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Is Another Banking Crisis Inevitable?
- Bond
- Book Value
- CDO
- Collateralized Debt Obligations
- default
- Eastern Europe
- ETC
- European Central Bank
- Eurozone
- goldman sachs
- Goldman Sachs
- Greece
- Gross Domestic Product
- Hungary
- International Monetary Fund
- net interest margin
- NPAs
- Peter Oppenheimer
- Real estate
- recovery
- Reggie Middleton
- Romania
- Sovereign Debt
- Sovereign Default
- Stress Test
Today, Bloomberg reports that Goldman Sachs Turns Bullish on Europe Banks as Debt Risk Eases.The report goes on to state:
The U.S. bank that makes the most revenue from trading
advised investors to take an “overweight” position on banks, raising
its previous “neutral” recommendation, according to a group of equity
strategists led Peter Oppenheimer. Investors should pay for the trade by
lowering holdings of consumer shares, he wrote.
“For financials the narrowing of sovereign spreads in peripheral eurozone, which our economists expect to continue, is a clear positive,” London-based Oppenheimer wrote in the report dated Feb. 3. “Banks are one of the least expensive sectors in the market and the trade-off between their growth prospects and earnings in the next few years looks especially attractive.”
Unfortunately, the risks of this particular trade were not
articulated, and I feel that the risks are material. Far be it for me to
disagree with the “U.S. bank that makes the most revenue from trading”, but they have been wrong before – many times before. Reference Is It Now Common Knowledge That Goldman’s Investment Advice Sucks??? or Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best? for more on this topic.
So where is the risk?
The impact of the Asset Securitization cum Sovereign Debt Crisis to
bank balance sheets should become the market and media focus. The full
cost of cleaning up the balance sheets of financial institutions
particularly against the backdrop of adverse macro shocks emulating from
sovereign defaults is not fully known. Structural weaknesses in
sovereign balance sheets could easily spill over to the financial system
due to the fact that most banks are stuffed to the gills with sovereign
debt – highly leveraged, and marked as risk free assets at par. This
can have broad, adverse consequences for growth in the medium term.
Since banks balance sheets are still highly vulnerable to external
shocks with precedent setting levels of NPAs, particularly from an
economic perspective (as opposed to an accounting perspective which is
what is commonly followed) a sovereign crisis [read as
defaults/restructurings] could cause equity wiping holes in banks’
balance sheets. Overall, NPA’s to bank loans (world average) have
increased to 7.6% in 2010 from 5.9% in 2005. Greece’s NPA-to-loans has
increased to 9.0% from 6.3%, Hungary to 7.8% from 2.3%, Spain to 5.5%
from 0.8%, Romania to 17.5% from 2.6%, Central and Eastern Europe to
11.5% from 4.5% and US to 10.3% from 0.8%, in the corresponding period.
Elevated NPA levels which already pose a threat to banks loan losses
coupled with sovereign risks losses could result in massive write-downs
on investments in banks trading (AFS – available for sale) and banking
books (HTM – hold to maturity). A common shenanigan used both in Europe
and the states is to shift the most problem assets from the AFS category
where they are more rigorously marked to market to the HTM category
where they are considered kosher because they are allegedly to be held
to maturity. The issue is, if there is a default or restructuring, they
are worth materially less – no matter how long they are supposedly held
for. This valuation his is multiplied several time since it is banks
business models to leverage up on these securities to increase yield.
|
Banks NPAs to total loans |
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Source: IMF, Boombust research and analytics |
Euro banks remain weak as compared to their US counterparts
Health of European banks is weaker when compared to US banks.
European banks are highly leveraged compared to their US counterparts
(11.1x versus 4.1x) and are undercapitalized with core capital ratio of
6.5x vs. 8.5x. Also, the profitability of European banks is lower with
net interest margin of 1.2% compared with 3.3%. However, non-performing
loans-to-total loans for European banks are slightly better off when
compared to US with NPL/loans at 4.9% vs. 5.6%. Nonetheless, considering
the backdrop of high exposure to sovereign debt in Euro peripheral
countries, we could see substantial write-downs for Euro banks AFS and
HTM portfolio, which would more than offsets the relative strength of
loan portfolio.
