Markets update - Credit - Goodwill Hunting Redux

"Errors of opinion may be tolerated where reason is left free to combat it."
Thomas Jefferson

Dwindling liquidity has been leading to significant market volatility, in most asset classes. Credit hasn't been spared and while CDS single names and indices are still experiencing important intraday spread movements, Cash bonds in the European markets are not spared either. Thursday and Friday were very interesting, namely because we saw an important acceleration of bond tenders in the financial space (triggered by the Santander bond tender we mentioned in our "Mind the Gap" on the 15th), something we have been expecting to happen from our many previous conversations("Subordinated debt - Love me tender", "Crash Test for Dummies"). In fact in a more recent conversation ("Complacency") we argued:

"Something has gotta give" - subordinated bondholders or shareholders, or both.

Well, it looks like subordinated bondholders are the first in line, and are going to give some back, to help European banks shore up their Core Tier 1 capital as they rebuild/shrink their balance sheet in order to meet the June 2012 European Banking Association threshold of a core Tier 1 of 9%.

In today's long credit conversation, as we go through the latest price action and bond tenders, we will revisit Goodwill impairment, which is definitely back on the agenda, a subject which we already approached in December 2010 ("Goodwill Hunting - The rise in Goodwill impairments on Banks Balance Sheet").

But first it is time for a market overview:

The Credit Indices Itraxx overview - Source Bloomberg:

So, three weeks after a supposedly historic agreement on the 26th of October,  we are still near records levels CDS indices wise (Financial indices, and SOVx - European CDS sovereign risk gauge). Itraxx Crossover 5 year CDS index (High Yield gauge) is at around 760 bps, while Investment Grade Europe represented by Itraxx Europe Main 5 year CDS index is around 188 bps.

Itraxx credit indices for Financial Senior 5 year CDS and Financial Subordinate 5 year CDS, remain stubbornly high (300 bps and 538 bps respectively, close to September records level) - source Bloomberg:

Some respite in the Sovereign European CDS Space - source CMA:


In relation to the bond picture, contagion has been spreading to core Europe last week with some respite as well for France and Austria, as well as a pause in the flight to quality with German 10 year yield increasing, but for how long?- source Bloomberg:

In relation to our CPDO/EFSF relationship with French 10 year Government bond and German 10 year bund yields, while French OAT yields have receded, EFSF bonds yields are still rising towards 4%, currently at 3.87% - source Bloomberg:

Another indicator worth tracking is the relationship between 10 year Swedish Government yields and German 10 year Government yields, which, so far have been moving in lockstep, but recently spread between both are moving towards their highest level of 25 bps (contagion to Germany? Not yet) - source Bloomberg:

As far as the liquidity picture is concern, it is clearly deteriorating. The new reserve period for deposits at the ECB which started on the 9th of November will last this time around 35 days:

In relation to the liquidity update, please find an additional point made by Goldman Sachs Sales/Trading teams on EUR FRA/OIS Basis:

"FRA/OIS Basis shows the difference between the overnight and the 3 month interbank borrowing rate and shows the confidence of banks to lend to each other. Current levels show that the confidence is very low as the premium to borrow long term is very high despite recent unlimited LTRO (long term refinancing operation) by the ECB."

In our last conversation on the 15th, we discussed the latest bond tender by Santander in Europe, which in fact triggered a flurry of bond tenders in the market according to Bloomberg article by Esteban Duarte on the 18th of November:

"Societe Generale SA and Banco Santander SA are among banks offering to buy back or exchange part of about $30 billion of junior debt issuance to boost capital and raise money as borrowing costs rise.
The bond tenders that started in Europe this week allow the banks to repurchase subordinated notes at a discount, booking a capital gain, or swap the securities to raise senior debt. Others pursuing the strategy include BNP Paribas SA, France’s biggest bank, and Northern Rock Asset Management Plc, the so- called bad bank spun off from the lender being purchased by Richard Branson’s Virgin Money Holdings U.K."

And the article to detail the flurry of bonds tenders we have been expecting for a while:

"SocGen offered to repurchase as much as 900 million euros of a total $8.2 billion of Tier 1 notes today, at prices starting at 56 percent of face value. Banco Santander, the biggest Spanish lender, asked holders of 6.8 billion euros of subordinated bonds to swap their securities for new senior notes on Nov. 15.
BNP Paribas, France’s largest bank, offered to exchange or repurchase part of about $10 billion of subordinated bond issuance yesterday for as little as 72.5 cents on the dollar, according to a series of statements. SNS Bank BV of the Netherlands announced a tender of Lower Tier 2 notes yesterday, while nationalized U.K. bank Bradford and Bingley Plc is also tendering for debt."

