wall is part of the suspension of disbelief (or delusion) between the "fictional" recovery we have commented on numerous occasions and you, the audience.

Before we dive more into our first conversation of the year, which will relate once more to the state of affairs in the credit and macro space, we would like to make a quick parenthesis on two subjects of interest of ours, namely idiosyncratic risks in credit markets and the state of shipping (given for us it is not only a deflationary indicator, but a credit indicator as per our past conversations).

A good illustration of the idiosyncratic risk in the credit space was once more illustrated on the 29th of December by the price action relating to the "sucker punch" delivered to the senior bond holders of Novo Banco, the supposedly "good part" of former Portuguese bank Banco Espirito Santo - graph source Bloomberg:

- graph source Bloomberg

So what happened on the 29th of December that spooked the "innocent" senior financial bond holders you might rightly ask dear audience? Well, Bank of America Merrill Lynch in their note on Novo Banco from the 4th of January tells it all:

"The Bank of Portugal announced that, as part of the resolution of BES, it was transferring five bonds from Novo, back to the ‘bad bank’, BES. We believe that the resolution of BES could be viewed as a process and not a discrete series of events, since Novo is still a ‘bridge’ institution (the intention is that the resolution of Novo is complete when it is sold, although the deadline for the sale now appears to be indefinite). In our view, recovery on these securities should be viewed as uncertain as BES’s total assets were only €197m at end-2014 compared to a negative net asset position of €2.7bn, before the transfer of a further €2bn of senior bonds. It is our understanding that the senior bonds’ Governing Law is Portuguese. We note that in the original resolution of BES, the Bank of Portugal, as resolution authority, has reserved the right to move assets and liabilities between ‘bad’ bank and ‘bridge’ bank. In addition, the BoP appears to have chosen large denomination seniors, to avoid imposing losses on retail bondholders. In any case, with the transferred securities trading at ~€11, and BES now to be liquidated. 

Further losses could lie ahead 

Novo has in effect been given a further €2bn in capital post-transfer which, according to the company, means that its CET1 ratio has now increased to 13%. However, Negocios, at the end of 2015, reported that a further €2bn of ‘irregular’ loans linked to the ancien regime of the bank had been discovered (the newspaper adduces these irregular loans as the reason for the senior bail-in). The newspaper reports that the provisions relating to these exposures may be taken in 4Q15 (and beyond) leading to a significant deterioration in the accounts of the bank. Note Novo Bank did not comment on the press reports. The June report already detailed a loss of €252m. We would expect this to deepen through year end as provisioning likely catches up with the asset quality decline we saw at the bank in 2015. 

Cheap but we await clarity 

In our view the 5% bonds are quite cheap, with yields of nearly 10%. However, many erstwhile bondholders of Novo are now nursing substantial losses from their senior exposures – we assume this could lead to a degree of reluctance to take exposure on the name, at least for a while, which could mean poor technicals for the bonds. We understand that Novo is now better capitalised. However, this capital could come under pressure in the coming quarters if more losses are recognised. Events of the past few weeks have highlighted Novo’s problems and the fact that the deadline for its sale is no longer subject to public disclosure suggests a drawn-out sales process, especially as Santander has just bought Banif, so arguably does not necessarily need to add to its Portuguese assets." - source Bank of America Merrill Lynch

No, these bonds are not "cheap" and should be avoided. 

In addition to senior bond holders nurturing their losses, as of the 1st of January, depositors are now "pari passu" with senior creditors and are indeed next in the line of fire should additional "hidden losses" materialize (they will). When it comes to recovery assumption, we read with interest CMA (now part of Capital IQ)'s take on the estimated recovery value. They estimate it to be at 1%. You read that correctly. So much for an assumed recovery value of 40% for senior CDS. 

We might be sounding yet again in 2016 as a broken record but, we told you before dear readers, in the next downturn in credit, recovery values, rest assured, will be much lower. That's a given.

Moving on to the second part of our parenthesis namely "shipping", and "cheap credit", we read with interest the FT's recent article on the subject from the 3rd of January entitled "Cash burning up for shipowners as finance runs dry":

"The challenges facing DryShips are among the most acute of those facing nearly all dry bulk shipping companies after a slump in earnings drove most owners’ revenues well below their operating costs. Owners are haemorrhaging cash. Owners of Capesize ships — the largest kind — currently bring in around $3,000 a day less than the $8,000 they cost to operate. The losses for the many owners who have to service debts secured against vessels are far higher.
Basil Karatzas, a New York-based corporate finance adviser, points out that in an industry that has already been making steady losses for 18 months, such substantial losses quickly mount up.
“If you have 10 ships and you’re losing $3,000 to $4,000 per day per ship, that’s, let’s say, $40,000 per day, times 30 in a month, times 12 in a year,” he says. “You are losing some very serious money.”
The question is how long dry bulk owners — and the private equity firms which have invested heavily in the companies — can survive the miserable market conditions.
Michael Bodouroglou, chief executive of Paragon Shipping, another New York-listed dry bulk shipowner, says that owners are looking to negotiate partial repayments, standstills and payment moratoriums with their banks.
“They’re trying to batten down the hatches, reduce costs as much as they can,” he says.
Yet the brief arrest — seizure over unpaid debts — in November in Singapore of the Sparta, a Capesize dry bulk carrier controlled by private equity firms, illustrates why shipowners are especially pessimistic about this slump. The vessel’s arrest, at the request of Deutsche Bank, has been widely interpreted as a sign that banks’ readiness to keep amending loan terms to allow owners to ride out the slump might be coming to an end." - source Financial Times

We chuckled because although some pundits have the memory span of a goldfish, we don't and we clearly remembered the warnings we gave back in December 2013 on the billions poured by Private Equity players in the shipping industry in our conversation "All that glitters ain't gold":

"There is a wave of private equity money flowing into shipping, which for us is yet another manifestation of "mis-allocation" and "Cantillon Effects".We have long argued that "Shipping is a leading credit indicator", as well as a "leading deflationary indicator". We have also discussed at length the link between consumer spending, housing, credit and shipping back in August 2012.
The latest manifestation of the consequences of "cheap credit" and record cash is leading outside players such as private equity investors to dip into the structured finance shipping business

Whereas traditional shipowners tend to hold vessels for at least 20 years, private equity groups hope to turn a quick profit by listing companies or selling their vessels once charter rates and ship valuations recover.

The issue of course for our private equity friends that they will soon discover is that if quick profits depend on valuations, they also depend on "recovery". We think they are bound for some disappointment as overcapacity is still plaguing the industry. " - Macronomics, December 2013

Given the "evident signs" of the recovery as displayed in the latest dismal print for the Baltic Dry Index to 467, a new record low (since its creation in 1985), one might wonder if indeed the PE players will make their "quick buck" on their "shipping" ventures. We don't think so:

- source Bloomberg.

Why we don't think so? Because "cheap credit" has led to "malinvestments" with PE pundits placing bets on a business they hardly know, and they have added overcapacity to overcapacity. Simply put, there is a "shipping" glut.