EURO Stress Test Rebuffed, Again
The OECD working paper “The EU stress test and sovereign debt exposures”
by Adrian Blundell-Wignall and Patrick Slovik rebuffs the EU stress
test, as we have several times in the past. The argument in the white
paper echoes BoomBustBlog view that accounting policies allows banks and
financial institutions to mask their true economic health. An asset
that has declined in value leads to economic loss irrespective of its
classification as held-to-maturity or held-for-trading, but accounting
policies allow banks to mark down only their trading portfolio to the
current market value while leaving a large chunk of held-to-maturity at
book value even if said asset loses 50% in value that would take years
to recover, or the bank could be presented with the very distinct
possibility that there may be no recovery of said value loss. The former
event (of recovering back to book value) would mask the true economic
picture at a given snap shot of time while the latter (no recovery) is
more of time shifting distortion wherein current profits are inflated
for future losses.
Coming back to the EU stress test, the paper contends that by
focusing only on the trading book exposures, the EU stress test gave a
rosy picture of banks true health.
• Sovereign bond haircuts were applied only on the trading book
holdings with implicit assumption that bonds held to maturity will
receive 100 cents in the euro. This assumption severely understates the
banks losses as 83% of banks investment portfolio is in banking books in
form of held-to-maturity assets while only 17% of assets are held in
trading portfolio. In case of sovereign default, the distinction between
the banking book and the trading book simply disappears. By considering
only a smaller component of banks investment books, EU stress tests
have severely undermined the estimated write-downs on banks books and
have given rosy picture about banks true health. The logic of said
methodology is that with the EU/ECB/ EFSF SPV (basically, a giant new
European CDO) backing, no sovereign state will be allowed to default.
• Second, and more importantly, the market is not prepared to
give a zero probability to debt restructurings beyond the period of the
stress test and/or the period after which the role of the EFSF SPV comes
to an end.
o The assumption of no default over 2010-2012 appears reasonable
given that the EFSF is made up of a €720bn lending facility (€220bn from
the IMF; €60bn from the EU; and the SPV can build exposures for 3 years
to the limit of €440bn for the 16 Euro area countries) which provides a
guarantee of funding for any countries facing financing pressures,
certainly for the next 3 years.
o However, the concerns in the market beyond 2012 are: the
longer-run fiscal sustainability problem; and the difficulty of
achieving structural adjustments in labor and pension markets and
ability to achieve a sustainable growth in a period of budget restraint.
The fear is that this will not be resolved by the time the support
packages run out, and hence the probability of restructuring may not be
put at zero by portfolio managers. Angela Merkel has recently announced
her willingness to spearhead several common nation reforms to put the EU
block of nations on heterogeneous footing in regards to regulation,
debt management etc. This will go a long way to solving the problem at
hand, but will also put significant strain on several of the weaker
nations, again exacerbating the probability for restructuring to bring
said nations in line with their stronger counterparts.
Impact of bank’s banking books on haircuts
EU banking book sovereign exposures are about five times larger than
trading book. The table below gives sovereign exposure of major European
countries for both trading and banking book. The EU trading book has
€335bn of exposure while banking book has €1.7t exposure towards
sovereign defaults. EU stress test estimated total write-down’s of €26bn
as it only considered banks trading portfolio. This equated to implied
haircut of 7.9% on trading portfolio with losses equating to 2.4% of
Tier 1 capital. However, if the same haircuts (7.9% weighted average
haircut) are applied to banking book then the loss would amount to
€153bn equating to 13.8% of Tier 1 capital.
We have also presented an alternative scenario since we believe that
EU stress test had failed not only to include banks HTM books but also
the loss estimates were highly optimistic, as has much of the economic
and financial forecasting that has come from the EU. It is highly
recommended that readers review Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse! for a detailed view of a long pattern of unrealistically optimistic forecasting. Here’s and example…
Revisions-R-US!
In an alternative scenario, we have assumed weighted average haircut
of 10% (exposure, haircut assumptions and writedowns for individual
countries are presented in detail in the tables below) and have applied
writedowns on both banking and trading books with the results available
in the subscription document 
The Inevitability of Another Bank Crisis?
