European Sovereign Debt - There will be blood

There will be blood...when it comes to European Debt. There will be haircuts and restructuring. For Greece, the markets already know it cannot be avoided.

It is already happening for some Irish Banks Sub debt which will bare the brunt of significant haircuts. It will be extended probably to senior debt as well.

On the 26th : ANGLO IRISH BANK CUT SIX NOTCHES BY S&P TO JUNK FROM BBB.

When it comes to politicians and their lack of moral values and to what extent they are ready to go to plug the gaps in their mis-managed budget, I give you Hungary this week, as highlighted in a Bloomberg article by Zoltan Simon:

http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=a6848KPU9JA0

Another country, another amazing heist: Hungary following the steps of Argentina.

"Hungary is giving its citizens an ultimatum: move your private-pension fund assets to the state or lose your state pension."

"Economy Minister Gyorgy Matolcsy announced the policy yesterday, escalating a government drive to bring 3 trillion forint ($14.6 billion) of privately managed pension assets under state control to reduce the budget deficit and public debt. Workers who opt against returning to the state system stand to lose 70 percent of their pension claim."

“This is effectively a nationalization of private pension funds,” David Nemeth, an economist at ING Groep NV in Budapest, said in a phone interview. “It’s the nightmare scenario.”

You can expect EUR/HUF currently trading at 270 on the 25th versus the Euro, to go much higher...280 on the 26th...

"Hungary’s pension changes are making the country more risky for investors, according to market reactions to the government’s plan. The forint weakened 2.1 percent versus the euro so far this month, making it the world’s worst-performing currency for that period."

Foreclosed Homes for Sale in Spain May Triple in 2011:

There will be blood...

http://noir.bloomberg.com/apps/news?pid=20601087&sid=aqVwPTMwc4oY&pos=3

"Spanish lenders have a total of 181 billion euros ($242 billion) in “troubled” construction and real estate loans, the Bank of Spain said last month. Since Sept. 30, the banks have been required to account for falling property values more quickly, encouraging them to shed assets without waiting for the market to recover from a three-year decline."

Price Reductions

“By changing the rules on provisions, the central bank has really put a shotgun to their heads,” said Fernando Rodriguez y Rodriguez de Acuna, founder of Madrid-based property adviser R.R. de Acuna & Asociados. “The banks will have to cut their price expectations more aggressively to reduce their stock of homes.”

"Property values will fall 20 percent over the next five years, Rodriguez y Rodriguez de Acuna estimates. Most of the declines will come in 2011, he said. Since the Spanish market’s peak in April 2007, home prices have dropped 22.5 percent, according to a survey by real-estate website Fotocasa.es and IESE Business School.

Under the changes introduced by the Bank of Spain in September, lenders must take account of a drop in value of at least 30 percent if they keep the assets for more than two years. They must also make provisions for bad loans after 12 months, rather than as long as 72 months.

The new rules will lead to an average increase in provisions for 2010 of 2 percent, the central bank said in May. They will also knock off an average of 10 percent from the pretax profit that lenders generate from their Spanish businesses, the Bank of Spain said."

Ireland, Portugal next, and the scary Spain...

Source: The Economist, November 27th issue, page 30.

For 2011, in the US you can also expect trouble in the US coming from the Municipal bond space.

The ongoing deflation of the housing bubble is still the ongoing theme. At the same time you have inflation in commodities due to QE2 and the debasement of currencies. The US need a new RTC has I posted previously. The sooner, the better.

Dominos in Europe - "Get the door. It's Domino's."

Irish banks Sub debt whacked to oblivion:

Allied Irish Banks Plc (SUB) 5 year CDS today: 5108 bps +1237 bps +31.98%

Allied Irish Banks Plc (SNR) 5 year CDS today: 1129 bps +175 bps +18.36%
(source cmavision.com)

At the same time, Anglo Irish Bank Corp. investors are forced to take 20 cents on the euro for subordinated debt this week. 20% is the implied recovery rate used to calculate a CDS value on CDS referencing SUB debt (most of the time Lower Tier 2 debt because coupon cannot be deferred).