One can ascertained QEs and ZIRP have been deflationary by looking at the fall in the US of M2 "velocity":

-source CLSA

In similar fashion in the shipping industry, the "velocity" of ships aka their speed has been as well falling as reported by Bloomberg in their article entitled "Slowing Boat From China Provides Clue to Health of World Trade" from the 17th of December:

"Even with fuel at its cheapest price in almost a decade, the ships that carry goods around the world have been reducing speed in line with the slowdown in China, the biggest exporter.
Shipping companies have been “slow steaming” since the global financial crisis in 2008, as a way to save costs and keep as many ships active as possible. Vessels are now operating at an average of 9.69 knots, compared with 13.06 knots seven years ago, according to data compiled by Bloomberg. 

That means Nike sneakers and Barbie dolls made in China can now take two weeks to arrive in Los Angeles and a month to reach Le Havre, France -- a week longer than if the ships were moving at full speed. And there’s scope for ships to go even slower, according to A.P. Moeller-Maersk A/S.
“This is the new norm,” said Rahul Kapoor, a Singapore-based director at Drewry Maritime Services Pvt. “The overall speed of the industry has gone down and there’s no going back.”
In the boom years before the 2008 financial crisis, shipping lines expanded fleets and ran ships as fast as they could to keep up with the surging demand for goods manufactured half a world away. As demand dropped, the lines were left with too many vessels, and customers eager to reduce inventory, who would rather pay a lower rate to receive goods than guarantee quick delivery." - source Bloomberg

The new norm has been slower M2 velocity, slower growth, slower shipping. For the PE punters who have played the "recovery" game, they will have to face the "music". End of our parenthesis.

In this week's conversation, given the on-going "bloodbath" in the oil space, we will look at some of the implications. We will also look at the debilitating state of the credit markets once more.

Synopsis:

• US Energy sector (ETF XLE) versus oil price - Much more downside to come
• Credit - The credit cycle has turned and global financial conditions are tightening
• Final chart - Correlations getting higher in a macro-driven market

• US Energy sector (ETF XLE) versus oil price - Much more downside to come

While watching the continuous downward spiral of oil prices, what really struck us is the resilience from the US energy sector in the equity space versus the price of oil. We are convinced that there is more downside to come on the equity side - graph source Bloomberg from the 6th of January:

- graph source Bloomberg.

Whereas at the end of 2008, oil and XLE where trading roughly at the same levels, today it appears to us that ETF XLE as a proxy for the oil equity sector is still at least 30% above the lows of 2009 with an oil barrel at a much lower level. More pain to come, we think...

On a side note, should a rebound of oil happen at some point in 2016, one sure way of playing it would be through Fx via the Canadian Dollar (CAD) and/or the Norwegian Krona (NOK). 

Whereas, equities present more downside risk, credit has already significantly underperformed in recent month in fact as indicated by Barclays in their Oil and Gas monthly note from the 5th of January indicates the following:

"High Yield Energy Bonds Drop 23.6% in 2015 

The Barclays high yield energy index decreased 12.2% in December, the second largest monthly decline since 1991 (worst was October 2008 at -19.2%). This month’s drop leaves high yield energy down 23.6% for the year, underperforming the overall high yield market by 19.1% in 2015. In December, high yield energy credits moved lower because of a 12% decline in front month WTI and a collapse in natural gas prices to a low of $1.75/mmBtu on warm winter weather. By rating category, BB bonds returned -11.6%, B bonds returned -13.6%, and CCCs returned -12.9%. The independent index declined 18.3% in December, reflecting sharp decreases in the unsecured bonds of California Resources, Legacy Reserves, Vanguard Natural Resources, and Memorial Production Partners. Oilfield services dropped 8.4% on decreases in Seadrill, Atwood Oceanics, and CGG. New issue activity dried up completely in December, leaving year-to-date high yield energy issuance at $33bn, down from $55bn issued in 2014. 

Leverage Sensitivities and Breakevens at $40/bbl WTI 

We recently published an E&P update on leverage sensitivities and breakevens at $40/bbl WTI (report). In the report, we show sensitivities to debt/EBITDA in 2016 assuming $40/bbl WTI and $2.25/mmbtu Henry Hub, close to where strip prices are today. Two-thirds of the peer group has leverage north of 5.0x and five companies have leverage north of 10x (SandRidge, California Resources, MEG Energy, Denbury, and EXCO). However, hedging gains account for almost half of the peer group EBITDA in 2016, leaving unhedged debt/EBITDA at an average of 20x. Under this screen, 16 of the 27 companies we model have leverage north of 10x. Lowest leveraged companies under a $40/2.25 deck include Concho Resources (2.2x), Hilcorp Energy (3.2x), Baytex Energy (3.7x), and EP Energy (3.8x). Although not our base case, we note that Moody’s recently lowered its 2016 price forecast to $40/2.25, potentially foreshadowing additional ratings downgrades. 

Hedging Protection is Limited in 2017 

In our latest hedge study (report), we found that high yield E&P companies have protected 36% of 2016 oil and gas production and only 12% of 2017 production. While some high yield producers used the rally in oil to $60/bbl in May 2015 to fortify hedges, few producers have added to hedges in 4Q15 given the decline in strip prices. Almost half the peer group remains unhedged in 2017. As of 3Q15, we estimate that the peer group had a hedge book value of $12.6bn, with Antero Resources leading the peer group at $2.8bn. Top hedgers in 2016 and 2017 include Memorial Production Partners and Antero Resources, with an average 78% and 76% of 2016/17 production hedged, respectively. Credits with no hedges in place for 2016/17 include Goodrich Petroleum, MEG Energy, Midstates Petroleum, and Swift Energy. Energy Spreads Wider in DecemberIn December, energy spreads widened 292bp, to 1,296bp, compared with 58bp of widening for the overall market. December’s move left energy spreads trading 636bp wider than the high yield market, cheap compared with the 10-year average of 38bp through. The sharpest outperformance came in the oilfield services subsector, which widened as little as 5bp versus the high yield market." 

- source Barclays

Given the lack of hedges for some as reported by Barclays, should the "oil conundrum" continues, meaning lower for longer, no doubt to us that some players are going to face the default/restructuring music in 2016. 

This brings us to the second point of our conversation relating to credit and the current state of affairs.

• Credit - The credit cycle has turned and global financial conditions are tightening

While looking at the evolution of Global Fx reserves and their evolution since 2003 and in comparison with the recent periods, one being 2008 and the start of the rise in the cost of capital since mid 2014, if we use the evolution of these Global Fx reserves as a proxy for "global liquidity", one can ascertain that an expansion of these reserves indicates expansion, whereas a fall, indicates a global contraction - graph source Macronomics / Bloomberg:

One can notice from the above chart that during the financial crisis of 2008, between the 31st of July and the 31st of March 2009, Global Fx reserves tightened by 4.86% ($339 bn in 8 months, roughly $42bn per month). Since the 31st of July 2014 until the 31st of December 2015, Global Fx reserves have fallen by 6.39% ($768 bn in 17 months = roughly $45 bn per month). The on-going "liquidity" crisis, which is indeed a very big US dollar "margin call", is not only much bigger than in 2008, but, is lasting much more longer!