Love me tender?

We already know the liquidity is poor and we discussed previously how issuance under current market conditions is difficult to say the least, it isn't really a surprise to read in the same article:

"“Banks are currently taking advantage of poor liquidity in the market to buy back, or more often exchange, redundant capital instruments on very attractive terms for the issuer,” said Mark Harmer, an analyst at ING Groep NV in Amsterdam.
“It’s definitely a growing trend, especially where traditional access to senior funding channels is limited.”

Given we already know 2012 is going to be a significant year for term issuance for banks ("Mind the Gap..."), you can expect more of the same. 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.

It was interesting to see as well Deustche Bank increasing the size of a previous 2 year Senior Unsecured FRN (Floating Rate Note) issue by 250 million euros (previous issue size was 1.75 billion Euros, maturity October 2013), at 3month Euribor +75bps.

So yes there is worrying liquidity and funding stress in the European financial system, and according to Bloomberg Liz Capo and Gavin Finch in their article - "Bank Stress Gauges Show Pain Lasting Through ’11: Credit Markets":

"Spanish banks borrowings from the ECB rose 10 percent to 76 billion euros in October, the highest level in more than a year, while Italian firms reliance increased 6 percent to 111.3 billion euros."

And added:

"Italian banks may be forced to increase their reliance on emergency funding from the ECB as their liquidity levels have fallen to levels not seen since January 2009 after the value of the government securities they held tumbled, the central bank wrote in its Financial Stability Report published on Nov. 3.
The ECB announced in October it would reintroduce year-long loans for the regions’ banks as the sovereign debt crisis threatens to lock local money markets. It had previously coordinated with the Federal Reserve to provide euro-area banks with dollars. The central bank offered 12-month loans last month and will off a 13-month loan in December."

According to Radi Khasawneh in the article published on the 18th of November - Italian Banks May Need $8.2 Billion as Government Bonds Slump:

"Italy’s five biggest banks, including Intesa Sanpaolo SpA, may need to raise a combined 6.1 billion euros ($8.2 billion) of additional capital as the Italian government bonds they own deteriorate in value.
Two-year Italian debt, which the banks valued at 97 cents on the euro or better on Sept. 30, trades at about 92.7 cents.
That suggests Intesa, UniCredit SpA, Unione di Banche Italiani
SCPA, Banco Popolare and Monte Dei Paschi di Siena SpA need more capital, today’s Bloomberg Risk newsletter reports."

Given the issue of circularity discussed in our previous post, the more pressure we get on Italian sovereign spreads, the more capital, they will need to raise.

All of the above lead us to revisit a subject we approached already in December 2010 as indicated above, and my good credit friend to comment:

"In term of credit market, following Santander, SNS bank and BNP…Here comes SocGen announcing a tender offer on $1.2 billion of subordinated debt! Hooray! The haircut is 44 %, the tender price is 56%…. I guess the bank will do better next time, if there is a “next time” and will offer tender prices below 50 %.

Tip for “banks’ friends”: First came dividends cuts, then bonds haircuts. Next, we will see some massive write-off (Goodwill ?). UniCredit started, others will follow. The path will be very painful for both shareholders and bondholders."

Goodwill:
"Goodwill is an accounting convention that represents the amount paid for an acquisition over and above its book value. Under the accounting rules European banks use, the International Financial Reporting Standards, companies have to write down goodwill on their balance sheets if the underlying assets have permanently deteriorated in value."

Indeed, it will be painful. According to Liam Vaughan and Charles Penty, "EU Banks Face $270 Billion Goodwill Hangover for Past Purchases":

"European banks may have to write down some of the $270 billion of goodwill from their purchases in the run up to the financial crisis before they can sell assets, or new stock, to bolster capital.
UniCredit SpA, Italy’s biggest lender, this week opted to take an 8.7 billion-euro ($10 billion) impairment charge following a series of acquisitions at home and in eastern Europe. Other European banks are yet to follow, analysts said.
Credit Agricole SA, Banco Santander SA and Intesa Sanpaolo SA are among European banks with the most goodwill remaining on their balance sheets, according to data compiled by Bloomberg.
“Banks that paid a premium for businesses when the outlook was better will need to reassess the goodwill on their balance sheets,” said Andrew Spooner, an accounting partner at Deloitte LLP in London. “Previous acquisitions which are exposed to peripheral Europe are most vulnerable to impairments.”

