non-performing loans

"Preservation of Capital," has reached epic seriousness in a world with interest rates at unsustainable lows and underlying economic fundamentals that cannot support today's yields. The irrational game goes on based upon one thing and one thing only which is the creation of capital by all of the world's central banks. The money must go somewhere and so it does but the disconnect between the equity markets and bond yields from the real world is frightening. Nowhere on the planet is it scarier than in Europe.

Europe's non-performing loan problem is such an issue that there is increasing bluster that the ECB may take this garbage on to its balance sheet since policymakers realize that bad debts and non-performing loans (NPLs) reduce the capacity of banks to lend, hindering the monetary policy transmission mechanism. Bad debts consume capital and make banks more risk averse, especially with respect to lending to higher risk borrowers such as SMEs. With Italy (NPLs 13.4%) now following the same dismal trajectory of Spain's bad debts, the situation is rapidly escalating (at an average of around 2.5% increase per year). With Periphery non-performing loans totaling EUR 720bn across the whole of the Euro area in 2012 and EUR 500bn of which were with Peripheral banks, it seems the Cyprus deposit haircut 'non-template' may indeed become the key template.

A month ago we pointed out that even as the Chinese credit bubble - at a record 240% of GDP on a consolidated basis - is now clearly out of control, the far more disturbing aspect of China's credit-fueled economy is the ever declining boost to economic growth as a result of every incremental dollar created. Indeed, as the economic response to "credit shock" becomes lower and lower, even as the inflationary impact lingers, the PBOC is caught between a stagnating rock and an inflationary hard place. Nonetheless, there are few options and with the shark-like need to continue growing, or at least moving, in order to prevent collapse, China did precisely what we expected it to do: boost credit growth even more despite the obvious tapering economic impact of such money creation. Sure enough, overnight China reported that its M2 growth accelerated in April from 15.7% in March, to 16.1% on a Y/Y basis: the fastest pace of credit creation in two years. Yes, the PBOC may not be creating money, but the Chinese pseudo-sovereign commercial banks, sure are, and at a pace that puts the rest of the world to shame.

More thoughts on the ECB's balance sheet and why a negative deposit rate is unlikely.

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As the IMF delivers its first 'health check' on Greece since 2009, the beleaguered nation's finance minister proudly proclaims, "the worst is over," and the country had reached its economic trough. However, while the finance minister appears unaware of the people living in caves, the record youth unemployment (that is rising still), and the accelerating non-performing loans (no green shoots there), the IMF remains a little less confident, "Greece's debt remains much too high". As the Sydney Morning Herald reports, Stournaras added that ''in May 2014, the loan installments will come to an end and the country has to be in a position where it can go on its own to the markets.'' We can't wait (with GGBs under 10% yield to see which greater fool snaps up those beauties). The IMF is a little less sanguine warning Greece of its "insufficient structural reforms," and worries of the "socially painful recession." The last jab, in line with the new normal 'template' (that is not a template but really is), "very little progress has been made in tackling Greece’s notorious tax evasion," as the IMF demands, "the rich and self-employed are simply not paying their fair share."

Most of the SAREB's loans are linked to finished properties, for which it might be easier to find a buyer, but 4.3 percent are for unfinished developments and nearly 10 percent are for empty lots, for which there is little or no demand. Nearly all of the foreclosed properties in its portfolio are empty, including apartment blocks far outside big cities. Only 6,000 of nearly 83,000 housing units have tenants.

The next Great Depression is already happening - it just hasn't reached the United States yet.  Things in Europe just continue to get worse and worse, and yet most people in the United States still don't get it.  We have been warning that the next major wave of the ongoing economic collapse would begin in Europe, and that is exactly what is happening.  In fact, both Greece and Spain already have levels of unemployment that are greater than anything the U.S. experienced during the Great Depression of the 1930s. Pay close attention to what is happening over there, because it is coming here too.  A full-blown economic depression is raging across southern Europe and it is rapidly spreading into northern Europe.  Eventually it will spread to the rest of the globe as well. The U.S. economy has become a miserable junkie that is completely and totally addicted to reckless money printing and gigantic mountains of debt. If we stop printing money and going into unprecedented amounts of debt we are finished. If we continue printing money and going into unprecedented amounts of debt we are finished. Either way, this is all going to end very, very badly.

This is a descriptive not a normative claim. My focus is on what people are actually doing, not what they might have done or what some think they should have done.