Irish Banks Senior debt as well is in the turmoil:

"Credit-default swaps on the senior debt of Ireland’s biggest lenders approached records highs. Contracts on Allied Irish Banks Plc climbed 103 to 954.5 while Bank of Ireland Plc jumped 89.9 to 735.7, according to CMA."

http://noir.bloomberg.com/apps/news?pid=20601087&sid=aFgwTw.672w4&pos=3
As per the above Bloomberg article, contagion is spreading in sick Europe.

"Fears of burden sharing are also being seen in senior bank bonds. The 1 billion euros of senior unsecured floating-rate notes due 2012 issued by Banco Espirito Santo were at 90.8 cents, down from 93.4 on Nov. 4, according to Bloomberg composite prices. Its 500 million euros of senior notes due 2013 were at 83 cents, down from 88.38 on Nov. 4."

Paddy Power the Irish bookmaker is know bigger than Bank of Ireland, founded in 1783. The Irish government will get a majority stake in Bank of Ireland.

Spanish and Portuguese Banks Sub CDS getting crushed:

S&P downgraded Ireland’s credit rating two notches to “A” with a “negative outlook...

Spain 5 year CDS trades at 303 bps today...

Greek 10-year bonds yield 11.93%, compared with 8.96% before the European Union and the IMF agreed to the bail out on the 2nd of May 2010.
For Greece, it will end up in restructuring, no doubt about it.

Markit iTraxx Financial Index of 5 Year credit-default swaps on senior debt rose 12.5 basis points to 163.5 basis points, the biggest increase since June.

As you can see, since the beginning of 2010, insuring Senior Financial debt is more expensive to insure than insuring Senior Corporate debt. It is reflected by the above graph highlighting the relationship between Itraxx Main Europe 5 year CDS and Itraxx Senior Financial 5 Year CDS.

The European Vortex

It looks like the European Financial Stability Facility is going to be triggered early to help out Zombie Ireland.

The issue is that, following Ireland, there is Portugal and then Spain to take care of.

There is 440 Billions Euros available (probably less given its similar resemblance to a CDO structure). Clearly not enough to bail out everyone. If the EFSF wants a AAA to issue bonds to fund the oncoming bailouts, it will need to overcollateralize to 120% and maintain a cash buffer. It cannot lend against backing of troubled nations. The more countries in trouble, the smaller the pot available for bailing out countries in trouble, simple as that. Given Austria is witholding already its funding for Greece, the entire unity of the European Union is being tested.

For more explaination about the weakness of the EFSF, you can read the excellent article written by Tracy Alloway in FT Alphaville, published on the 27th of September as well as the post by Dr. Constantin Gurdgiev in the link below:


http://ftalphaville.ft.com/blog/2010/09/27/353176/europes-spv-really-is-not-saving-anything/


http://trueeconomics.blogspot.com/2010/11/economics-131110-efsf-ireland-and.html


The EFSF game is well summarised by Dr. Constantin Gurdgiev:

"Now, any sovereign with an once of sense now will know that a race to tap EFSF is on. The faster you get to it to borrow from it, the more likely you’ll arrive to the borrowing window before the limits are reached. Portugal, Spain and possibly even Italy are in the race.

This is why the markets have never been easy about the entire EFSF – they know that Ireland tapping into EFSF simply does two things:

It delays the inevitable restructuring of the massive debts accumulated on the Irish economy side – either sovereign or banks or households or any two or all three. EFSF does not remove the need for such a restructuring. It simply delays it.
It signifies an exponential increase in the probability of EFSF acting as a conduit for contagion from the PIIGS to the rest of the Euro area."

European politicians are trying all they can to kick the can down the road with the EFSF. The "only" major issue is that they are running out of road. Structural issues have not been addressed.

The problem for Ireland, has I discussed in my last post is that its financial sector is damaged beyond repair and need additional support. Currently Irish banks are heavily depending on the ECB for their funding, they are indeed truly zombie banks. The issue is that it is such a black hole for Ireland's public finances, that some external support is necessary. As for Iceland, the Irish banks where too big to fail for the country, hence an estimated budget deficit of 32% for 2010.

On the 17th of November Allied Irish Banks Plc (SUB)was trading at 2568 bps, +405 bps on the day, a 18.76% widening...

Ireland faces the same issue than Iceland did in relation to its banking sector. It did not kept its banking sector under scrutiny and now the whole banking sector is taking the country with it in its downfall.