We already discussed Austria's exposure to Eastern Europe ("Long hope - Short faith"). Erste Bank in fact, wrote down the value of its Hungarian and Romanian units by a combined 939 million euros in October.

Liam Vaughan and Charles Penty also commented in their article:

"UniCredit wrote down goodwill on assets in its home market, eastern Europe and former Soviet Union countries in its third-quarter earnings report this week, though it didn’t tie the charge to any specific deals among the $60 billion of acquisitions it made from 2005 to 2008."

In December 2010 ("Goodwill Hunting - The rise in Goodwill impairments on Banks Balance Sheet"), this is what we discussed as a reminder:

"When a bank acquires another one, goodwill as intangible asset goes on its balance sheet. When a medium bank acquires a smaller one, goodwill is created onto the balance sheet. But, when the medium bank is acquired by a larger one, there is a compounding effect given that the larger bank will also create some more goodwill of its own and therefore inflates its balance sheet.
As the process goes on and on, for banks on the acquisition war path, you find more and more goodwill making up the capital."

On June 29, 2001, The Financial Accounting Standards Board (FASB) unanimously voted in favor of Statement 142, Goodwill and Other Intangible Assets. Prior to this statement, goodwill was amortized over its useful life not to exceed forty years. Under FASB 142, goodwill will still be recognized as an asset, however, amortization of goodwill will no longer be permitted. Instead, goodwill and other intangibles will be subjected to an annual test for impairment of value. This will not only affect goodwill arising from acquisitions completed after the effective date, but will also affect any unamortized balance of goodwill."

We also indicated at the time:

"Looking at non-cash intangible assets (i.e., goodwill) can be a good indicator and used as a proxy to determine the health of banks.

The significance of the write-downs on Goodwill is often presaged as rough waters ahead. These losses often take a real bite out of corporate earnings. It is therefore very important to track the level of these write-downs to gauge the risk in earnings reported for banks."

And we concluded back then:

"Large Goodwill Impairments increase the debt to equity ratio.
It is therefore paramount to track goodwill impairments in relation to future banks earnings."

For more on the subject, Bloomberg Columnist Jonathan Weil had an interesting column relating to Goodwill impairments - "UniCredit Bombshell Shouldn’t Be the Last One".

Time has come once again to become "Goodwill hunters" in relation to bank earnings!

On a final note I leave you with Bloomberg Chart of the Day from the 18th of November relating to debt collection in Spain (the hunt for bad loans...):

"The CHART OF THE DAY shows the proportion of staff in Bankia SA, Banco Popular Espanol SA and the Spanish unit of Banco Bilbao Vizcaya Argentaria SA working in the banks’ collections teams. The second panel shows the amount of bad loans being chased by each of the collection units’ employees. “I’d say it’s more crucial than ever for the Spanish banks to show they’re trying as hard as they can to recover bad loans,” John Raymond, a southern European banking analyst at CreditSights Inc. in London, said in a phone interview.
As the country’s property crash and a stalling economy drive up defaults, the bad-loans ratio of Spanish banks rose to 7.16 percent in September, the highest level since November 1994, according to Bank of Spain data."

"I believe that banking institutions are more dangerous to our liberties than standing armies."
Thomas Jefferson

Stay tuned!

Markets update - Credit - Mind the Gap...

"There is a time to take counsel of your fears, and there is a time to never listen to any fear."
George S. Patton

Following our previous post relating to the "Italian Peregrine Soliton", it was interesting to read about Grant Williams comparable analogy relating to the freak wave that sank the Big Fitz in John Mauldin's latest Outside the Box, with our Italian "rogue wave-soliton".
In fact we could go further into the analogy relating to the "three sisters" rogue waves that sank SS Edmund Fitzgerald - Big Fitz, given we are witnessing three sisters rogue waves in our European crisis, namely:
Wave number 1 - Financial crisis
Wave number 2 - Sovereign crisis
Wave number 3 - Currency crisis
In relation to our previous post, the Peregrine soliton, being an analytic solution to the nonlinear Schrödinger equation (which was proposed by Howell Peregrine in 1983), it is "an attractive hypothesis to explain the formation of those waves which have a high amplitude and may appear from nowhere and disappear without a trace" - source Wikipedia.

