Equities, there's life (and value) after default! - Russia, Argentina, Iceland, examples for Greece.

"Hope is definitely not the same thing as optimism. It is not the conviction that something will turn out well, but the certainty that something makes sense, regardless of how it turns out."
Vaclav Havel

As a follow up to our recent credit conversations, it appears to us interesting this time around to focus on Greek equities, given Argentina and Russia are living proof there is life (and value!) after default. Having a brief overview to what happened to the Russian and Argentinian equity indices, could be used as long term proxy to what could happen to Greece's equity index ASE, following a default and a return to a "new" drachma.

Before we look at the possible medium to long term outcome, it is important, we think, to look at the evolution of the Greek index over time and its current composition.

ASE Greek index members as of the 24th of February 2012 - source Bloomberg:

The outstanding weight of "Financials" in the ASE Greek index, 21.70%:

Greek debt ownership as of 24th of February 2012 - source Bloomberg:

We know from our conversation "Schedule Chicken":
"The immediate write-down of the remaining 53.5% of principal on Greek debt equates to a net present value loss of over 70%. Given Greek banks have the largest exposure to their domestic debt, you can expect a lot more of additional pain for the likes of National Bank of Greece. Taking a 75% coverage on their Greek bond portfolio (12.9 billion euros as of June 2011) implies an additional pre-tax charge of just over 8 billion euros, or around 6.5 billion euros allowing for a tax credit according to CreditSights. National Bank of Greece's core tier one capital was only 6.3 billion euros in September 2011. The 30 billion euros capital shortfall derived from the EBA (European Banking Association) exercise in 2011, was based on 50% private sector value loss. An impairment of 70 to 75% loss would equate to an additional 45 billion euros worth of aggregate recapitalisation for the Greek banking system."

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.

ASE Index evolution from 1990 to May 1993 - source Bloomberg:

The ASE index is currently trading around May 1993 levels.

ASE Index evolution from 1994 to 2003 - source Bloomberg:

Since 1999, it has all been downhill from then.

ASE index year to date, picture taken on the 24th of February 2012, back to 1993 levels- source Bloomberg:

While discussing the subject with our friends at Rcube Global macro research, we thought it would be interesting to compare the evolution of the Greek Index relative to the GDP - Source Bloomberg:

Indeed, the ASE index matched the GDP level in November 2007, and today only represents 12.5% of GDP.

Argentina's Merval index in dollar terms, yes, there is life after default (2002) and value as well! Monthly evolution from March 1992 to March 2012 - source Bloomberg:

Argentina's Merval index in dollar terms relative to the local currency ARS from 1997 to December 2011 - source Bloomberg:

Russia equity index evolution from 1995 to March 2012 following the default in 1998 in USD terms:

From a low of 37.74 on the 30th of October 1998 to a high of 2498.10 on the 30th of May 2008.

Life and value after default, you have to be patient.

Greece has already reached its "Minsky" moment.
"A Minsky moment is the point in a credit cycle or business cycle when investors have cash flow problems due to spiraling debt they have incurred in order to finance speculative investments. At this point, a major selloff begins due to the fact that no counterparty can be found to bid at the high asking prices previously quoted, leading to a sudden and precipitous collapse in market clearing asset prices and a sharp drop in market liquidity." - source Wikipedia.

By preventing default, creative destruction cannot happen in true Schumpeter fashion. Minsky was a disciple of Schumpeter.

The work of Joseph Schumpeter, Hyman Minsky and Irving Fisher (see our post "AAA ratings - 10 little indians...and debt deflation - why Irving Fisher is right") should not be ignored, as highlighted by the recent work of Steve Keen - “A much more nebulous conception”

Schumpeter:
"There is another method of obtaining money...the creation of purchasing power by banks...It is always a question, not of transforming purchasing power which already exists in someone’s possession, but of the creation of new purchasing power out of nothing...which is added to the existing circulation."
(Joseph Alois Schumpeter, 1934, The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest and the Business Cycle).