We have commented numerous times on the inexorable rise in Spanish non-performing loans (NPLs). Since the Spanish economy started to weaken at the end of 2006, NPLs have been rising sharply; but the subsequent collapse of the Spanish property market exacerbated the matter further, causing a spike in NPLs in 2007 and 2008. Since then, the Euro area crisis and subsequent sharp rise in unemployment have led NPLs at Spanish banks to make new record highs. However, they are not alone. Italian banks did not suffer a property market collapse and so the rise in NPLs started later than in Spain and was not as severe. However, as JPMorgan notes, the sharp rise in unemployment we have seen since mid 2011 has led to an acceleration in NPLs at Italian banks. What should be most worrying for incoming PM Letta, is that from the respective troughs for each country (the trough for Spain was a lot earlier than for Italy, about two years in actual fact), Italy is looking eerily similar. The rise in NPLs at Spanish banks over the past two years has had a lot to do with the recession and rise in unemployment. To the extent that Italian unemployment has only started to rise sharply a year and a half ago, the future path for NPLs at Italian banks looks set to follow that of Spain. So why aren't bond spreads blowing wider? Answer below...

After reading the Spiegel article below, which reveals so much about German thinking, it becomes very clear that not only is Cyprus the "benchmark", but that the second some other PIIG country runs into trouble again, and its soaring non-performing loans inevitably demand a liability "resolution" a la Cyprus, it will be Germany once again at the helm, demanding more of the same equity, unsecured debt and ultimately depositor impairment. As the following punchline from Spiegel summarizes, "It would be more sensible -- and fairer -- for the crisis-ridden countries to exercise their own power to reduce their debts, namely by reaching for the assets of their citizens more than they have so far. As the most recent ECB study shows, there is certainly enough money available to do this." And that is the crux of the wealth-disparity demand of the European Disunion.

Yesterday’s quarterly bank lending survey capped off a series of indicators with a bleak message for the Eurozone economy. Almost all signs suggest that Europe continues to spiral downwards. The lending survey, compiled by the European Central Bank (ECB), is one of the best leading indicators of all because it tells us about the critical credit link in the economy. In the Eurozone today, tight credit is part of a vicious circle that includes business retrenchment, weakening demand, job cuts and falling incomes. And the scariest thing about the circle is that it feeds on itself – each part reinforces the other parts. It won’t go on forever, but we need to see some improvement in the leading edge of the economy before we can expect it to end. As far as the most telling leading indicators, those that can be directly manipulated through monetary policy are the only ones pointing to a possible end to the vicious circle.  In other words: interest rates and equity markets. Until we signs of strength in at least one or two of the leading indicators discussed below, bet on the recession to continue.

When it comes to Italy, the market may have priced in every possible favorable outcome (the ECB and Kuroda will take care of the rest), but the country still has no Prime Minister and its economy continues to be in freefall with record unemployment and ever higher bank non-performing loans month after month. And while it may have elected a new figurehead president after 6 attempts last week, the choice of Prime Minister will hardly be as simple, especially since as the WSJ reports, this will likely be Enrico Letta, deputy of the Democratic Party (which as a reminder is in complete chaos following last week's internal coup and the resignation of its head Bersani over the weekend), at a time when Berlusconi's PDL lead in the polls continues to increase. Why the Bunga veteran would agree to a premiership by his opponents remains unclear, and with a parliamentary vote coming, it is doubtful just how smooth the approval process will be in a country best known for its dysfunctioning political process.

Despite rising (and record) unemployment, non-performing loans at record levels crushing the banking system's balance sheets, pension funds all-in, and their Italian neighbor now expecting more budget cuts of almost 1% of GDP in 2015-17 (and further downside risks to the GDP forecasts); Italian and Spanish bond spreads are pressing below critically 'positive' levels. While Italy remains above recent low spreads, Spain has just breached the 300bps (spread to Bunds) level; last seen in November 2011. The last 3 days have been the best run in Spanish bonds for six months. This level has been significant resistance a number of times since the European crisis began, but this time it's different, since the BoJ is seemingly blind to 'risk' and only sees 'return'. With the market telling the politicians that Europe is fixed, is it any wonder they are all asking for a stop to austerity? Or is bad once again good, as it forces Draghi's hand to follow his BoE, BoJ, Fed compatriots down the rabbit hole?

An attempt to look ahead at the drivers of the capital markets in the week ahead.