Strategic Thinking Behind Trading the Inevitability of the Inevitable Pan-European Bank Crisis

In continuing the discussion of trade setups and related strategies started with As Requested By Our Constituency: Trade Setups Based on BoomBustBlog Research, and continued in …

• More On Trading with BoomBustBlog Research;

• A Conversation Between a CDS Trader and an Equity Strategist,

I
bring you the next installation in the discussion of trading the
Pan-European Sovereign Debt Crisis. The annotated email chain is
actually quite long so it will be continuously broken up. I will also
include the comments of the European equity trader in later posts. Any
accomplished tradeer who wishes to join the crowdsourced debate is more
than welcome to throw their hat into the ring.

Eurocalypse, the European CDS trader

At
this stage i have a remark/question in your « the inevitability of a
banking crisis »(dated when ?) you were waaay too optimistic (!!) seeing
172bn of losses related to PIIGS. We may be over that only on Greece
exposure!

Reggie Middleton, the American Realist

For those that don't read me regularly, Eurocalypse is referring to my work below...

Is Another Banking Crisis Inevitable?

Attention subscribers: A new subscription document is ready for download The Inevitability of Another Bank Crisis

Banks NPAs to total loans

Source: IMF, Boombust research and analytics

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!

image044.pngimage044.png

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

Eurocalypse, the European CDS trader

Certainly,
if we compare the fiscal trajectory of the Eurozone as a whole with the
US, the US is not really on a better path. Austerity has started in
Europe. US seems still in full spending spree.

Reggie Middleton, the American Realist

I
disagree, in a way. The US situation is truly FUBAR, indeed, but it is a
slightly differently  FUBAR'd than the EU. The US still:

1. is the world's reserve currency,
2. has
   the world's pre-eminent military and technological forces (which go
   hand-in-hand with number 1, hence is essentially the same thing if
   history is any indicator),
3. has a much more contiguos economy than the EU,
4. although
   is prone to lie about its book keeping situation, is definitely not as
   detached from reality as the EU states. Reference:
5. Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!,

6. Once You Catch a Few EU Countries "Stretching the Truth", Why Should You Believe Any Others

7. LGD 100+: What's the Possibility of Certain European Banks Having a Loss Given Default Approaching 100%?

Then
there is the commercial real estate issue looming in the EU. The two
strongest economies in the EU are being looked to pull the rest of the
EU out of the fire through bailouts, but the ugly truth is that they are
tied to the proflicate (and not so profligate, but still hampered)
states by the waist. Outside of the (borderline recessionary) EU being
their major trading partner(s), they have pretty much bankrolled CRE
lending throughout the entire trading block. Those loans are due to be
rolled over, and they are due to be rolled over on property that has
materially declined in value - leaving a significant equity gap. We're
talking close to 70% to 80% of CRE loans coming due in the next year and
a half on properties that have significant oversupply, weakening rents,
recesionary economies, sovereign debt issues and staunch austerity
plans, and generally devalued properties leaving many a loan underwater.
Haircuts, anyone? Inflation Misconceptions Hide A Downright U-G-L-Y Real Estate Landscape! - Part 1

You
see, there is a highly reflexive relationship between overvalued
sovereign debt held on a higly leveraged basis on EU bank balance sheets
and CRE loans coming due on devalued and underwater real estate. The
sovereign debt crisis is straining lending capacity at the same time
that excess lending capacity is needed to fund underwater property loans
that need to be rolled over. No one is discussing the real estate
portion of the EU banking crisis to be, but it is very real!

I
have delved deeply into this topic during my lectures in Amsterdam.
Reference my featured article in Property EU, one of Europes leading
real estate publicatios

Those who wish to download the full article in PDF format can do so here: Reggie Middleton on Stagflation, Sovereign Debt and the Potential for bank Failure at the ING ACADEMY-v2.

Now,
the US is in a similar situation, but we have managed to fudge the
books to such an extent that some of our CRE investors have actually
risen in price. See The
Conundrum of Commercial Real Estate Stocks: In a CRE "Near Depression",
Why Are REIT Shares Still So High and Which Ones to Short?

With the dearth of synthetic profit streams to support accounting earnings (as banks did in their supposed recover of 2009/10), Weakening Revenue Streams in US Banks Will Make Them More Susceptible To Contingent Risks. I believe, due to major policy errors in dealing with our crash, that we will see our own lost decade(s) in the US...