Minsky:
"If income is to grow, the financial markets, where the various plans to save and invest are reconciled, must generate an aggregate demand that, aside from brief intervals, is ever rising. For real aggregate demand to be increasing, it is necessary that current spending plans, summed over all sectors, be greater than current received income and that some market technique exist by which aggregate spending in excess of aggregate anticipated income can be financed. It follows that over a period during which economic growth takes place, at least some sectors finance a part of their spending by emitting debt or selling assets."
(Hyman P. Minsky, 1982, Can “It” Happen Again? : Essays on Instability and Finance. Armonk, N.Y.: M.E. Sharpe).

On a final note, it is not a surprise for us to see a strong recovery for Iceland ("Iceland - The Great Debt Escape", August 2011), which was recently upgraded to BBB- by ratings agency Fitch.
Iceland in recovery mode Iceland stock market from March 2009 to March 2012 - source Trading Economics:

Iceland 5 year  Sovereign CDS versus Ireland 5 year Sovereign CDS, 24th of February 2012 - source Bloomberg:

Since the start of the European debt crisis of 2010 and the significant widening in CDS peripheral spreads, Iceland has seen its CDS spread significantly tighten versus Ireland, 241 bps versus 571 bps, 330 bps apart as of the 24th of February. Iceland Sovereign 5 year CDS has tightened by 1230 bps since its 2008 demise.

In August 2011 we wrote:
"While Iceland is back from the brink by deciding not to save its banks, Ireland is still trying to recover from that ill-fated decision of bailing out its entire banking sector."

"I am not a pessimist; to perceive evil where it exists is, in my opinion, a form of optimism."
Roberto Rossellini

Stay tuned!

Credit jitters - Market Update on Ireland - the game is changing

Big sell-off in late afternoon on Irish Banks senior debt thanks to the comments from the Finance Minister:

"Finance Minister Michael Noonan has said Ireland will go to our European partners with a plan to impose significant losses on the senior bondholders in Anglo Irish Bank and Irish Nationwide Building Society.

He was speaking in Washington after meeting the IMF and the US Treasury Secretary Timothy Geithner.

Mr Noonan said the Government will seek to impose losses on senior bondholders in Anglo Irish Bank. He said that around €3.5 billion in senior unsecured, unguaranteed bonds issued by Anglo Irish Bank and Irish Nationwide Building Society should have losses imposed on them.

Mr Noonan said he had discussed this with the IMF, who supported the strategy.

The Finance Minister said these banks are no longer normal entities and are more like warehouses for bad debts. In that context, he would be going to our European partners to propose significant cuts in the money to be paid to the bondholders.

Mr Noonan also revealed that he had asked Mr Geithner to support Ireland's effort to cut the interest rate paid on the European parts of our bailout programme. He said Mr Geithner agreed to support Ireland's effort and would speak to the French in connection with this."

Senior bonds for both entities got whacked after these comments:

Source: the market...

Anglo Irish has 3.1 billion euros in unsecured senior bonds not covered by a state guarantee.
Irish Nationwide Building Society, (which by the way is being merged with Anglo Irish), has 601 million euros worth in unsecured senior bonds not covered by the state guarantee as well.

Both have already cost 35 billions euros worth of bailout funds courtesy of the Irish taxpayer.

Ireland seeks to go after Anglo's senior bondholders - Reuters
From Reuters:
"No euro zone government has imposed losses on senior bank bonds, which are ranked on a par with depositors, but senior unsecured debt amounting to 320 million euros was subjected to a 41.2 percent haircut when Danish bank Amagerbanken failed in February."

The game is changing.

Meanwhile all is not well at Bank of Ireland either:

Shareholder Anger Erupts At Bank Of Ireland Meeting - WSJ

"The bank, which is already 36% owned by the Irish government after receiving EUR3.5 billion in bailout aid, needs EUR5.2 billion more in capital and new buffer reserves, mainly to make good lending excesses during the boom years."

I wrote in December 2010 in Europe - The end of the Halcyon days that:
"Either bondholders of Irish banks debt agree take a haircut on both the sub and senior debt, or the Irish Goverment will have to cut more spending, which means more austerity for the Irish people."