So even if some "pundits" tell you that at these levels High Yield is a "bargain", dear reader you should think again, although no doubt there are some interesting credit story out there (much more likely in Europe where leverage is lower), credit in the High Yield space continues to deteriorate in the US, hence our recommendation of moving higher in the rating spectrum for the last few months and favor Europe from a relative value perspective (better credit metrics).

When it comes to US High Yield we have to agree with Bank of America Merrill Lynch's take from their latest High Yield strategy chartbook from the 6th of January, "Winter is coming":

"2014 redux 

Last year was a lot like 2014, only amplified. Bigger oil slump, worsening fundamentals and gappier price movements in HY, more geopolitical turmoil, and higher EM volatility. These factors were already eroding investor sentiment within HY when the US economy also buckled, showing signs of a slowdown at the heels of an already faltering global economy. The news of liquidation of several HY funds due to mounting losses from distressed credits turned out to be the last straw, driving US HY to a return of -4.6%, its first negative annual return in a non-recessionary period. The only bright spot: mutual fund redemptions were comparatively much lesser last year (-$10bn) vs 2014 (-$21bn), which arguably gave US HY a level of support. Across asset classes, US HY was the second worst performer. Only EM equities underperformed more, while less risky securities such as Treasuries, Munis, and Mortgages were the best performers. Leveraged Loans outperformed HY returning -0.69bps despite the heavy outflows (-$25bn). 

Winter is coming 

It’s a binary world we live in: 2015 returns were heavily dragged down by commodities, outside of which the index was roughly flat (tab 1.01). Half the HY universe by market value today trades at 310bps, while the other half is at 1050bps. The distressed list has a disproportionate representation of commodities (33%). However, this dispersion doesn’t bode well for US HY, as our fears of valuations eventually catching up to fundamentals have not abated. Default and distress ratios are increasing, even outside commodities:

and while rating migrations ex-commodities have not reached 2011 levels, they are heading in the wrong direction. CCC issuance has plummeted (chart below) and the US-domiciled USD HY market has seen a net annual contraction for the first time since 2008:

We expect all of this to continue well into 2016, putting more pressure on non-commodity paper. In terms of opportunities, we think Fallen Angels will provide a unique one to HY investors in 2016 as demand for higher quality paper increases, especially in light of reduced primary market activity. We also like Leveraged Loans for many of the aforementioned reasons, and believe they will outperform bonds once again this year." - source Bank of America Merrill Lynch

2016, no doubt will be an interesting year for US High Yield particularly given the contagion risk, should market turmoils continue to run unabated as it seems to be the case so far. As displayed in Bank of America Merrill Lynch's data, not only leverage is higher than in 2008, but earnings have been falling faster in terms of EBITDA YoY changes:

Even Ex Energy earnings are falling...

We know nothing, Jon Snow 

Is it possible that the world remains in its current bifurcated state? Yes, if oil prices don’t bounce back and ex-commodity fundamentals don’t degenerate further. We can sympathize with the commodity bears given the levels of global oversupply, but corporate earnings power has been eroding for one too many quarters (charts above), and top cycle behavior has surfaced one too many times this past year for us to think that the corporate credit cycle has not turned. This is the foundation of our opinion that spreads have more room to widen from here, and a broader default cycle is looming, especially if outflows pick up. The more nuanced questions for 2016 and beyond however, include: what will be the direction of the global economy and how will that impact the business cycle back home? Will events in the HY market be enough to create another impediment for the US economy? Enough to turn the business cycle? The answers to these, we don’t know yet." - source Bank of America Merrill Lynch

So, don't push your luck dear reader, we might be breaking the fourth wall, but "overplaying" the "beta" game when the US credit cycle has turned is, we think asking for more trouble than "carry".

What we have long argued during the course of 2015 is that the more correlations were getting "positive" the higher the number of "sucker punches" aka large standard deviation moves. It is no surprise to us, that the year ended, for some bond holders of Novo Banco, with a bang as described earlier in our conversation. When it comes to 2016, given cross asset correlations have risen, we do expect even more "sucker punches" being delivered hence our mention of "risk reversal" opportunities in our last conversation of the year 2015. When it comes to a macro-driven market as "central banks' put" are losing their "magic", correlations unfortunately are still moving higher, which, we think is a sign of great instability brewing.

• Final chart - Correlations getting higher in a macro-driven market

We already discussed the rise in +/-4 standard deviations moves or more in various asset classes back in August 2015 in our conversation "Charts of the Day - Positive correlations and large Standard Deviation moves":

"Cushing's syndrome" aka central banking "overmedication" leads to a rise in "positive correlations. There is a growing systemic risk posed by rising "positive correlations. Since the GFC (Great Financial Crisis), correlations have been getting more positive which, is a cause for concern" - Macronomics, August 2015

The correlation between macro variables such as bund yields, FX and oil and equity market factors (Momentum, Value, Growth, Risk) is now higher than the correlation between macro variables and the market. There lies the crux of central banks interventions. There is now deeper inter-linkages in the macro economy as well as financial markets globally post crisis. This is confirmed by our chosen chart from Bank of America Merrill Lynch's Credit Derivatives Strategist note from the 6th of January entitled "When credit met technical analysis":

"Correlations getting higher in a macro-driven market 

The credit CDS index market is a macro risk gauge. Post the global financial crisis and the subsequent central bank interventions, we find that pairwise correlations among different credits are now at a different (higher) regime (chart 4). 

Macro shocks (oil, Greece, China, EM risks, Fed, ECB) dominate credit markets. We see little prospect of the current market set-up changing in view of ECB QE.

Pairwise correlations across different asset classes have also been trending higher. Chart 5 shows the cross-asset pairwise correlations for equity, credit, implied vol and FX markets both in Europe and the US. Note that recently cross-asset correlations were at the highest level in a decade."

- source Bank of America Merrill Lynch.

Sorry to be breaking again the fourth wall dear readers, but, in our book, rising cross asset correlations is not a good sign for a smooth ride, but, at least indicates, there is convexity and risk reversal opportunities out there...and volatility is therefore a buy...

"A heart well prepared for adversity in bad times hopes, and in good times fears for a change in fortune." - Horace

Stay tuned!

Credit - The European Polyneuropathy

"Politics is the art of looking for trouble, finding it everywhere, diagnosing it incorrectly and applying the wrong remedies." - Groucho Marx

Following up on our June conversation "Deus Deceptor" where we indicated our deep concerns relating to France's economic situation, we think it is time for us to revisit our negative stance on France. On a side note we share Charles Gave from Gavekal latest views on this very "French" subject. Given it is the 14th of July and France's national day, it is time, we think to look at the growing evidence of a slowdown and turmoil brewing in the quarters ahead.

In relation to our chosen title, with problems brewing at the core of Europe, in France in particular, and continuity in banking woes in the periphery, we thought our title should reflect the continuation of European woes using a medical analogy such as "Polyneuropathy" which is a damage or disease affecting peripheral nerves, which can be acute or chronic, but we ramble again...

In this week's conversation we will discuss France in general and peripheral European banking woes in particular. (we already discussed France in 2012 in our conversation "France's Grand Illusion").

As we posited back in June on our main subject France:

The story for  the remainder of 2014 in Europe is still France:

This is what we argued in January 2013 and this is still what we are arguing now. While French politicians are benefiting from low rates on French debt issuance courtesy of on-going Japanese support, but, on the economic data front France is increasingly showing signs of growing stress. 