Individual and more explicit haircut calculations are available for the
following nations for professional and institutional subscribers:
- Greek Default Restructuring Scenario Analysis
- Greek Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts
- Portugal’s Debt Ridden Finances: An Analysis of Haircuts, Restructuring and Strategy – Professional Analysis
- The Spain Sovereign Debt Haircut Analysis for Professional/Institutional Subscribers
- Ireland Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts
Interested readers can follow me on twitter and review our latest European opinion and analysis.
I will be lecturing on this “realistic” style of analysis as the
special guest speaker at the ING Real Estate Valuation seminar in
Amsterdam. See www.seminar.ingref.com.
- advertisements -
Yes.
Next article.
Hi Reggie,
Pardon my pedanticism, but your following sentence:
"The full cost of cleaning up the balance sheets of financial institutions particularly against the backdrop of adverse macro shocks emulating..."
should employ the word emanating instead of emulating. If you'd like some help editing I'm available.
Reggie, I think you are wrong here.
Human stupidity knows no bounds.
Just ask Kerry (I served in Vietnam), and parse the response.
Reggie you are way cool but i think you are wrong on this one. I forgot the link but there are estimates the ecb can get away with two trillion in quantitative easing. That ought to cover it. I read so much in a week that all my sources blur. Has anyone else read that and looked at the calculations? I would like to find it again to review it.
Who cares about the bank stock prices DONT BUY BANKS. Just kill the headline criminals like DImon and Blankfein.. America would heal alot if these known criminals were thrown in jail
Al queda is going to take care of them. First decent thing they have done. I would hate to be the wife or secretary of one of these guys and open a letter from treasury, the family doctor, or their credit card company. Lots of potential nasty surprises.l
The banks have a crisis. The people of the world hate them and will hate them for a long time. There needs to be a cleansing episode where a bunch of them go to jail or are murdered en mass
If al queda goes after them I will tip my.hat and send an alahu akbar their way!>
There Aint no crissis... Banksters aint going nowhere unless, Crazy Ole Uncle Ben gets locked down in the basement. Otherwise, he is just gunna keep on feeding the monsters, all the world over. Oh the humanity... What is it the gubmint want me to watch on Netflix that I cant see on Fox News ? strange shit
We just closed on our super jumbo refinance today at 4.375% on a 15 year note.
Thanks Ben...bring on inflation?
lets increase the debt ceiling to 50 trillion that should work
Pop Quiz: If you are levered 10:1 and suffer a 10% loss, are you wiped out?
Is that a ZH log in math question?
I was just saying to myself this morning "Where's Reggie?".
Societal crises are the true inevitable; and are the end result of ignoring debt, not allowing failure, and the IMF and worldwide reserve banking system bailing each other out until inflation and currency devaluation leads to riots.
The politicians and bankers will bleed out their middle class and watch societies collapse before admitting that their theories and stratagems are devoid of ethics, morality, and efficacy.
Right now they are managing perceptions with the mistaken belief that it will induce a 2001-2007 "recovery" where they can raise rates and slow inflation.
You and Meredith are letting air out of their perception balloon; prepare for the Congressional Theater (bring popcorn).
What is on your mind Reggie?
BTW Great work!
Welcome to the new and improved managed economy Reggie:
We probably will NOT see a new bankng crises. Almost everything has been backstopped.
Consider:
- QE2 now in place. The Bernak is making plans for QE3. The stock market will be protected becasue it has to be.
- The FED is there to backstop Europe and China if necessary.
- The flow of oil is assured through the professionalism of the US Military. Iraq and Afganistan will be protected thru 2015.
- Mark to market will not see the light of day.
- Obama has to be re elected. All the stops will be pulled out to make it happen.
Am I delusional in all of this? Perhaps - but the entire ponzi depends on it. If more than one of the above fails, they all fail. Failure is simply not acceptable to the worlds financial elite.
Slightly off-topic, but there was an interesting development in Ireland yesterday, regarding their Banks. One which hasn't been covered by any of the financial blogs that I've seen. The biggest home mortgage provider there has just done away with fixed interest rate home loans. From now on, all home loans are adjustable.