We have reach that point.

Portugal and Ireland drifting wider still:

Source CMA

French banks as well today have been put under pressure by the rating agencies due to their exposure to Greek debt.
Moody's Investors Service placed the three largest French banks on review for a possible downgrade.
The three banks are:
BNP Paribas, down 2.55%.
Credit Agricole, down 2.49%.
Societe Generale, down 2.48%

French banks CDS wider on Moody's rating threat:

Source CMA


EUR/USD is down 2% today on these news to around 1.4165:

Itraxx 5 Year Financial Senior CDS was wider today by 16 bps at around 178 bps whereas the Itraxx 5 Financial Sub widened by 26 bps, market being around 304-310, 6 bps bid-offer spread...ouch.


"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."
Henry Ford

Vae Victis - the acceleration in the European turmoil and markets review

April has made a turn for the worse. While we have witnessed a flight to safety with further tightening of German 10 year government debt, for peripheral countries, things have turned sour.

2 Year Greek debt ended April at an incredible 26% yield with 5 year CDS reaching 1350 bps, equating to a cumulated probability of default of around 68%. On the 7th of April, Portugal threw in the towel and asked for help, meanwhile ECB's concerns on inflation was marked by a raised to 1.25% of its key rate.

Greece Sovereign CDS reaching stratospheric levels in April:

Greece is facing a wall of maturity between 2012 and 2015, bond redemptions represent 112 billion Euros. No matter what Georges Papaconstantinou says, a restructuring cannot be avoided. It is already priced in the market. Greece has around 330 billion euros in outstanding bonds.
Greece debt distribution:

Greek bonds deterioration accelerated in April:

Real Estate Market in Greece is falling:

Non-performing loans in Greece surging:

A debt restructuring for Greece, three options:
-Reduction in the coupon
-Extension of the maturity
-Both extension of maturity and extension of the coupon

European Union finance officials, had an unannounced meeting May 6 in Luxembourg. They are trying the help to ease the debt burden. It would be better to deal with the restructuring now than later. The pain inflicted will be larger down the line. They have to stop kicking the can down the road and bite the bullet, time is running out fast.
Luxembourg Prime Minister Jean-Claude Juncker is still trying to avoid it: “We were excluding the restructuring option which is discussed heavily in certain quarters of the financial markets,”. The consequences of the ongoing turmoil affected the Euro which dropped like a stone from 1.49 to 1.43 in a couple of days:

There is a wall of refinancing for Greece but the elephant in the room for Greece in particular, and for some other countries in general, is the issue of unfunded liabilities (Ponzi scheme?):

A clearer picture on unfunded liabilities for Greece, a gigantic problem:

Portugal Sovereign CDS has reached the level of Ireland, the widening has been significant since February:

Following issues relating to the Peripherals in trouble, namely Spain, Portugal and Ireland, Spain, Italy and Belgium widen on Friday according to CMA:

But concerns on Spanish banks in the CDS market have come down since February:

Spain is the last line of defense. The revised ESM in March, in conjunction with the EFSF is enough to ensure proper liquidity issues for Greece, Portugal and Ireland until 2013, but cannot be viewed as resolving the outstanding solvency issues.
Spanish GDP grew 0.2 percent in the 1st quarter, matching 4th Quarter 2010. GDP expanded 0.7 percent from a year earlier according to the Bank of Spain on the 6th of May.
IMF forecast a GDP expansion of 0.8% in 2011, while the central bank forecast the economy will expand 1.5%.
Consumer spending is still weak with record unemployment. Spain has one of the highest private-debt burdens in the euro region. 97 percent of mortgages have variable rates, which mean that further rate hikes from the ECB could potentially have a serious impact on an already fragile economy.

As a reminder (from my post Europe - The end of the Halcyon days, this is the German banks exposure to peripheral debt:

And another reminder, Countries cross border exposure:

Consequences of European turmoil, U.S. two-year note yields dropped on Friday to the lowest level since March. Flight to quality or is it?

