17/2/17: European Non-Performing Banks' Loans 2016

Latest Fitch data shows some significant progress achieved by Ireland in dealing with non-performing loans on banks' balancesheets:

According to Fitch, Irish banking system ranked 6th worst in terms of NPLs in the EU at the end of 2016. This is a significant improvement on second and third places for Ireland during the height of the Greek and Cypriot crisis. However, the above data requires some serious caveats:

1. Ireland has been the earlier starter in the game of repairing banks' balancesheets than any other country in the Fitch's Top10 Worst systems table above;
2. Ireland's performance crucially depends on the assumed quality of mortgages debt restructurings undertaken by the banks over recent years - an assumption that is hardly un-contestable, given that the vast majority of mortgages arrears resolutions involve extend and pretend types of measures, such as extending mortgages maturity, rolling up arrears into a new (for now cheaper) debt and so on; and
3. Ireland is compared here to a number of countries where the banks bailouts have either been much shallower or completely absent.

Still, for all the caveats, it is good to see that after 9 years of a crisis, Irish banking system is no longer in top-5 basket cases league table in Europe. At this speed, by 2026, me might be even outside the top-10 table... 

14/11/2013: With banks or without, things are heading for desperate in Italy...

The banks stress tests are coming up and the Euro periphery system is quickly attempting to patch up the massive cracks in the facade. The key one is the continued over-reliance of banks on sovereign-monetary-banking loop of cross-contagion. The banking system weakness is exemplified by Italy: Italian banks are the main buyers of Italian sovereign debt, which in turn means that Italian government stability rests on the banks ability to sustain purchasing, which implies that the ECB (with an interest of shoring up Italian economy) is tied into continuing to provide cheap funding necessary for the Italian banks to sustain purchasing of Italian Government debt… and so on.

Three key facts are clouding this 'stability in contagion' picture:

1. Banks in Italy and elsewhere are not deleveraging fast enough to allow them repay in full the LTROs coming due January and February 2015;
2. Banks in Italy are now fully saturated with italian Government debt, posing threats to future supply of Italian bonds and putting into question the robustness of the banking stress tests; and
3. Italian Government is running out of room to continue rolling over its massive debts.

If all 3 risks play out at the same time or close to each other, things will get testy for the Euro.


Point 1: Banks in the euro zone continue to carry assets that amount to three times the size of the euro area economy. This puts into question the core pillar of banking sector 'reforms' that the ECB needs to see before the banking union (BU) comes into being. The ECB needs to have clarity on quality of assets held by banks and, critically, needs to see robust deleveraging by the banks before th BU can be launched. If either one of these conditions is not fully met, the ECB will be taking over the banking system that is loaded with unknown and unpriced risks.

Per recent ECB data, Banks in the euro zone held EUR29.5 trillion in total assets by the end of 2012. That is down 12% on 2008. Too slow of a pace for a structural deleveraging. Worse, the bulk of the adjustments was back in 2009 and little was done since. Which makes the level of assets problem worse: on top of having too many assets, the system has virtually stopped the process of deleveraging. Knock on effect is that the firming of asset markets in Europe in recent two years was supported by a slowdown in assets disposals by the banks. In turn, this second order effect means that many banks assets on the books are superficially overvalued due to their withholding from the market. Nasty, pesky first and second order effects here.

Worse. Pressure on assets side is not limited to the 'periphery'. German banks held EUR7.6 trillion in total assets at the end of 2012, followed by the French banks with EUR6.8 trillion. Spain and Italy's banking sectors came in distant second and third, with EUR3.9 trillion and EUR2.9 trillion in total assets.