France should be seen as the new barometer for Euro Risk. With Industrial Production at -3.7% (implying a negative GDP print, see below), the French government is seriously in denial when it comes to growth assumptions: 1% in 2014 (down from 1.2%) and 2% in 2015 is way over optimistic we think. 

A sobering fact, services in the French economy represent around 80% of the GDP versus 76% for the rest of the European union. the latest read at 48.2 for Services PMI is indicating contraction (the lowest level reached in February 2009  was at 40.2).

France appears to us as the weakest link if we take for example World Manufacturing PMI (50 = no change on prior month) as an illustration of the troubles brewing ahead as illustrated by our friends from Rcube Global Asset Management with France standing clearly at the bottom:

Another worrying trend illustrated by our friends at Rcube Global Asset Management lies in the growing financing gap between France versus Europe:

Or one could also look at the Corporate Financing Gap as a percentage of GDP in various European countries as displayed by Rcube Global Asset Management:

"Investment will keep plunging since French corporates' debt to value added ratio is so high. Furthermore, the French corporate financing gap is massive (as per above chart). It means that French companies' financing needs are extremely high, not only historically, but also compared to other countries in both Europe and the rest of the world. With France in such a difficult situation, the ECB will be under increased pressure to join the WE club

Corporate margins are thus decreasing, and are the weakest in Europe:

The high corporate debt to added value ratio suggest also that investment will soon turn negative

The French housing sector looks also mispriced compared to the rest of core EU:

- source Rcube Global Asset Management

We would like to add some more illustrations on France being the weakest link in Core Europe.

The recent evolutions of European house prices in some European countries seem to illustrate the start of a weakness in French real estate prices - graph source Bloomberg:

In blue: France

In red: United Kingdom

In yellow: Spain

Also, French industrial production (white line), French GDP (orange line) and French Services PMI (blue line, data available since 2006 only) tell the story on its own, we think - graph source Bloomberg:

An industrial production at -3.3% equals zero growth. With industrial production at -3.7% you can expect a negative GDP print for France.

As we argued back in June:

"If the Services PMI contracts, it doesn't bode well for France's unemployment levels. Services represent the number one employment sector in France (34% of total employment in 2010 according to INSEE).

Normally "entrepreneurial economy" can do that well as long when they are entrepreneurs in the picture but in the special case of France, given French civil servants have done their best to "kill" the entrepreneurs in France with great success, the economy will continue to linger.

A tight credit channel, high inventory levels vs. order books, depressed consumer sentiment and a forced fiscal tightening create a dangerous economic environment for an already weak economy."

We have also plotted France Consumer Confidence against GDP and the evolution of the French government debt to GDP (inverted) - graph source Bloomberg:

Deteriorating Debt to GDP level rising while French Consumer Confidence Indicator sliding, it doesn't bode well for growth and unemployment levels.

On numerous occasions we have discussed France and our growing concerns such as in our conversation "In the doldrums" where we touched the subject surrounding credit-less recoveries:

So for us, unless our  "Generous Gambler" aka Mario Draghi goes for the nuclear option, Quantitative Easing that is, and enters fully currency war to depreciate the value of the Euro, there won't be any such thing as a "credit-less" recovery in Europe and we remind ourselves from another conversation "Squaring the Circle" that in the end Germany could defect and refuse QE, the only option left on the table for our poker player at the ECB:

"The crux lies in the movement needed from "implicit" to "explicit" guarantees which would entail a significant increase in German's contingent liabilities. The delaying tactics so far played by Germany seems to validate our stance towards the potential defection of Germany at some point validating in effect the Nash equilibrium concept. We do not see it happening. The German Constitution is more than an "explicit guarantee" it is the "hardest explicit guarantee" between Germany and its citizens. It is hard coded. We have a hard time envisaging that this sacred principle could be broken for the sake of Europe." - Macronomics

The reasons for Germany's racing ahead have all been explained not only in the title of a previous post of ours "Winner-take-all" in February 2013 but also in the contents should you want to dig further on the subject:

"In similar fashion to the winner-take-all computational principle, when ones look at the growing divergence between France and Germany when it comes to PMI, in the pure classical form, it seems only the country with the highest activation stays active while all other see their growth prospects shut down" 

On the topic of France and the "overvalued"  Euro, French Industry Minister Arnaud Montebourg has most recently validated our Groucho Marx quote from above as indicated by his latest staunch attack on the ECB as reported by Mark Deen and Helene Fouquet on their July 10 article in Bloomberg entitled "France's Montebourg Hits Out at ECB in Campaign-Style Speech":

French Industry Minister Arnaud Montebourg hit out at the European Central Bank, calling on it to buy bonds and weaken the euro in order to boost growth.

“We have the most depressed region in the world with a currency that has appreciated the most globally and a European Central Bank that has not respected its mandate,” Montebourg told an audience of executives in Paris, citing the risk of deflation. “No one should leave the economy in the hands of moralists and accountants.”

The remarks were made against the backdrop of a screen reading “economic patriotism” and “fight for growth” in a packed and darkened room that resembled Montebourg’s campaign meetings in the Socialist primaries of 2011 in which he placed third. He pledged to run again after his defeat to Francois Hollande. France’s next presidential election is due in 2017.

With a French economy that has barely grown in two years and euro-area inflation that remains at less than half the ECB’s target level, Montebourg is taking aim at policies that he says are letting France and Europe behind the rest of the world. “Growth is a political problem that will be achieved through political action,” he said. “To allow unemployment to remain high is to help the National Front and destroy Europe.” The National Front, which led the European parliamentary elections in France, is an anti-euro, anti-immigration party. “I only have one enemy; it’s conformism,” Montebourg said. Conformism “is not a candidate, it is ruling” the country, he said.

Hollande’s approval rating at less than 20 percent is at a record low for a French president" - source Bloomberg

From our conversation  "Squaring the Circle" here is the simple answer to Arnaud Montebourg's euro concerns in a very self-explanatory diagram:

As pointed out previously by our friend Martin Sibileau (who used to blog on "A View From The Trenches"), here is a reminder from his work which we quoted in our conversation "The law of unintended consequences" in Macronomics on the 25th of January 2012:

"With a more expensive Euro, Germany is less able to export to sustain the rest of the Union and growth prospects wane. At the same time, the private sector of the EU looks for cheaper funding in the US dollar zone, which will eventually force the Fed to not be able to exit its loose monetary stance."  - Martin Sibileau

Europe's horrible circularity case - Martin Sibileau

By tying itself to Europe via swap lines, the FED has increased its credit risk and exposure to Europe:

"If the ECB does not embark in Quantitative Easing, the Fed will bear the burden, because the worse the private sector of the EU performs, the more dependent it will become of US dollar funding and the more coupled the United States will be to the EU." - Martin Sibileau

As a reminder from our previous conversation  "Squaring the Circle":

As a side note and in relation to the EU private sector seeking USD funding as displayed in Martin's chart above, in 2012 over a third of the US Investment Grade supply (net issuance in $430 billions) was from non-US issuers up from 25% in 2011. In 2013 we have seen about a third of the new issuance from non-domestic issuers (estimated net issuance for 2013 $400 billions).