But I ramble once again, and given poor liquidity, and recent price action it is time for another credit overview. In the process we will review the unfolding scenarios we have been discussing in recent months, namely liquidity issues leading to a financial crisis, contagion to Emerging Markets (Eastern Europe in the front line), bond tenders and more. So, yet another long conversation.

The Credit Indices Itraxx overview - Source Bloomberg:

We still have high volatility, with Itraxx Credit Indices experiencing big price movements, in an environment where liquidity is definitely dwindling.
A market maker in fact commented on today's price action:

"One of the worst days of the year in terms of flow biz if it can be considered that anymore. A difficult environment to trade with clients mostly on the sidelines watching the Hollywood horror flick become a reality as SOV cash got decimated, particularly in the front end. Underperformers today the Italian/French/Iberian names which closely followed the Sovs. Even names like RBS & Lloyds SUB which are considered the "hairier" of the UK names failed to widen as much."

European Financials wider:

Italian Financials 5 year CDS were wider by around 70 bps on the day with Senior Financials CDS trading from 495 bps up to 760, depending on the Italian bank.
Spanish Financials 5 year Senior CDS were wider as well (BBVA +90 bps, Santander +80 bps).
French Senior Financial 5 year CDS also took a severe beating with Credit Agricole wider by 55 bps to around 570 bps, Societe Generale wider by 30 bps to around 370 on the 5 year Senior 5 year point and BNP Paribas wider by 55 bps to around 300 bps on 5 year Senior.

The issue of circularity for financial spreads and correlation with sovereign spreads is alive and well:


In relation to the bond picture, contagion has been spreading to core Europe with France drifting wider still - source Bloomberg:

And, if we only look at core Europe, it seems Austria is effectively now drifting in tandem with France towards 4% yield with core Europe now only made of Netherlands, Finland and Germany - source Bloomberg:

We previously discussed Austria's banking issues relating to Eastern Europe exposure, namely Hungary in our previous post "Long hope - Short faith" and why I was closely monitoring the situation.
On the 11th of October I indicated:

"I am expecting Austria's sovereign CDS to trade wider than France at some point, given the exposure of Austria's banking sector to Eastern Europe and in particular Hungary where a new law has been passed allowing foreign currency mortgages borrowers in Hungary to repay their loans at a fixed exchange rate with large discounts to current FX market rates, which will trigger losses to Austrian Banks."

In relation to the Hungarian situation we discussed a month ago:

"Under the new legislation borrowers can repay their mortgage in a single instalment at a HUF/CHF rate of 180 or a HUF/EUR rate of 250. Current FX rates are around 239 for HUF/CHF and HUF/EUR is around 297, a 25% and 16% discount according to CreditSights."

HUF/EUR rate was 297 at the time, and is now much higher (315), meaning losses for European banks and in particular the likes of Austrian Erste Bank exposed to these mortgages will be significantly higher - source Bloomberg:

In our conversation "Leda and the (Greek) Swan and why Europe matters more for Emerging Markets", we indicated that "European banks’ lending to Hungary amounted to more than 70 percent of that country’s GDP, according to estimates by Barclays Capital based on BIS data. Lending to Poland reached 40 percent of GDP, and that to Brazil and Mexico was equal to about 20 percent of their economies." Following up on our Austrian conversation, it is interesting to see it followed up by Eric Frey from the Financial Times - "Austria moves to defend top rating" as well as by Geoffrey T. Smith from the Wall Street Journal - "Austria Has a Déjà Vu Moment":

"Austrian banks’ foreign assets at the end of 2010 were 137% of domestic GDP, according to Raiffeisen Zentralbank.

Data published in the European Banking Authority’s stress tests showed a combined exposure of around €210 billion to central and Eastern Europe, although that excludes loans made to the region through Unicredit SpA’s local subsidiary, Bank Austria.

Those assets have generated stellar growth over the last 15 years for the banks, but a small domestic economy can hardly underwrite them if things turn sour.

By contrast, the Bank for International Settlements suggests that Austria’s exposure to the five most indebted countries of the euro zone is relatively modest, with even Italy accounting for no more than €18 billion.

As a result, the biggest threat to Austrian banks is still what it was in 2009—wholesale capital flight from emerging Europe."