Capital ratios are up to the median Tier 1 ratio rising from 8% in 2008 to 12.7% in 2012. Quality of this capital is, however, subject to the above first and second order effects too - no one knows how much of the equity valuation uplift experienced by the euro area banks in recent months is due to banks reducing the pace of assets deleveraging…


Point 2: Assets quality in some large banking systems is too closely linked to the sovereign bonds markets. Italy is case in point. ECB tests are set to exclude sovereign debt risk exposures, explicitly continuing to price as risk-free sovereign bonds of the peripheral euro area states. But in return for this, the ECB might look into gradually forcing the banks to limit their holdings of sovereign bonds. This would be bad news for Italian banks and the Italian treasury.

The problem starts with a realisation that Italian banks are now primarily a vehicle for rolling over Government debt. Italy's Government debt is over EUR2 trillion. EUR397 billion of that is held by Italian banks. Another EUR200-250 billion can be safely assumed to be held by Italian banks customers who also have borrowings from these banks. Any pressure on the Italian sovereign and the ca EUR600 billion of Italian debt sloshing within the banking system of Italy is at risk.  That puts 20.7 percent of Italian banks assets at a risk play. [Note: by some estimates, Italian banks directly hold around 22% of the total Italian Government debt - close to the above figure of EUR397 billion, but way off compared to Spanish banks which are estimated to be holding 39% of the Spanish Government debt, hence all of the arguments raised in respect of Italy herein also apply to Spain. A mitigating issue for Spain is that it's debt levels are roughly half those of Italy. An exacerbating issue for Spain is that its deficit is second highest in Europe, well ahead of Italain deficit which is relatively benign).

Worse, pressure cooker is now full and been on a boiler for some time. In the wake of LTROs, Italy's banks loaded up on higher-yielding Italian Government debt funded by cheap LTRO funds - Italian banks took EUR255 billion in LTROs funds. In August 2013, Italian banks exposure to Italian Government debt hit EUR397 billion, just shy of the record EUR402 billion in June and double on 2011 levels. I

Either way, with or without explicit ECB pressure, Italian banks have run out of the road to keep purchasing Italian Government debt. Which presents a wee-bit of a problem: Italy needs to raise EUR65 billion in new debt in 2014. Italy is now in the grip of the worst recession since WWII and its debts are rising once again.

Chart below shows that:
1) Italian Sovereign exposures to external lenders declined in the wake of the LTROs, but are back to rising in recent quarters;
2) Italian banks reliance on foreign funding rose during the LTROs period, declined thereafter and is now again rising; while
3) Other (non-financial and non-state) sectors remain leveraged at the levels consistent with late 2006.

Point 3: Overall, Italian Treasury is now competing head on with the banks for foreign lenders cash and Italian corporate sector is being forced to borrow abroad in absence of domestic credit supply. Foreign investors bought almost 2/3rds of the last issue of Italian bonds, but how much of this appetite can be sustained into the future is an open question. Foreign investors currently hold slightly over a third of Italy's debt, or EUR690 billion, down from more than EUR800 billion back in 2011. The Italian Government is now turning to Italian households to mop up the rising supply. Italy issued EUR44 billion worth of inflation-linked BTP Italia bonds with 4 year maturity. As long as inflation stays low, the Government is in the money on these.

Next in line - desperate measures to raise revenues. Per recent reports, there is a proposal working its way through legislative corridors of power to raise tax on multinational on-line companies trading in Italy. The likes of Google, Amazon and Yahoo will be hit with a restriction on advertisers to transact only with on-line companies tax-resident in Italy, per bill tabled by the center-left Democratic Party (PD). The authors estimate EUR1 billion annual yield to the state - a tiny drop in the ocean of Italian government finances, but also a sign of desperation.

25/7/2013: More on Sovereign-Banks Contagion risks in Spain and Italy

Two interesting charts detailing continued rise in risk links between the sovereigns and Italian and Spanish banks:

 Both via Ioan Smith @moved_average.

19/7/2013: Spain's Bad Loans: Heading for the Eurotroit solution?