Arguably in recent months, thanks to the US Fed tapering, the 1 year/1 year forwards for the US dollar and the Euro have increasingly diverged as displayed in the below Bloomberg chart:

But it looks to us that what the market is pricing indeed is a trigger at some point of QE in Europe because when it comes to the European Polyneuropathy, we think our friend's Martin Sibileau's above diagram depicts clearly the situation particularly when ones take into account that a huge amount of euro denominated assets remain to be sold. For instance, Société Générale reported on the 7th of July reported in a specific report on European banks entitled "Rise of the "zombie" assets", non-core banking represents a €1.5 trillion industry:

"Non-core banking: A €1.5trn industry 

European banks have become highly skilled in separating off the unwanted, the unsellable, and the unexplainable. Across our coverage, there is now €1.5trn of non-core banking balance sheet, consuming €80bn of tangible equity. These operations have had a major impact on profitability, dragging a full 4ppts off sector ROTE in 2013. Cleaning up the non-core will have a major bearing on when profitability will creep higher for the sector, in our view.

The major operations 

Five banks account for €1trn of the non-core balance sheet currently. This is where we believe restructuring the “bad parts” of the book has the most potential to drive profitability higher. These banks are UBS, Barclays, CBK, ING, and UCG. We are seeing progress, with ING recently completing the NN Group IPO and CBK disposing of a block of assets.

Raising the bid for “bad” assets 

We believe that the combination of ECB liquidity, lower funding costs, and improving confidence should raise the level of attractiveness for noncore operations. We have seen more robust financials IPO deal flow, and decent returns for distressed debt funds. This should help banks to run down the “bad”, and focus on the

“good”.

Further assets could become non-strategic 

We expect restructuring and consolidation to become a major theme for European banks after the AQR. This could bring further operations into question, particularly if the disposal process becomes easier (or even profitable). There is the potential for further restructuring at CS (CIB), DBK, and UCG (CEE)." - source Société Générale.

We can also point out that European banks need to sell another $795 billion worth of property assets as reported by Bloomberg by Neil Callanan and Patrick Gower on the 14th of July in their article entitled "European Banks needs $795 billion Problem Property Loan Solution":

"European banks and asset managers plan to sell or restructure 584 billion euros ($795 billion) of riskier real estate as they try to clean up their balance sheets, Cushman & Wakefield Inc. said.

The region’s lenders, asset managers and bad banks, such as Spain’s Sareb, sold 40.9 billion euros of loans tied to property in the first six months, 611 percent more than a year earlier, the New York-based broker said in a report today. Transactions including foreclosure sales will reach a record 60 billion euros this year, Cushman & Wakefield estimates.

Lenders such as Royal Bank of Scotland Plc are accelerating loan-portfolio sales as borrowing costs fall from a year ago and economic sentiment improves. Lone Star Funds and Cerberus Capital Management LP are among U.S. investors that are taking advantage as sellers opt to offer bigger groups of loans, making it more difficult for smaller firms to make purchases, Cushman & Wakefield said." - source Bloomberg

As we have argued in our conversation "Mutiny on the Euro Bounty" in April 2012:

"More downgrades mean more margin calls, more margin calls means more liquidation and more Euros being bought and dollars being sold, with a growing shortage of AAA assets, Europe is moving towards mutiny on the Euro Bounty ship..."

Unless of course Mario Draghi goes for the nuclear option, Quantitative Easing, that is.

And as indicated by Martin Sibileau from his note from the 17th of October "The EU must not recapitalize banks":

"The circular reasoning therefore resides in that the recapitalization of banks by their sovereigns increases the sovereign deficits, lowering the value of their liabilities, generating further losses to the same banks, which would again need more capital."

What would be a solution for the EU? We have repeatedly said it: Either full fiscal union or monetization of the sovereign debts. Anything in between is an intellectual exercise of dubious utility."

Of course it is! QE being the only card left but we have our doubt Germany will agree to play that card.

Moving on to the subject of lowering value of European peripheral banks liabilities generating further losses to same banks, needing more capital, the Banco Espirito Santo is a clear illustration once more of the above diagram. 

We already touched at length in our past credit conversations on the liability exercise management taken by many weaker peripheral banks in relation to raising capital to reach the 9% Core Tier 1 Capital target set up by the European Banking Association for June 2012 (see our conversations, "Peripheral Banks, Kneecap Recap", "Subordinated debt - Love me tender?" and "Goodwill Hunting Redux"):

"First bond tenders, then we will probably see debt to equity swaps for weaker peripheral banks with no access to term funding, leading to significant losses for subordinate bondholders as well as dilution for shareholders in the process." - Macronomics - 20th of November 2011.

In fact in our conversation "Peripheral Banks, Kneecap Recap", Banco Espirito Santo was prominently featured given October 18 2011 Banco Espirito Santo had announced a capital increase in effect via its bond tender which meant at the time a 83.5% dilution for shareholders. This was followed by another capital increase of 1 billion euro announced mid-April, to be completed by early May (see our conversation "All Quiet on the Western Front").

We argued at the time:

"We believe additional debt to equity swaps will have to happen for weaker peripheral banks, similar to what we witnessed with Banco Espirito Santo in October 2011, as well as for German bank Commerzbank ("Schedule Chicken" - 25th of February 2012)."

As our good credit friend said in November 2011: 
"The path will be very painful for both shareholders and bondholders."

The BES (Banco Espirito Santo) situation, is indeed a reflection of the European Polyneuropathy and is by no mean without "consequences" as shown in the above diagram from Martin Sibileau and the effect of "margin calls" given that Espirito Santo's board as not only appointed a new CEO but its largest shareholder was forced to sell a stake in the Portuguese bank to meet a margin call on loans as reported on the 14th of July in Bloomberg by Joao Lima: in his article entitled "Espirito Santo Owner Sells Stake to Meet Margin Call on Loan":

"Banco Espirito Santo SA’s largest shareholder was forced to sell a stake in the Portuguese bank to meet a margin call on a loan, heightening market concerns about the group’s finances. Espirito Santo Financial Group SA said today it sold 4.99 percent of the bank, reducing its holding to 20.1 percent, to meet the call on the loan taken out during the bank’s 1.04 billion-euro ($1.4 billion) rights offering in June. Banco Espirito Santo, Portugal’s second-biggest lender by market value, fell as much as 11.9 percent in Lisbon trading.

The sale came as Chief Executive Officer Ricardo Salgado, the 70-year-old great-grandson of the bank’s founder, was replaced by Vitor Bento after the Bank of Portugal urged the lender to speed up changes to its executive management. The Espirito Santo family’s hold on the bank slipped further as

Moreira Rato, 42, head of the government’s debt agency, was named as chief financial officer.

Banco Espirito Santo roiled global markets on July 10 after another parent company, Espirito Santo International SA, missed some payments on commercial paper. The stock plunged 36 percent last week and its credit rating was cut by Standard & Poor’s and Moody’s Investors Service on July 11. German Chancellor Angela Merkel said at the weekend the market turmoil caused by the Portuguese bank underlined the euro region’s fragility." - source Bloomberg.