In the US:
U.S. added 244,000 jobs according to the NFP published on Friday but unemployment was up, reaching 9% from 8.8 percent in March, the first increase since November.
US GDP growth slowed to 1.8 per cent in the first quarter of 2011: Slowdown, headwinds and headaches...
ISM’s index of non-manufacturing companies fell heavily to 52.8 in April, the lowest since August 2010, from 57.3 in March.
Retail sales rose by 0.6 percent in April, up from 0.4 percent.
Overall we have very mixed data.

Risk of a double dip?
We have a double dip in housing in the US.
Housing is still very weak and still falling in the US. U.S. home prices back down to their 2009 lows according to the S&P Case-Shiller Index for February.
Sales of new single-family houses in March 2011 were at a seasonally adjusted annual rate of 300,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development. This is 11.1 percent (+/-21.7%)* above the revised February rate of 270,000, but is 21.9 percent (+/- 10.3%) below the March 2010 estimate of 384,000. Still very weak.
We have an acceleration in distressed sales in Q1 in the US, as well as falling prices. Economic 101: Higher percentage of distress sales = downward pressure on house prices.

For more on the US weekly summary, the always excellent CalculatedRisk blog:

Summary for Week ending May 6th

Positive news worth tracking for the US:
"New Households Form at Fastest Rate Since ’07 in Resurgent U.S."according to this Bloomberg article.

This is important to track as it will generate positive contribution to GDP.

Good thing about recession (or is it?):
Divorce rates are falling. From the same Bloomberg article:
"The number of divorces dropped to 6.8 per 1,000 people in 2009 from 7.4 in 2006 prior to the recession, according to the National Center for Health Statistics in Hyattsville, Maryland."

Fed and BOE kept rates at the same level in April. The Fed has kept its target rate for overnight lending between banks at zero to 0.25 percent since December 2008.

Commodities update: Pop goes the bubble in conjunction with Glencore's IPO? How ironic.

Silver in a tailspin after an unsound meteoric rise:

Tip for silver or possibly the trade of the year?
How to make 6.3 millions USD profit since April 11 on Silver? Start with a 1 million USD bet:
Would The Silver Medalist Please Stand Up?
"Market watchers want the anonymous April silver bear in listed options to take a bow. The unknown investor's mid-April $1M bet that iShares Silver Trust (SLV) would hit $25 or lower before mid-July is worth more than $7M after this week's plunge. Not just the drop in price, but huge jump in price volatility, has goosed has enriched this trader's options position. "The investor didn't get this trade right. He or she got it spectacularly right."
source Dow Jones.

The big positive for GDP: The drop in Oil prices
2008 Redux?

The WTI contract lost 15.4 per cent from Monday's peak near 115 USD, a level last seen in early September 2008.

Higher resource prices act as a tax and sap consumer disposable income.
Oil prices receding are indeed good news. Commodity prices have been driven to excess by speculators, the correction so far is not due to faltering demand in emerging markets.

What happened to curb the ongoing speculation:
CME futures exchange has increased margin requirements sharply, rapidly and several times. Traders had the choice of putting up more cash for their trades or cash in, taking their profits.

This is a very important lesson to be learned: This shows what can be done by the authorities to pop bubbles.
We all know the common know adage: "Don't fight the Fed". For commodities, here is a new one, don't fight the authorities.

For Silver the bubble has clearly pupped, oil has well, for the moment.

"The fall in the price of oil and commodities is good to take for all reasons, certainly for inflation, not only immediately but with the danger of second-round (effects) in the medium run," ECB President Jean-Claude Trichet declared.

"It is also good to take in terms of consolidating the recovery because any increase in the price of oil and commodities has an inflationary impact and a depressive impact (on growth)," he added.

A welcome respite in the surge in commodities.
We shall see in the coming months if it is just a big pull back like we had in 2008. Let's see how long this one lasts!

Ireland in the need of a lucky Shamrock...

Anglo Irish Bank is definitely a black hole for the Irish Government.

I wrote about zombie banks and zombie hotels in Ireland recently.

It looks the zombie bank is decaying more rapidly than expected, pushing the Irish budget in very dangerous waters.