Spanish banks bad loans ratio of all assets for May 2013:

H/T: Ioan Smith @moved_average

The Eurotroit keeps rolling on... Notice how Spain has by now largely erased the reductions in bad loans driven by assets shifts to 'bad bank' Sareb (EUR50.45bn portfolio, with 76,000 empty housing units, 6,300 rented homes, 14,900 plots of land and 84,300 loans). Spanish bad loans as a percentage of total credit rose from10.5% in March to over 11.2% in May.

And they will continue rising.

That's because in Spain, ultimate level of bad loans is going to be closer to Ireland's, where over 50% of SME loans are non-performing, over 25.8% of all mortgages are non-performing or at risk of default, and as of June 2013, 24.8% of all loans were non-performing, against EuroTanic's average 7.5-7.6% (EUR920bn or so). Irish numbers exclude Nama.

So even with the sunshine and sea, Costa del Concrete is going to cost Spain over 20% in terms of bad loans ratio in the end.

29/6/2013: Banks-Sovereign Contagion: It's Getting Worse in Europe

Two revealing charts from Ioan Smith @moved_average (h/t to @russian_market ): Government bonds volumes held by Italian and Spanish banks:

Combined:

• Italy EUR404bn (26% of 2013 GDP) up on EUR177bn at the end of 2008
• Spain EUR303bn (29% of 2013 GDP) up on EUR107bn at the end of 2008

Now, recall that over the last few years:

• European authorities and nation states have pushed for banks to 'play a greater role' in 'supporting recovery' - euphemism for forcing or incentivising (or both) banks to buy more Government debt to fund fiscal deficits (gross effect: increase holdings of Government by the banks, making banks even more too-big/important-to-fail); 
• European authorities and nation states have pushed for separating the banks-sovereign contagion links, primarily by loading more contingent liabilities in the case of insolvency on investors, lenders and depositors (gross effect: attempting to decrease potential call on sovereigns from the defaulting banks);
• European authorities and nation states have continued to treat Government bonds as zero risk-weighted 'safe' assets, while pushing for banks to hold more capital (the twin effect is the direct incentive for banks to increase, not decrease, their direct links to the states via bond holdings).

The net result: the contagion risk conduit is now bigger than ever, while the customer/investor security in the banking system is now weaker than ever. If someone wanted to purposefully design a system to destroy the European banking, they couldn't have dreamt up a better one than that...

7/1/2013: A scary chart from Spain

If you want a frightening figure for the start of the week, here's one, courtesy of the WSJ:

Per WSJ: "At least 90% of the €65 billion ($85.7 billion) fund has been invested in increasingly risky Spanish debt, according to official figures, and the government has begun withdrawing cash for emergency payments."

"In November, the government withdrew €4 billion from the reserve fund to pay pensions, the second time in history it had withdrawn cash. The first time was in September, when it took €3 billion to cover unspecified treasury needs." Such withdrawals can lead to sales of bonds, which in turn can lead to higher yields - classic scenario of a ponzi scheme unwinding.

The point is not valuations, but risk.

"Spain will have trouble finding buyers for the estimated €207 billion in debt it plans to issue in 2013, up from €186 billion in 2012, to cover central-government operations, debt maturities of 17 regional administrations, and overdue energy bills," according to WSJ. 

But there is, of course, more. "Spain's commercial banks already have increased their Spanish government-bond portfolio by a factor of six since the start of the crisis in 2008, and now own one-third of government bonds in circulation." In other words, there is a closed loop between Spanish State, State pensions fund and the banks. A liquidity crunch or solvency problems for banks will cascade all across the debt markets, potentially triggering defaults on pensions.