Of course what has started in earnest is the application of "bail-in resolutions" of subordinated bondholders of weaker European financial institutions if one looks at the BES story - graph source Bloomberg:

"Banco Espirito Santo's June capital raise boosted its regulatory capital buffer to 2.1 billion euros ($2.9 billion), according to a press release from the bank. This buffer may be considerably smaller under the macroeconomic assumptions of the adverse scenario in the forthcoming ECB stress tests. Concerns will also mount on the application of bail-in rules for bank debt, suggesting that investors may re-examine reported capital and debt prices for periphery lenders." - source Bloomberg

It isn't only happening in Portugal if one follows the events surrounding Austrian Hypo Aldria issues given the first Chamber of Austria's parliament, the Nationalrat, has given the green light to wipe-out subordinated lenders despite the debt being guaranteed by the state of Carinthia. When the game changes, you can expect politicians to change the rules. This is what makes the difference between "implicit" guarantees from "explicit" guarantees (The German Constitution is more than an "explicit guarantee" as stated above). The rest of Hypo Aldria's network such as its Balkan banking network has been put on for sale. Yet another effect of "margin calls".

For now it seems subordinated bondholders and shareholders are getting the "kneecap" treatment to raise much needed capital with the surge of "margin calls". When one looks at the debt distribution of Banco Espirito Santo with a small cushion of perpetual subordinated debt, one can legitimately wonder if senior bondholders will not suffer at some point a similar "treatment" - graph source Bloomberg:

"The reopening of senior subordinated debt markets to many periphery banks and nations has alleviated funding and deposit-cost pressures since 2013, though recent discussions on bail-in rules and the ECB stress tests have damped investor appetite. Banco Espirito Santo's plummeting debt value and share price suggest the cost of refinancing its 2.76 billion euros ($3.76 billion) of senior subordinated notes maturing in 2015 will have risen, likely also driving up funding costs for peers." - source Bloomberg

It appears to us that the cost of maintaining "zombie" entities afloat is getting pricier by the day. On a final note given European Growth and Consumer Confidence go hand in hand, we think we have reached a plateau as per the below Bloomberg graph:

"If there must be trouble, let it be in my day, that my child may have peace." - Thomas Paine

Stay tuned!

Credit - Peripheral Banks, Kneecap Recap.

"That's the method: restructure the world we live in in some way, then see what happens." - Frederik Pohl

We already touched at length in our past credit conversations on the liability exercise management taken by many weaker peripheral banks in relation to raising capital to reach the 9% Core Tier 1 Capital target set up by the European Banking Association for June 2012 (see our conversations "Subordinated debt - Love me tender?" and "Goodwill Hunting Redux"):
"First bond tenders, then we will probably see debt to equity swaps for weaker peripheral banks with no access to term funding, leading to significant losses for subordinate bondholders as well as dilution for shareholders in the process." - Macronomics - 20th of November 2011.

In 2011 as well as very recently, bond tenders have been a recurring theme in the credit space.
As a reminder on bond tenders:
Debt tender offer:
"When a firm retires all or a portion of its debt securities by making an offer to its debt holders to repurchase a predetermined number of bonds at a specified price and during a set period of time. Firms may use a debt tender offer as a mechanism for capital restructuring or refinancing."

We believe additional debt to equity swaps will have to happen for weaker peripheral banks, similar to what we witnessed with Banco Espirito Santo in October 2011, as well as for German bank Commerzbank ("Schedule Chicken" - 25th of February 2012).

We wrote in October 2011 relating to bond tenders and the move towards debt to equity swap:
"We expected others to follow suit and given the difficulty for the weaker players in the peripheral space to access capital at a reasonable rate, as well as needing to boost their core Tier 1 capital base, it was of no surprise to see Portuguese bank Banco Espirito Santo following French bank BPCE in tendering some of its subordinated debt on the 18th of October, but this time around, we have a debt to equity swap."

Banco Espirito Santo stock price evolution - source Bloomberg:

Survival of the fittest...On October 18 Banco Espirito Santo announced a capital increase in effect via its bond tender which meant at the time a 83.5% dilution for shareholders. This was followed by another capital increase of 1 billion euro announced mid-April, to be completed by early May (see our conversation "All Quiet on the Western Front").

According to recent note by CreditSights (Euro Financial Movers - Walking on Eggshells - 15th of April 2012):

"Unnamed major shareholders have committed to subscribe just over half of the amount (50.63%), and the remainder is underwritten by a syndicate of banks. On an FY11 pro-forma basis, this will take BES's Core Tier 1 ratio to over 10.5% and allow it to meet the EBA's end-June requirement of 9 Core Tier 1. The consolidated EBA shortfall for BES's parent, Espirito Santo Financial Group, is €1,597 mln."

All clear for Banco Espirito Santo, but definitely not for its Portuguese peer, Banco Comercial Português (BCP):
"Banco Comercial Português has yet to give details of how it will cover a shortfall of €2.1 bln identified by the EBA. There is a €12 bln government recapitalisation facility available to Portuguese banks under the bailout package." - CreditSights - Euro Bank Capital Model FY11: We Are The 9%, 2nd of May 2012.

When it comes to BCP, a debt to equity swap could be a solution if we take a look at the stock price - source Bloomberg:

Not pretty to say the least...

When it comes to Greek banks, they are in the front line (see our post "Liquidity? The IV Greek Credit Therapy").
Lack of capital follows the results of the Greek PSI, leaving them with dire needs as indicated by Marcus Bensasson, Maria Petrakis and Natalie Weeks
in their article on Bloomberg on the 20th of April - Top Greek Banks Post $37 Billion in Losses on Debt Restructuring:

Greece’s four biggest banks reported a combined loss of 27.9 billion euros ($36.9 billion) for last year after participating in the country’s debt exchange, the largest sovereign restructuring in history.

The four, including National Bank of Greece, EFG Eurobank Ergasias SA, Alpha Bank SA and Piraeus Bank SA, said they wrote down about 25 billion euros in the combined value of their Greek government bond holdings.

Prime Minister Lucas Papademos is trying to finalize a plan to recapitalize Greek banks, which wrote down more than half the face value of their government bonds and posted an increase in bad loan ratios after five years of recession. Greece’s bank-recapitalization body yesterday got 25 billion euros in a first tranche of funds, or half the total assigned for the purpose, as part of a second bailout by the European Union and International Monetary Fund."

And the Bloomberg article to add:
"National Bank, the nation’s biggest lender, had a net loss of 12.3 billion euros for 2011 after a 406 million-euro profit a year earlier, the Athens-based lender said in a statement today. The average estimate from three analysts surveyed by Bloomberg News was for a loss of 9.29 billion euros.
EFG Eurobank Ergasias SA, the second-biggest lender, had a 5.51 billion-euro loss after a 68 million-euro profit in 2010 and Alpha Bank SA, the third biggest, lost 3.81 billion euros after an 86 million-euro profit in 2010. Piraeus Bank SA, the fourth largest, had a 6.3 billion-euro loss.
National Bank took 10.8 billion euros of post-tax impairments on Greek government bond holdings after writing down their value by 75 percent. Eurobank wrote down 4.6 billion euros of government bonds after taxes and Alpha Bank 3.8 billion euros. Piraeus wrote down 5.1 billion euros."
Another nice job done by "analysts"...

