There's A Very Nasty Storm Brewing in Euroland and Umbrellas Are Selling At Premiums With Insolvent Counterparties Attached - Prepare For It to Get Ugly!

Reggie Middleton's picture

I have been bearish on European banks since the UK mortgage banks
collapsed several years ago. To this day, despite mounds of fundamental
and macro evidence pointing to very bad things happening, there are
still cheerleaders stating that concerns are overblown. A good example
can be found in the post “Greek
Crisis Is Over, Region Safe”, Prodi Says – I say Liar, Liar, Pants on
, on March 14th:

“The worst of Greece’s
financial crisis is over and other European nations won’t follow in
its path”
, said former European Commission President Romano
. “For Greece, the problem is completely over,
said Prodi, who was also Italian prime minister, in an interview in
Shanghai today. “I don’t see any other case now in Europe. I
don’t think there is any reason to think the euro system will collapse
or will suffer greatly because of Greece

Okay, I shouldn’t have called him a liar,
but a tad bit optimistic, maybe? I actually agree with the last part of
his statement. The euro system will not suffer greatly because of
Greece, it will suffer greatly because of individual member countries’
problems collectively weighing on the union. As for Mr. Prodi’s
accuracy, let’s take a look at the Greek CDS over the time period in

Greece cds spreads

Yeah, that’s right! Listening to the former EC President would have
gotten you on the wrong side of the TRIPLING of CDS spreads. Not to fret
though, the ECB allocated 1 trillion dollars to alleviate this problem,
and now spreads have just more than doubled, but are still rising. And
for those of you who believed me over Prodi (I apologize again for the
“liar, liar pants on fire” bit, though)…

nbg - may 15 - June 8th

On that note, people have been asking me is it too late to join in on
the euro-bank brigade. My opinion is that the cat is out on these
popular names, and the option prices have finally caught up with the
fundamental and macro prospects of the actual entities. With that being
said, those fundamentals and macro prospects look awfully negative. In
the posts “With
the Euro Disintegrating, You Can Calculate Your Haircuts Here
“, “What is the Most Likely Scenario in the Greek Debt
Fiasco? Restructuring Via Extension of Maturity Dates”
and A
Comparison of Our Greek Bond Restructuring Analysis to that of
, I detailed prospective haircuts to be taken on Greek
debt, using a thorough forensic analysis methodology. To be absolutely
honest, the numbers contained withing the first two were quite
optimistic. In reality, in order for any restructuring to work, debt to
GDP should be reduced to below 100%. This wasn’t done i the previous
Greek analysis, but was hinted at in the Argentinian comparison…

Now, referencing the bond price
charts below as well as the spreadsheet data containing sovereign debt
restructuring in Argentina, we get…

Price of the bond that went under
restructuring and was exchanged for the Par bond in 2005


Price of the bond that went under
restructuring and was exchanged for the Discount bond


With this quick historical primer
still fresh in our heads, let’s revisit our Greek, Spanish, and Italian banking analyses (the
green sidebar to the right), many of which are trying to push the 400%
mark in terms of returns if one purchased OTM options at the time of the
research release. It may be worthwhile to review the Sovereign debt exposure of Insurers and Reinsurers
as well.

We may very well get a bear market
rally or two that may pop prices, but from a fundamental perspective, I
do not see how significantly more pain is not to come out of this debt
fiasco. The only question is who’s next. We feel we have answered that
question is sufficient detail through our Sovereign Contagion Model. Thus far, it has
been right on the money for 5 months straight!

I am now releasing the updated version of the Greek bank haircut
analysis, with the realistic goal of attaining sustainable debt to GDP
levels. This is a professional level subscription document, but be
assured, the number are ugly – quite ugly. Just as it was for
Argentina.  Now, just imagine 4 or 5 Argentinas, all multiples of the
size of Argentina attempting this style of restructuring and aggressive
hair cutting in the midst of aggressive QE going nowhere through another
sharp economic decline exacerbated by austerity measures. Long story
short, you ain’t seen nothing yet! No matter which way Greece looks at
it, and no matter how they restructure, they will have to hit the public
markets again by 2014, and that is with subsidies, ECB/EU/IMF bailouts,
haircuts, restructurings, the whole nine yards. It ain’t pretty!



This is why the European banks are scared shitless to lend to each
other. There’s a very nasty storm brewing up ahead, and umbrellas are
selling at premiums, with insolvent counterparties attached. Reference
today’s articles from ZeroHedge on the topic:

Deposit Facility Usage Hits Fresh Record At €362 Billion As Liquidity
In Europe Worse Than Ever

Europe’s banks are not buying the
propaganda about liquidity moderation on the continent. In fact quite
the contrary: yesterday’s total usage of the ECB’s overnight deposit
hit a fresh all time record of €361.7 billion. This is an
€11 billion increase from the night before and €55 billion from a week
earlier. This means that all the excess liquidity in Europe is getting
tied into the safety of the central bank, and the market continues to
experience a liquidity glut. It also explains why both 3 and 6 month
Euribors crept higher today, to 0.713% and 0.999%, just wider compared
to yesterday’s fixings. Ignore all the populist rhetoric: the liquidity
in Europe is getting worse with each passing day, as the banks’ own
actions confirm.

Oh yeah, this is all despite the fact that the Eurozone Nations Set Up $1
Trillion Bailout Fund
. European banks are hitting the ECB for
parking their cash (as opposed to to lending to fellow banks that are killing themselves or are nearly guaranteed suspect counterparties) at a
greater rate that at ANY time during the crisis including the collapse
of Bear Stearns and the bankruptcy of Lehman Brothers.

Professional subscribers should reference the live, online spreadsheet: Greek Debt Restructuring Analysis with Sustainable
Debt/GDP Ratio Limits – Professional