Note: per Eurointelligence report earlier today, "This is old news as already back in June there was a report that Spanish debt holdings by the Reserve Fund had gone from 55% in 2007 to 90%, and it was government policy to reach 100% by replacing maturing foreign debt holdings with new Spanish debt. It is also a bit of a noisy red herring, as a stock of €65bn is about 2/3 of the government's annual pension bill, it is clear that the Social Security Reserve Fund accumulated over the past decade can never be a substantial contributor to future pensions. However, the Euro's prohibition of central bank financing of state budgets may require the creation of such buffer stocks"

28/10/2012: BNP note on Spanish Bonds risks

A neat summery from BNP on (1) current bond ratings, and (2) links between ratings and eligibility for inclusion in bond indices:

And a few words on the importance of Spanish ratings risks to ESM/OMT etc:

"As has been demonstrated throughout the EU debt crisis, credit ratings can have a material impact on sovereign bond markets. ...However, not all downgrades have the same effect on bond yields. More specifically, the loss of an AAA rating (S&P on France and Austria, for example) and, more importantly, the loss of investment-grade status (Greece, Portugal) matter more than other downgrades and may have dire consequences for sovereign bonds, because of the significance of those two ratings levels as critical thresholds for investors."

"The downgrade to sub-investment grade, in particular, is linked to the eligibility criteria for various global bond indices, i.e. the minimum rating required for a sovereign bond to be included in an index. Fund managers tend to track the performance of major bond indices and, as a result, when a country’s sovereign bonds drop out of an index due to ratings ineligibility, investors have to adjust their portfolios and offload the country’s bonds. So, any downgrades to sub-investment grade could lead to massive selling flows and have a huge impact on the bond yields of the country in question. More than that, quite often, markets tend to front-run the ratings agencies and start to offload the bonds of the country they suspect may be downgraded to sub-investment grade in the near-term future."


"... Currently, Spanish ratings are getting extremely close to those same [as Portugal in 2011 downgrade case] eligibility thresholds. In general, BBB- is the critical limit for bond index eligibility, but different indices have different rules on calculating a single rating for each country (they can use, say, the average, middle, best of all, or specific ratings). For Spain, currently rated BBB-/Baa3/BBB, any trio of one-notch downgrades is going to push the average rating below the eligibility threshold."

"Credit ratings are important not only with respect to eligibility for the major bond indices, but also in calculating the haircut the ECB applies to collateral posted by European banks. According to the ECB’s graduated haircut schedule, an extra 5% haircut is applied to ratings in the BBB+/BBB/BBB- range (the ECB uses the best rating of S&P, Moody’s, Fitch and DBRS). This extra 5% haircut applies only to category 1 assets, which include government bonds. For other assets, like bank, corporate and agency debt, this extra haircut can reach up to 23.5%, creating severe additional collateral requirements for banks."

"This is particularly important for Spanish banks, which tend to absorb around EUR 400bn of liquidity from ECB’s open market operations. The ECB recently announced that it is suspending the application of the minimum credit-rating threshold to its collateral eligibility requirements for the purposes of the Eurosystem’s credit operations for marketable debt securities issued or guaranteed by the central government of countries that are eligible for OMTs or are under an EU-IMF programme and comply with the associated conditions. However, this does not affect the application of the previously mentioned graduated haircut approach."

"So, focusing on Spain, a one-notch downgrade by DBRS would mean that marketable securities issued by Spain would fall into the higher haircut range and Spanish banks would have to post additional collateral with the ECB. A trio of one-notch downgrades by S&P, Moody’s and Fitch would push the Spanish average rating below BBB- and Spanish bonds out of those bond indices that use the average rating as the threshold for eligibility. For those bond indices that use the middle rating of S&P/Moody’s/Fitch (or the better of the first two), a one notch downgrade by each of Moody’s and S&P would be enough to push the single rating below the eligibility threshold, too. Because of this, any upcoming developments in relation to (1) direct bank recapitalisation by the ESM, (2) a Spanish request for a precautionary programme, (3) economic and social developments in Spain and (4) funding rates are going to be critical, as they could prompt further downgrades, with severe implications for the Spanish bond market."

"If any of these downgrade combinations takes place before Spain has made an official request for a programme, we believe a request would, in effect, become inevitable. At the same time, if Spain asked for a programme tomorrow, this would not necessarily mean that any further downgrades would be off the cards. Almost all of the ratings agencies have said that they will have to assess whether ESM intervention is likely to become a complement to or a substitute for market access. If it turns out to be the latter, this would be in line with a downgrade to the sub-investment-grade category."