So, no surprise for us to hear recently about the bond tender exercise being followed by Greek bank Alpha Group Limited:

"Alpha Group Limited (the "Offeror"), a member of the Alpha Bank A.E. group (the "Group) announced today tender offers (the "Offers")for Any and All of two Tier One Securities, one Upper Tier II Security and two Lower Tier II Securities ("Securities") with an aggregate face amount outstanding of approximately EUR 985mm."

For similar purposes as all other bond tenders we have seen so far, namely to boost Core Tier 1 Capital:

"The purpose of the Offers is to generate Core Tier One capital for the Group and to strengthen the quality of its capital base. If completed, the Offers would generate a gain for the Group and thereby increase Core Tier One capital. The Offers also provide investors with an opportunity to monetise their investments at the relevant Purchase Price."

Opportunity for the bondholders to "get to the exit while they can" and take their losses...

Alpha Bank SA offered to buy back a nominal 1.58 billion euros of outstanding securities in a bid to boost its capital. If completed, this offer would generate a gain for the group’s Core Tier 1 capital, which the bank reported at 3 percent for 2011 according to Bloomberg, when the target is 9% for June 2012 for European banks as required by the European Banking Association plan but, for Greek Banks, they have until September 2012 for achieving the 9% required. In 2011, during the last EBA stress tests for European banks, 30 billion was assigned to Greece's banking system out of the 115 billion original EU-wide bailout plan.

Alpha Bank stock price - 24th of April 2012 - source Bloomberg:

ASE - Greek stock index evolution - 24th of April - source Bloomberg:

From our conversation "Equities, there's life (and value) after default!", we know that the outstanding weight of "Financials" in the ASE Greek index, is roughly around 21.70%. We wrote at the time:

"Given the outstanding weight of financials in the Greek ASE index and knowing their current Greek debt holdings, Alpha Bank, National Bank of Greece, EFG Eurobank and Piraeus bank respective equity is probably worth zero. It should in theory equate to an additional write down of at least 16.74% of the ASE Greek index."

The same Bloomberg article also indicated the following in relation to Greek Banks Core Tier 1 ratios:

"National Bank, Eurobank and Piraeus Bank did not disclose what their Core Tier 1 ratios would be without support from the Hellenic Financial Stability Fund, the state recapitalization body. National Bank reported a Core Tier 1 capital ratio of 6.3 percent after an injection of 6.9 billion euros from the HFSF.

Agricultural Bank of Greece SA and TT Hellenic Postbank SA, two state controlled lenders, were granted extensions and will report earnings by May 31, the banks said in exchange filings.

The bank recapitalization plan includes incentives for private investment such as rights for shareholders to purchase the government’s stake and safeguards for buyers of convertible bonds, according an IMF report released March 16. The HFSF will continue to hold voting rights in the event of strategic decisions related to the banks to avert the risk of asset stripping by investment funds, according to the report."

When it comes to rising pressure in relation to the need for fresh capital, it could not be more truer given the significant rise in non-performing loans as reported by Bloomberg on the 4th of May:
"Greek banks collectively saw the level of non-performing loans rise to 17 percent of their total loan portfolio at the end of the first quarter from 14.7 percent at the end of the third quarter of 2011, Kathimerini reported.
Bad mortgages climbed to 16 percent of the total, or 12.5 billion euros ($16.4 billion), from 14 percent, the Athens-based newspaper said today, citing Greek banking officials. Bad consumer loans increased to 29 percent, or 9.6 billion euros, from 26.4 percent and bad business loans nose to 15 percent, or 18 billion euros, from 13 percent, it said." - source Bloomberg, Paul Tugwell.

So what is the plan for Greek banks? So far no plan...

"Greece’s government has yet to settle on the final terms to recapitalise the nation’s banks after a 100 billion-euro writedown of sovereign debt, said an official at the Hellenic Financial Stability Fund.

Agreement still needs to be reached on a number of different issues and this may not occur before May 6 elections, the official, who declined to be named, said after a meeting in Athens between Panayotis Thomopoulos, the head of the fund, and Prime Minister Lucas Papademos.

The official said he hoped the full 50 billion euros allocated to the fund wouldn’t need to be used and that an initial 18 billion euros had been provided to the four biggest Greek banks in the form of commitments." - source Bloomberg, Eleni Chrepa - 24th of April 2012.

The HFSF (Hellenic Financial Stability Facility) total 13 billion, 1.3 billion for Alpha Bank, 4.2 billion for EFG Eurobank, 6.9 billion for National Bank of Greece (who had the largest holding of Greek bonds on its balance sheet). According to CrediSights, these facilities allow the banks to report total capital ratios of at least 8% under the current EU Capital Adequacy Directive, which in turn makes them "officially solvent" and therefore "eligible" for ECB funding...
Looking at the outcome from the Greek elections on the 6th of May with the losses of pro-austerity parties, it spells trouble ahead for Greece and its ailing financial system, resorting to desperation tactics like
-suing Reuters News agency:
"Greek bank sues Reuters over investigative report" - Reuters, 2nd of May.

"One of Greece's biggest banks has filed a lawsuit against Reuters claiming 50 million euros ($66 million) in damages over a story that exposed a series of property deals between the bank and companies run by the family of its executive chairman."

-making desperate appeal for fresh private equity to avoid total shareholder equity wipeout:

"Apostolos Tamvakakis, chief executive of National Bank of Greece, launched a last-ditch attempt to fend off a wipeout of private shareholder control, widely considered inevitable across the banking system as lenders struggle to absorb losses on their government bond holdings and other bad debts." - Financial Times, Patrick Jenkins, Banking editor - Greek banks appeal for fresh equity.

We believe debt to equity swaps will likely happen for weaker banks as well as full nationalisation for some.
As our good credit friend said in November 2011: 
"The path will be very painful for both shareholders and bondholders."
30% of National Bank of Greece shares are in the hands of foreign investors such as Bank of New York Mellon, BlackRock, Allianz, Pictet, Prudential Financial, Aviva, AXA, HSBC and BBVA, according to Bloomberg data.

"When liberty is taken away by force it can be restored by force. When it is relinquished voluntarily by default it can never be recovered." - Dorothy Thompson

Stay Tuned!

Credit - All Quiet on the Western Front

"We have lost all sense of other considerations, because they are artificial. Only the facts are real and important to us. And good boots are hard to come by."
- Erich Maria Remarque, All Quiet On The Western Front, Ch. 2

"The phrase "all quiet on the western front" has become a colloquial expression meaning stagnation, or lack of visible change, in any context." - source Wikipedia

All Quiet On The Western Front is a novel by Erich Maria Remarque. The book was published in 1929, and it was the author's way of coming to terms with the war. We thought this time around, a reference to this classic would be appropriate looking at recent events in the European space, because, as the colloquial expression goes, when it comes to the European situation, the lack of visible change, with the economic stagnation clearly moving towards recession, we think the title of the post is spot on. The book by Erich Maria Remarque has also a history with censorship as the book was banned in Germany.