In relation to the deleveraging risks for Emerging Markets coming from European banks we discussed on the 2nd of November, Morgan Stanley in a report published on the 13th of November entitled "What Are the Risks of €1.5-2.5tr Deleveraging?" had to say the following:

"Contagion to EM is a key risk, although our concerns centre on CEE/SEE rather than Asia. 12 of the 16 major European banks in CEE (~78% of these banking assets) either had a capital shortfall in the recent 9% test or are TARP recipients. We expect the greatest strain in SEE. In contrast, while we see growing risks to global trade finance – French banks looking to reduce dollar dependency represent 25% of outstandings – our assessment is that in a more orderly scenario this will be passed to local banks or globals (HSBC, STAN, C, JPM) although clear risks if disorderly."

The Morgan Stanley report was also quoted in relation to the heightened possibility of a Credit Crunch in Europe by Lisa Pollack in ft.com/Alphaville in "It’s a capital ratio of two halves" who has been following up on our post "Leda and the Greek Swan" (published by Pragmatic Capitalism courtesy of Cullen Roche) in relation to the impact of deleveraging.

The truth is that the liquidity picture is not improving, it is sliding still - source Bloomberg:

We have discussed at length upcoming term funding issues (in our post "Complacency"), and why liquidity issues always trigger financial crisis.

Morgan Stanley in their report commented:

"Bank funding roll is considerable – €1.7tr of debt due to refi for the major banks in the next three years. We think a step change in the pricing and availability of senior unsecured debt as well as dollar funding challenge many businesses. Whilst intense ECB support has helped, lack of a temporary bank debt guarantee plan is unfortunate, we feel.

Funding is no small issue. European banks lost $100bn of CP over the summer alone – making some major European banks more dependent on the ECB for funding. Given the dollar is the functional currency of global trade, this will impact European banks’ ability to be global lenders."

In relation to the issue of circularity, Morgan Stanley has come up with an interesting illustration - Source Morgan Stanley Research:

In fact financial stocks performance has been deeply correlated to Sovereign risk according to Morgan Stanley research:

We already know how difficult term funding issuance has been in recent months and is an ongoing problem moving towards 2012 - source Morgan Stanley Research:

Itraxx Financial Senior 5 year CDS index evolution versus Itraxx Financial Subordinate 5 year CDS index - source Bloomberg:

Moving back towards the widest levels reached in September.

Here is Morgan Stanley's take on the subject:

"• Term markets have stuttered throughout the summer, unable to regain the momentum of H1; there have been ~30 covered bond deals and a handful of senior unsecured since late August.
• However, our 2011 funding survey shows that European banks are now 100% funded on average, having frontloaded their issuance inH1.
• Notably, the Nordics and BNP have prefunded some of 2012.
• But given the sector has ~€700bn of rolling debt in 2012, we see headwinds if funding conditions persist, resulting in a pick-up in the velocity of delevering and further compression of NII (Net Issuance)."

In that context, it is of no surprise to see a rise in bond tenders (on that subject please refer to our post "Subordinated debt - Love me tender?") , in fact Spanish bank Santander just announced a bond tender on 9 callable LT2 bonds:

Santander Issuances, S.A. €1,500,000,000 - Exchange ratio 90.50 (%)
ISIN - XS0291652203 - Callable Subordinated Step-Up Floating Rate Instruments due 2017
Santander Issuances, S.A. €550,000,000 - Exchange ratio 90.00 (%)
ISIN - XS0261717416 - Callable Subordinated Step-Up Floating Rate Instruments due 2017
Santander Issuances, S.A. €1,500,000,000 - Exchange ratio 90.00 (%)
ISIN - XS0327533617 - Callable Subordinated Lower Tier 2 Step-Up
Fixed/Floating Rate Instruments due 2017
Santander Issuances, S.A. £300,000,000 - Exchange ratio 88.00 (%)
ISIN - XS0284633327 - Callable Subordinated Step-Up Fixed/Floating Rate
Instruments due 2018
Santander Issuances, S.A. €500,000,000 - Exchange ratio 88.00 (%)
ISIN - XS0255291626 - Callable Subordinated Step-Up Fixed/Floating Rate
Instruments due 2018
Santander Issuances, S.A. €500,000,000 - Exchange ratio 87.00 (%)
ISIN - XS0301810262- Callable Subordinated Step-Up Fixed/Floating Rate
Instruments due 2019
Santander Issuances, S.A. €449,250,000 - Exchange ratio 99.50 (%)
ISIN - XS0440402393- Callable Subordinated Lower Tier 2 Step-Up
Fixed/Floating Rate Instruments due 2019
Santander Issuances, S.A. £843,350,000 - Exchange ratio 94.00 (%)
ISIN - XS0440403797- Callable Subordinated Lower Tier 2 Step-Up
Fixed/Floating Rate Instruments due 2019
Santander Issuances, S.A. €500,000,000 - Exchange ratio 87.00 (%)
ISIN - XS0201169439- Callable Subordinated Lower Tier 2 Step-Up
Fixed/Floating Rate Instruments due 2019