"At this point, we should mention that if Spanish bonds are removed from the global bond indices, this could have an impact on Italian bonds as well. The reason is that some investors may have replaced their Spanish bond holdings with an Italian bond proxy in order to benefit from better liquidity and protect themselves from panic selling, should Spain be downgraded further. As a result, if Spanish bonds’ drop out of various indices, these investors could suddenly find themselves overweight Italy versus the index, so they would have to sell some of their Italian bonds to re-adjust their weightings and track the index."

"We saw this kind of move when Portugal was downgraded to junk by Moody’s in July 2011 (taking into account that this was not completely expected by the markets and PGB liquidity had already dried up). In the five days after Portugal’s downgrade, 5y Italian and Spanish yields jumped by 95bp and 65bp, respectively."

Nasty prospect, albeit the risks are diminishing, in the short run, imo.

4/10/2012: Spanish Banks Stress Tests

My article for The Globe & Mail on Spanish banks stress tests (link).

28/9/2012: Thou Shalt Not Read Into the ECB PRs Too Much

You'll read a load about the Spanish Banks 'stress' tests (which they largely passed with just minor blemishes) in days ahead, but one thing worth remembering is that all the congratulatory patting on the back the Spanish authorities about to receive means diddly-nothing.

Here's what the ECB had to say about the most farcical of all 'stress' tests ever conducted anywhere this side of the Zimbabwean border - the stress tests of July 2010 which even the Irish banks passed with flying colors:

"The stress-testing exercise is comprehensive and rigorous. It confirms the resilience of EU and euro area banking systems to major economic and financial shocks. The exercise, therefore, represents an important step forward in supporting the stability of the EU and euro area banking sectors."

The farcical bit was of course that the 'comprehensive and rigorous' tests of 2010 found all euro area banks needing just €3.5bn of capital...

And here's what the ECB had to say about July 2011 stress tests that failed to find much at fault with the Spanish banking system (italics are mine):

"The European Central Bank (ECB) welcomes the publication today of the results of the EU-wide stress-testing exercise, which was prepared and conducted by the European Banking Authority (EBA) and the national supervisory authorities. The EU-wide stress test in the banking sector has proved to be an important tool to enhance transparency in the EU banking system. It provides for the disclosure of all the information that is relevant for the market to assess the resilience of the institutions in the context of an adverse scenario."

So let's not exercise too much about today's ECB 'welcoming' of the Spanish stress tests (link here)...

16/7/2012: GFSR July 2012 - more alarm bells for European banks

IMF published Global Financial Stability Report update for June 2012, titled “Intense Financial Risks: Time for Action”

Per report: “Risks to financial stability have increased since the April 2012 Global Financial Stability Report (GFSR).

• Sovereign yields in southern Europe have risen sharply amid further erosion of the investor base.
• Elevated funding and market pressures pose risks of further cuts in peripheral euro area credit.
• The measures agreed at the recent European Union (EU) leaders’ summit provide significant steps to address the immediate crisis. Aside from supportive monetary and liquidity policies, the timely implementation of the recently agreed measures, together with further progress on banking and fiscal unions, must be a priority.
• Uncertainties about the asset quality of banks’ balance sheets must be resolved quickly, with capital injections and restructurings where needed.
•  Growth prospects in other advanced countries and emerging markets have also weakened, leaving them less able to deal with spillovers from the euro area crisis or to address their own home-grown fiscal and financial vulnerabilities. 
•  Uncertainties on the fiscal outlook and federal debt ceiling in the United States present a latent risk to financial stability."