This really screws anyone who got an adjustable, and was hoping to refinance it to a fixed rate. Plus, the rates are going up.
http://www.independent.ie/business/personal-finance/property-mortgages/f...
This ought to dampen their housing industry even more. And one has to wonder if/when this kind of move is coming here.
That's an incredibly stupid move, unless their plan is to reinflate the bubble with liar loans.
Most aspiring homeowners are now scared shtiless of adjustable rates and resets.
It will take many years before they can run this scam again.
I agree, it's an incredibly stupid move, if the goal is to better the Irish nation.
It strikes me as a superb move if the goal is to scare the Irish people into voting to elect representitives who will further the EU cause. I.e. not repeal the EU bank bailout. If/when they do that, interest rates will rise and a lot of mortgage owners will be screwed.
It's also an absolutely superb move to keep people in debt slavery forever. All done without having to use foreign troops.
An interesting question would be what would happen if Ireland dropped the Euro with their own local currency? I suspect that, over the longer term, the Euro would implode, making these loans much more affordable.
My apologies, Reggie. I didn't mean to threadjack, and won't comment any more. This should probably be a separate story on it's own. If I thought Tyler would publish it as such, and knew how to submit it, I'd have done so.
Is another crisis inevitable?
You mean, will the same one crawl out from the rug under which it was swept?
Reggie, your Twitter link goes to a picture of you, not your feed.
It's fixed - http://twitter.com/ReggieMiddleton
BTW, what's the matter with a picture of me?
Nuthin,...You're a good lookin' dude.
[and Yes, I'm female, so I can speak with authority.]
I hope you're not a flatchestedtrader.
Cheers!
boobielovincoon
Oh, not at all.
To put it in trader talk, I would say that I am "long boobs", but it might conjure up the wrong mental image.
Can we see? Its all anonymous around here.
No.
You'll just have to make do with the many boob-themed avatars here on ZH.
Junked @ dweeby. No offense.
tha's more trader with the wisdom of "experience"
No more US banking problems are likely until the Fed balance sheet gets to $18,446,744,073,709,551,615.00
Then the typical 64bit computer to create infinite money
will run out of bits. I say we have 2-3 years tops.
"....will run out of bits."
Ben will just buy another computer.
The world will have to switch to an alternate numerical notation, like logarithms or Phoenician base 60, the cuneiform notation. Like the switch from English measures to metric, no problem!
Is Another Banking Crisis Inevitable?
About as inevitable as AAPL falling on compressed margins, as you wrote. So in other word, it won't happen.
Inevitable? Sure, here's how:
"I didn't get the Fed memo, did you get the Fed memo?"
that's an incredibly broad sample of the market
WHY NOT, YOU FUCKING PARROT???
Right, Apple's falling margins didn't really fall. There is no smartphone or tablet competition either.
Reggie, Dont forget to charge ING----unless it causes another bank run
This advice from GS seems to be right in line with where you'd expect them to be though, right? "Suspiciously wrong" is how I think I'd describe it.
Good work. So a multinational bank , ING, invited you to highlight problems in the industry?
"How to value real estate now and in the future" - im assuming you wont be saying mark to fantasy , which is where most of these banks have theirs marked.
Reggie...you keep this up and you're gonna find yourself with an invitation to visit congress and explain yourself a la Meredith Whitney.
Besides...haven't you heard? Banking crisis (or even the implication or mention thereof) is now Illegal and the market will continue to rise for ever and ever and ever and ever and ever...Just ask Harry...he knows everything.
by the way...Great work...as usual. I really appreciate your attention to detail.
What do you mean 'great work?
You infidel, logic and reason will not be tolerated!
Quick, sacrifice a middle income worker before the banker-god grows angry!!!
Hah! I've seen Reggie on TV, and he would Mop the Floor with those cretinous oafs. In fact, they would quiver in fear before the might of his research. He couldn't Buy publicity like that! Probably kill Goldman Sachs overnight. Bring it on!
I'd happily pony up ringside prices to watch Reggie serve our congress-critters an over due dose of a reality bitch slapping.