In our new Santander proposed haircuts, bond holders have until the 23rd of November to decide if they want a new "hairstyle".

Not even our CPDO/EFSF has been successful in raising recently much needed funding to help out on the ongoing European debt crisis, in fact, 10 year French Government bonds are yielding now for the first time above June issued 10 year EFSF bond - source Bloomberg:

It looks like the EFSF is too late to be materially effective in preventing contagion to spread in Europe.

So, given what we know so far, with heightened volatility, liquidity dwindling and European solitons, as in indicated in our previous post, please "mind the gap" - source Bloomberg:

There is still a disconnect between the 10 year German Bund and the Eurostoxx, while it had been moving in lockstep until recently, it appears the divergence between both still does not look correct, and warrant caution.

On a final note I leave you with the European Zew Indew, relating to European investor and analyst expectation - source Bloomberg:

"The ZEW center in Mannheim Germany said today its index of investor and analyst expectations, which aims to predict developments six months in advance, declined to minus 55.2 from minus 48.3 in October. That’s the lowest since October 2008." - Source Bloomberg.

"If we take the generally accepted definition of bravery as a quality which knows no fear, I have never seen a brave man. All men are frightened. The more intelligent they are, the more they are frightened."
George S. Patton

Stay tuned!

Markets update - Credit - The Italian Peregrine soliton

"In mathematics and physics, a soliton is a self-reinforcing solitary wave (a wave packet or pulse) that maintains its shape while it travels at constant speed." - source Wikipedia

"A single, consensus definition of a soliton:

1. They are of permanent form;
2. They are localised within a region;
3. They can interact with other solitons, and emerge from the collision unchanged, except for a phase shift." - source Wikipedia

Another interesting day in the ongoing European crisis.

It is of no surprise with liquidity dwindling as we move towards year end to see a lot more ongoing volatility, definitely not helping. It seems Six Sigma standard deviation is not the norm anymore, it is higher still. So another long post, focusing on our Italian Peregrine soliton, liquidity issues affecting bid-offer prices and touching on fine-tuning risk weighting assets for banks to shore up Core Tier 1 capital.

Italy took centre stage today with some epic price movements:

Italian 2 years:  --- 6.37 yesterday ---- 7.13 today ---- +75 bps

Italian 5 years:  --- 6.87 yesterday ---- 7.62 today ---- +75 bps

Italian 10 years: --- 6.77 yesterday ---- 7.38 today ---- +61 bps


Time for a market overview.

The Bond Picture - Source Bloomberg:

Italy reaching "Terminal velocity"? The move today was epic to say the least.

Here is the intraday picture for 10 year Italian Government bond yield move- Source Bloomberg:

The CDS picture, Italy and Spain 5 year Sovereign CDS drifting apart - Source Bloomberg:

New record, 140 bps apart.

In the process, CDS wise, everything Italian widened - Source CMA:


Banks as well as Italy and Italian Companies - Source CMA:


Triggering in the process, flight to quality, Germany 10 year Government bond trending back to record lows - Source Bloomberg:

There is an interesting disconnect between the move in the 10 year German Bund and the Eurostoxx, while it had been moving in lockstep until recently, it appears the divergence between both does not look correct, so mind the gap - Source Bloomberg:

Volatility rising in the process as shown in the bottom level of the graph displaying 6 month implied volatility and V2X index.

France as well was not spared either with today's price action, given its exposure to Italy, with the 10 year Government bond spread level with Germany reaching another record in the process, coming close to 150 bps - Source Bloomberg.

OAT and EFSF Bonds widening versus German 10 year Government Bond yield - Source Bloomberg:

At this stage we know that EFSF will not be enough to deal with ongoing contagion to Italy.