Aside from the headlines, some interesting points from the report are:

• Market conditions worsened significantly in May and June, with measures of financial market stress reverting to, and in some cases surpassing, the levels seen during the worst period in November last year.  (see Figure 1)

•   The 3-year LTROs helped support demand for peripheral sovereign debt but that positive effect has waned. Private capital outflows continued to erode the foreign investor base in Italy and Spain (see Figures 3 and 4)

An interesting point on Euro area banking sector [emphasis mine]: “Notwithstanding the ample liquidity provided by the ECB’s refinancing operations, funding conditions for many peripheral banks and firms have deteriorated. Interbank conditions remain strained, with very limited activity in unsecured term markets, and liquidity hoarding by core euro area banks. Bank bond issuance has dropped off precipitously, with little investor demand even at higher interest rates.

“Banks in the euro area periphery have had to turn to the ECB to replace lost funding support, as cross-border wholesale funding dried up, and deposit outflows continue. The April 2012 GFSR noted that EU banks are under pressure to cut back assets, due to funding strains and market pressures, as well as to longer-term structural and regulatory drivers. The sharp reduction in bank balance sheets in the fourth quarter of 2011 continued, albeit at a slower pace, in the first quarter of 2012.

Growth in euro area private sector credit diverged significantly. While credit has contracted in Greece, Spain, Portugal and Ireland, it has remained more stable in some core countries.

Survey data on bank lending conditions show that credit supply remains tight, albeit less so than at the end of 2011, but that demand has also weakened more recently.

Deleveraging is also a concern for many peripheral corporations, given their historic dependence on bank funding and the risk that credit downgrades and diminished investor appetite could drive borrowing costs higher, even for high credit quality issuers.”

Now, here’s an interesting point not raised in the GFSR, but linked to the above observations: equities issuance accounts for roughly 55% of total corporate capital in US and EU. However, because the US corporates issue more bonds-backed debt than their EU counterparts, banks lending accounts for 40% of the European corporate funds raised, against 20% in the US. Which means that banks credit is about twice more important in Europe than in the US in terms of funding corporate capex. In fact, recent research from BCA clearly links US corporates ability to raise direct market funding by-passing banks to faster economic recovery in the US than in EU or Japan.

Add to this equation that European banks are worse capitalized than their US counterparts and that they are more leveraged than their US counterparts and you have a bleak prospect for the EU economy. BCA recently estimated that to bring Euro zone banks’ capital ratios to the levels comparable with the US average, the largest EU banks will have to raise some USD900 billion worth of new capital or cut their assets base by a whooping USD 9 trillion.

But wait, there’s more – you’ve heard about the latest report in the WSJ that Mario Draghi proposed to bail-in senior bondhodlers in Spanish banks? Much of the Irish commentary on this was positive, suggesting that Ireland is now in line for a retrospective deal from the ECB to recover some of the funds we paid to senior bondholders in Anglo and INBS. Setting aside the ‘wishful thinking’ nature of such comments – look at Draghi’s idea implications for EU economic activity. If bail-in does make it to the policy tool of European authorities, funding for the EA17 banks will only become more expensive in the medium and long term (risk premium on ‘bail-in probability’), which, in turn will mean even less credit for corporates, which will mean even less capex, and thus even lower prospect of recovery.

You know the story – pull one end of the carriage out of the quicksand pit, the other end sinks deeper… Let me quote BCA: “In Japan, credit contraction lasted well over nine years in the aftermath of the asset bubble bust. During that time, deflation prevailed and economic growth averaged a measly 0.5% annual pace.” Much of hope for Europe then? Not really. Recall that Japan had aggressive fiscal and monetary policies at its disposal plus booming global markets when it was undergoing credit bust. We, however, have psychotic monetary policy, no fiscal policy room and are running debt deflation cycle amidst global economic slowdown.

IMF is also on the note here: “Policymakers must resolve the uncertainty about bank asset quality and support the strengthening of banks’ balance sheets. Bank capital or funding structures in many institutions remain weak and insufficient to restore market confidence. In some cases, bank recapitalizations and restructurings need to be pursued, including through direct equity injections from the ESM into weak but viable banks…”