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/8033960/Ireland-faces-34bn-bill-for-Anglo-Irish-Bank-forced-to-redraft-budget.html

"Ireland faces €34bn bill for Anglo Irish Bank, forced to redraft budget."

"The country has so far ploughed €29.3bn into Anglo Irish Bank, and the country's Central Bank said on Thursday the lender could need an additional $5bn under a worst-case scenario."

In the previous post about Zombie banking in Ireland I indicated the below:

"Total support for Anglo Irish amounts to 22.9 billions Euros so far and will cost 25 billions to the Irish taxpayers according to its CEO Mr Aynsley but S&P put the figure at 35 billions Euros."

Looks like the CEO was a bit too optimistic on his forecast...

But there is also Allied Irish bank and Irish Nationwide in the need of additional support...

"Allied Irish Banks will need to raise an additional €3bn by the end of the year. Support for Irish Nationwide will rise to €5.4bn from €2.7 bn. The €40bn bailout of the banks has cost Irish taxpayers the equivalent of 20pc of GDP."

This is an horror blockbuster movie in the making...When fiction goes beyond reality.

The worst case scenario according to the Guardian is summarised below. I'll go for the worst case given the previous excellent forecast from Anglo Irish's CEO thank you very much.

Murphy's law: 'Everything that can possibly go wrong will go wrong'."

Murphy Junior's law: "My father is too optimistic."

http://www.guardian.co.uk/business/2010/sep/30/irish-bank-bailout-costs-breakdown

Bailout breakdown:

"Anglo Irish Bank €29.3bn (including €22.9bn already committed by government) – could rise to €34.3bn in worst-case scenario
Allied Irish Banks up to €6.5bn (including €3.5bn already invested by government)

Bank of Ireland €3.5bn (it says it does not need any more capital from government)

Irish Nationwide Building Society €5.4bn (including €2.7bn already committed by government)

Educational Building Society €350m (further requirement for €440m and possibly more expected to come from its new buyer)

Total €45bn, rising to €50bn in worst-case scenario."

By the way NAMA is also taking over 3.35 Billions GBP worth of Ulster loans...

I started drafting this post on the 30th of September, and given I was travelling, a lot of news have been unravelling during my trip:

Allied Irish was nationalised and on the 6th of October, Fitch downgraded Ireland from AA- to A+...

http://online.wsj.com/article/SB10001424052748703735804575535651744296256.html

"The ratings could be downgraded further if the economy stagnates and broad-based political support for and implementation of budgetary consolidation weakens," Fitch said.

Get ready for some more downgrades...



http://www.ft.com/cms/s/0/d7bcff58-cf1c-11df-9be2-00144feab49a.html?ftcamp=Popu_story3/NL/UKOctober2010/Vanilla_irehng/0/

"Unlike Greece this spring, it has cash. It has already secured all its borrowing needs until mid-2011. “We’re absolutely funded until next July and we’re not obliged to go to the markets,” says Mr Lenihan. Ireland’s average cost of borrowing this year, moreover, is the same as last year at 4.7 per cent – not the 6.9 per cent reflected by the spike in spreads last week, at which, obviously, no borrowing was taking place."

Well, Mr Lenihan, given the obvious downgrades Ireland just been hit with, get ready for a surprise in mid 2011 when you come back to the market for more funding...

Anglo Irish is a monster that should had never been let to grow unchecked. Where were the regulators and why the government did not step in earlier?

The Financial Times article quoted above goes through the rise and fall of Anglo Irish:

"Anglo Irish Bank, the bank responsible for 90 per cent of Ireland’s €40bn taxpayer-funded bail-out, was originally involved in financing the import of fridges and washing machines for Irish housewives after the trade reforms of the 1960s, writes John Murray Brown."

"By 2007 the bank was half the size of Bank of Ireland and, on a market capitalisation basis, it was briefly Ireland’s largest bank in July that year, valued at a scarcely credible €13.3bn."

"But, like the property market, Anglo was heading for a fall. Essentially a monoline business, it was concentrated in land and development property lending. It is thought 10 developers accounted for half its loan book."