The liquidity picture, not improving, new reserve period starting at the ECB hence the drop in the deposit levels at the ECB - Source Bloomberg:

In relation to liquidity dwindling as we move steadily towards year end, and dealers not particular eager to add risk towards year end, bid-offer spread are rising, but in relation to Italian debt, they have been soaring according to Bloomberg Chart of the Day relating to 2 year Italian Bonds bid-offer spreads:

By Matthew Brown - November 9 - Bloomberg:

"The gap between prices at which traders buy and sell Italian bonds has soared this week as market makers became less willing to deal in the nation’s debt, sapping liquidity from Europe’s largest bond market.
The CHART OF THE DAY shows the so-called bid-ask spread on Italian two year notes. The gap widened to 44 basis points today, the most since January, and up from 4 in March. Italian two-year yields climbed 98 basis points to a euro-era record 7.36 percent today, while 10-year yields climbed above 7 percent, the level that presaged Greece, Ireland and Portugal requesting international bailouts."

In recent post we have been discussing how banks will need to tackle revamped regulation needing them to beef up their core Tier 1 capital, as required by the European Banking Association.
We have already touched on the subject of DVA, bond tenders, debt to equity swap, upcoming deleveraging and of course reduction of appetite for risk with the reduction of the size of the trading book via attrition of Risk-Weighted-Assets.
As indicated by Bloomberg today by Liam Vaughan in his article "Financial Alchemy Foils Capital Rule as EU Banks Redefine Risk". It is worth mentioning the creativity of banks in dealing with capital rules imposed by regulators. When rules doesn't work your way, it is time to adapt:

"Banks in Europe are undercutting regulators’ demands that they boost capital by declaring assets they hold less risky today than they were yesterday.
Banco Santander SA, Spain’s largest lender, and Banco Bilbao Vizcaya Argentaria SA, the second-biggest, say they can go halfway to adding 13.6 billion euros ($18.8 billion) of capital by changing how they calculate risk-weightings, the probability of default lenders assign to loans, mortgages and derivatives. The practice, known as “risk-weighted asset optimization,” allows banks to boost capital ratios without cutting lending, selling assets or tapping shareholders.
Regulators in Europe, seeking to stem the region’s sovereign-debt crisis, ordered banks last month to increase core capital to 9 percent of risk weighted assets by the end of June."

And from the same article, an interesting comment from Adrian Blundell-Wignall deputy director of the Organization for Economic Cooperation and Development’sfinancial and enterprise affairs division in Paris:
"By allowing sophisticated banks to do their own modeling, we are allowing the poacher to participate in being the game-keeper”.

Yes, every bank uses their own models for calculating their RWA (Risk-Weighted-Assets) which are submitted once a year to national regulators according to the article.

Also from the same article:

"Sheila Bair, who stepped down as chairman of the Federal Deposit Insurance Corp. in June, has called Europe’s adoption of risk-weighting “naive.” The Washington-based regulator guarantees most consumers’ deposits in U.S. banks. “It is in a bank manager’s interest to say his assets have low risk, because it enables the bank to maximize leverage and return on equity, which in turn can lead to bigger pay and bonuses,” Bair wrote in Fortune magazine on Nov. 2. “Indeed, even during the Great Recession, as delinquencies and defaults increased, most European banks were saying their assets were becoming safer.
Some regulators, including Bair, have pushed for a leverage ratio that would require lenders to hold a fixed amount of capital against total assets.
One reason there’s a difference between risk-weighted assets and total assets is that some securities, such as certain sovereign bonds, carry a zero risk-weighting, requiring banks to hold no capital.

‘Gaming the System’

“A basic leverage ratio would be rougher, but it takes away the risk of gaming the system,” said Stephany Griffith-Jones, an economist and lecturer in financial markets at Columbia University in New York. “We need to move away from outsourcing regulation of the banks to the banks.” European bank stocks have tumbled 31 percent this year, valuing firms at 62 percent of tangible book value."

And the article to conclude quoting Mark Harrison, a Barclays
analyst, who is based in London:

“Gaming RWAs isn’t helpful, particularly if the objective is to convince the market to invest in banks again,” Harrison said. “The risk is that it’s counterproductive, because there
is even less faith in what the banks are telling you.”

Raising capital for Banks is therefore going to be an interesting exercise indeed in the coming months.

"Running a casino is like robbing a bank with no cops around." Ace Rothstein (Robert de Niro) in the movie Casino by Martin Scorsese

"Running an investment bank is like robbing a casino with no gaming regulators around."
Martin, Macronomics.

Stay Tuned!