As our good credit friend put it recently:

"The recent German industrial production posted a decrease of 1.3% against a decline of 0.5% expected.

Growth should remain non-existent in Europe, which should put more pressure on the sovereign credits (Spain first).

When somebody has too much debt and cannot reimburse it, how do you bail him out? Obviously by restructuring his debts, which imply losses for his creditors.

But when one lends him more money in order for him to pay back what he owes, he is not bailing him out but rather pushing him in a bigger hole! The game until now has been to "print" more money and to add more debt on the shoulders on the indebted ones, to gain some time in the hope that growth will resume and reduce de facto the weight of the existing debt burden and the additional new debt issued to support the initial debt troubles.

This is a big misunderstanding of debt dynamics and its effects on the economy. When debt becomes too big, which it is now the case in many parts of Europe, the servicing drains all the available cash flows and reduces the growth potential."

So yes "All Quiet" on the Western European Economic Growth front - US PMI versus Europe PMI - source Bloomberg

In Nomura recent "10 things we did not know" published on the 5th of April, they indicated:
"Maybe looking to Asia for the epicenter of the next risk-off move is not the right idea..."

"Did you know that in the latest PMI releases, emerging markets are outperforming G10 economies, while European PMIs are still below 50 and Asia is the main driver of improvement?"

"All Quiet" on the Western European Unemployment  front - source Bloomberg:

European unemployment increased to the highest in more than 14 years in February, the highest level since June 1997 before the euro was introduced...Around 17.3 million people are now unemployed in Europe.

"All Quiet" on the Western European Peripheral banking front - source Bloomberg:

"Banco Espirito Santo SA (BES), Portugal’s biggest publicly traded bank, dropped to a record low in Lisbon trading after announcing a plan to sell as much as 1.01 billion euros ($1.3 billion) of new stock.
The shares fell as much as 27 percent, or 31.2 euro cents, to 85.5 cents and were down 15 percent at 9:21 a.m. in the Portuguese capital, giving the lender a market value of 1.44 billion euros.
Espirito Santo, based in Lisbon, said yesterday after the close of trading that it will offer 2.56 billion shares to existing shareholders at a subscription price of 39.5 cents each. The stock price closed yesterday at 1.167 euros.
The rights offer will allow the bank to buy out its partner in an insurance unit and to increase its core Tier 1 capital ratio to 10.75 percent from 9.21 percent. Espirito Santo said it also agreed to buy 50 percent of the BES Vida insurance unit from Credit Agricole SA (ACA) for 225 million euros." - source Bloomberg

In our conversation relating to bond tenders "Subordinated debt - Love me tender?", back in October Banco Espirito Santo had announced a capital increase in effect via a bond tender. Banco Espirito Santo was trading at 1.51 euros per share and it meant that the debt to equity swap initiated in October lead to a dilution of 83.5% of the shareholders. Banco Espirito Santo total market cap was approximately euro 1,743 million in October last year.
At the time we argued:
"The need to raise capital will be acute for peripheral countries due to issue of circularity we previously discussed. Given we know by now that access to capital is only open to better quality issuers in the financial space, the current level of financial spreads for weaker issuers, make it impossible for them to access funding at reasonable rates. Survival of the fittest is still the name of the game with the liquidity support provided by the ECB for these weaker players."

"All Quiet" on the Western European Housing front - source Bloomberg:

The pain in Spain: Housing in the doldrums, but it isn't only Spanish people suffering the fall in real estate prices, according to Bloomberg's article from Sharon Smyth from the 14th of February, immigrants lured in the Spanish housing Boom are losing most in the imploding Spanish Market (European subprime crisis in the making?):
Immigrants Lured in Boom Lose Most in Imploding Spanish Market: Mortgages -Unwanted Assets:

"Financial institutions have foreclosed on 328,720 homes since 2007, according to Plataforma de los Afectados por la Hipoteca, a group known as PAH that campaigns against evictions. Repossessed houses in Spain are valued at 43 percent less on average than the appraisals on the mortgages, Fitch Ratings said in a Dec. 15 report.

Lenders, whose bad loans as a proportion of total lending jumped to a 17-year high of 7.42 percent in October, have also acquired properties from developers to cancel debt and may have as many as 900,000 finished, unfinished and foreclosed homes on their books, according to Borja Mateo, author of “The Truth About the Spanish Real Estate Market.”"

We agree with Bloomberg's editors take that Spain is entering a dangerous deflation trap, given the very significant fiscal tightening requested by the European leaders to achieve an overly ambitious target of 3% in 2013:
Spain Not Greece Is the Real Test for the European Union - Bloomberg
"The problem is not that Spain’s new austerity plan is too timid. Just the opposite: Under EU orders, Spain is promising what might be the tightest fiscal squeeze that it or any other European economy has ever faced. The new plan calls for the budget deficit to fall from 8.5 percent of gross domestic product to 5.3 percent this year. Since the economy is already shrinking, this requires a discretionary fiscal tightening of roughly 4 percent of GDP -- with the unemployment rate already standing at about 23 percent."

In their latest European Credit Tracker UBS argues the following in relation to the impact the LTRO has had on the Spanish banking system. We have long argued it amounted to "Money for Nothing":

"Collectively these sum to €233 billion, which we believe is likely to have been more than the increase in ECB drawings. However, banks have shrunk their Spanish loan books by €54 billion in the period, reducing funding needs though obviously contributing to the country’s economic contraction. Therefore there is likely to have been less left of the funds for lending or further government bond purchases, in our view."

- source UBS

In their note, UBS also indicated as well credit trends in February 2012:
"The latest data release by the ECB showed a m/m decline of €19.4bn in total credit in Feb 2012. All major economies except Germany showed a m/m increase in total credit (€2.8bn). Once again m/m credit declined the most in Spain (-€9.1bn), declining 13 times in the past 14 months."

- source UBS

We hate sounding like a broken record but, no credit, no loan growth, no loan growth, no economic growth and no reduction of aforementioned budget deficits:
"So austerity measures in conjunction with loan book contractions will lead unfortunately to a credit crunch in peripheral countries, seriously putting in jeopardy their economic growth plan and deficit reduction plans."- "Subordinated debt - Love me tender?" - Macronomics, October 2011

"In Spain the annual growth rate of loans to household adjusted for sales and securitization is -2.7% as against the unadjusted growth rate of -2.0%." - source UBS

In August 2011 we wrote in our conversation "It's the liquidity stupid...and why it matters again...":
"Lack of funding means that bank will have no choice but to shrink their loan books. If it happens, you will have another credit crunch in weaker European economies, meaning a huge drag on their economic recovery and therefore major challenges for our already struggling politicians.

As a reminder, 50% of banks earnings for average commercial banks come from the loan book: no funding, no loan; no loan, no growth; and; no growth means no earnings."

Hence our BIG reservations in relation to the unachievable Spanish deficit target of 3% in 2013. (which interestingly gives us our title for our upcoming credit post - "A Deficit Target too far", in reference to 1977's movie "A Bridge Too Far" relating to the overly ambitious Operation Market Garden, but we ramble again...).

"I rambled all the time. I was just like that, like a rollin' stone."
Muddy Waters

Stay Tuned!