What a sick joke...10 developers = 50% of the loan book. Have they heard about risk concentration?

"It was only later in January 2009 that the government was forced to nationalise Anglo, after another run on deposits following revelations that Sean FitzPatrick, its powerful chairman and former chief executive, had not disclosed to auditors that at the end of 2008 he had €87m of personal borrowings from the bank."

Conflict of interest for Sean FitzPatrick?

I would like to advise Mr Abramovich to get a new team of portfolio managers for his investment vehicle Milhouse.

"Roman Abramovich’s investment vehicle is threatening to sue Ireland over its treatment of junior debtholders in this week’s bail-out of several Irish banks."

http://www.ft.com/cms/s/0/be0897ce-cda6-11df-9c82-00144feab49a.html

Very amusing indeed...

"The bond held by Millhouse was yesterday trading at about 62 per cent of face value, implying that holders do not think they are likely to be paid back in full. But it is above similar bonds from Anglo, which are trading at between 20 and 30 per cent.

Subordinated bonds pay higher yields than senior debt to reflect the fact that they are more likely to take losses if the issuer gets into difficulties."

There are some greedy people, they are some stupid people, and they are also some stupid greedy people.
There is no free-lunch when you buy risky sub debt...If his team had done a proper risk assesment of their investment (which they are supposedly paid for...), they would have seen that the government guarantee's expiry was running out on the Thursday 30th of September.

There should not be bailout for stupid investors....

My very first post on this blog in 2009 was about Dubai and the stupidity of some "portfolio managers":

"Perception of the credit worthiness on Dubai World was all about implicit guarantees from the Dubai Government. Investors invested believing in implicit support. Probably the same investors who believed in the sacro-saint AAA rating issued on dodgy CDOs and CLOs as a gauge of credit quality of the underlying pool of assets in the structure. Probably the same investors who believed that a callable LT2 bond will be called on the call date by the issuer, because it has been market practice in the past. How suprised they were when Deutsche Bank, nearly a year ago in December 2008, decided not to redeem some sub debt on the date of the call! Investors trade sub debt based on the date of the call to calculate the price of the bond."

For Dubai World Debt, if the credit analyst or portfolio managers had done "properly" their job in assessing the risk, they would have read in the bond offering documents that there never was no implicit guarantee from Dubai government and not even a legal guarantee. They just assumed it.

Same applies for the "talented" portfolio managers running Milhouse, they got attracted by the yield of the risky sub debt and believed in an implicit guarantee which had an expiry date which everyone knew about, except them maybe...

My message to them: get real. My message to Mr Abramovich, I know some very talented portfolio managers out there, out of job and very cheap. It might be time for Milhouse to upgrade...

Ireland 5 years CDS is trading wider todat at 451.78 bps, Cumulative Probability of Default is at 32.50 % (Source Credit Market Analysis Ltd).



Anglo Irish Debt Swaps May Pay Out on Burden Sharing:

http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=aJ6LEncQh.2w

"There are 674 credit-default swap contracts insuring a net $390 million of Anglo Irish’s senior and subordinated debt, according to Depository Trust & Clearing Corp. data. It now costs 5.2 million euros in advance and 500,000 euros annually to insure 10 million euros of the bank’s junior bonds for five years, implying a more than 82 percent probability of default, according to data provider CMA."

Bye bye Anglo Irish...The game is over.

"The Anglo Irish rescue package will cost every man, woman and child in Ireland as much as 7,500 euros."

The Irish Taxpayers must be thrilled.

And Abramovich should start writing down some of his investment in risky Irish Bank sub debt:

"Lenihan said that, while senior bondholders will be paid in full under the bailout, legislation is being prepared to “address the issue” of junior bondholders taking a loss on their investments."

"After the U.K. government nationalized Bradford & Bingley Plc in 2008, it changed the rules to allow the troubled lender to defer interest on its subordinated debt without that legally constituting a default. Its failure to pay still triggered credit-swaps protecting all the Bingley, England-based bank’s bonds in July."

There will be a restructuring on the debt and a CDS event.

I don't think the current Irish Government will get re-elected...