There
are those who believe US CRE is on a bullish trend, but I believe they
have been mislead by accounting and regulatory shenanigans. Commercial
real estate rarely thrives in high unemployment, increasing interest
rates, stagflationary, sluggish economic times. Then again, maybe I'm
wrong... Reggie Middleton ON CNBC's Fast Money Discussing Hopium in Real Estate

The
US CRE situation is overshadowed (and possibly rightfully so) by the
popular realization that Reggie was accurate in his 2007 assertions that
we are in a residential real estate depression, further complicating
any truly organica economic recovery - at least until true price
discovery is allowed by the financial markets central planning cartel of
government and central bankers. Reference:

1. Reggie Middleton's Real Estate Recap: As I Have Clearly Illustrated, It's a Real Estate Depression!!!

2. The "American Realist" Says: Past as Prologue - Re-blown Bubble to Pop Before the Previous Bubble Finishes Popping!!!!

3. The Residential Real Estate Week in Review, or I Told You We're In A Real Estate Depression! The MSM is Just Catching Up

4. There's Stinky Gas Inside Of This Mini-Housing Bubble, You Don't Want To Be Around When It Pops!

5. Bubble, Bubble, Real Estate Toil and Trouble: Macro Climate for Real Estate Still Sucks, Despite New Bubbles

As this discussion/debate is getting rather lengthy, it will be continued in a later post. In the meantime, interested readers can follow me on twitter or subscribe to BoomBustBlog directly.

Comments

[AldousHuxley]

As long as Euro unravels first, US dollar is safe.

[mikmid]

I find the macinations that all of the banks, central banks, politicians, etc. go through to try to keep the rich, rich to be absolutely amasing. If price discovery was allowed and economic reset accomplished the rich would still be rich but the masses would be able to participate in a better economy and make the rich even richer. 

[PulauHantu29]

Stock market up..again...looks like The Long Depression is over. Also means Wall Street Bonuses will once again be record high based on the stock price.

BOOOOYAAAAH!

[Basia]

Reggie

You are a rising star.  Wish I could understand all your concepts.

[Sudden Debt]

Great article again Reggie!

It's a honor you keep on posting these!

[flacorps]

The wildcard is energy. Oil has been king for a long time, and those who would dethrone it have looked to uranium.

There are now a lot of pretenders to the throne, while the main pretender is in a lot of trouble.

The situation is in flux, and I think we could be on the verge of a major sea change, with a thousand flowers blooming.

Cheap, abundant and clean energy would lead to a lot of things being done very differently, and to other things being done that were heretofore impractical.

"This time it's different" could be because this time there are surprises around the corner.

The alternative, sadly is world war.

[Boilermaker]

BXP is trading at a PE of 102.5 and the rest of the CRE REITs are at 52 week highs. 

They aren't going to stop this shit until the bitter, bloody, friggin' end.  By then, it won't matter anyway.

[FunkyOldGeezer]

So the $14 Trillion (and rising) deficit that the US has, doesn't even come into the equation? Borrowing even more, on an astronomic scale, to pay off existing loans neither?

As a bloc, the EU is a bigger trading partner with China than the USA and China has started showing more interest in helping out the EU with cash injections, something that is far more hands-on than simply accepting $$$$ for the goods it exports to the USA.

I'm confused.

[topcallingtroll]

I mentioned earlier about six months ago that as long as Europe crashes first the USA squeaks through again.  We might not even crash as long as everyone else crashes first and we are able to continue to devalue the FRN

China might just be willing to throw some money away in Europe.  That is the only wildcard here.

[Ghordius]

What if this huge pile we call the First World Banking system just decomposes slowly?

China is putting it's chips on all tables

[DaveyJones]

as long as we're slightly different in the way we're FUBAR'd. I wouldn't want to stoop...  

what's that saying? oh yes... the harder they fall

[shortus cynicus]

2 mln m2 of CRE space is permanently free in Frankfurt.

As recycling attempt, there is some increased (but limited) trend to convert them into condos.

The book value of property not being rented for longer time is: land value minus demolition costs.

That's naked reality for investments in "real values" :-)

[snowball777]

Don't worry...."radiation free" will be a big selling point soon enough.

[66Sexy]

'INEVITABLE'... so much money lost on one word.

BTFD. The "crash" is MIA.