Minutes ago I posted So, What's Next Step Towards The Eurocalypse? wherein I illustrated the folly in believing this CAC-powered Greek bond deal will be the near term sovereign default issues. Following up on those thoughts of serial defaults, I remind my readers and subscribers what was revealed in the post The Biggest Threat To The 2012 Economy Is??? Not What Wall Street Is Telling You...
European banks are (in addition to borrowing on a secured basis from those customers they usually lend to) also paying insurers and pension funds to take their illiquid bonds in exchange for better quality ones, in a desperate bid to secure much-needed cash from the ECB, which only provides cash against collateral. This may not be as safe a measure as it sounds. First of all, there's trash and then there's real trash. The ECB has lowered there standards to accept some very low quality assets as collateral. The lower the quality of the asset, the more volatile that asset can be said to be in times of uncertainty. This is both common sense and taught in the first year of B School. Is it that no one at the ECB has common sense or went to school? Nah!!!! I doubt that's the case. In the post Greece's Problem Is Shared By Much Of The EU & Can't Be Solved Through Parlor Tricks, via ZeroHedge, it was noted:
This 'Deposits Related to Margin Calls' line item on the ECB's balance sheet will likely now become the most-watched 'indicator' of stress as we note the dramatic acceleration from an average well under EUR200 million to well over EUR17 billion since the LTRO began. The rapid deterioration in collateral asset quality is extremely worrisome (GGBs? European financial sub debt? Papandreou's Kebab Shop unsecured 2nd lien notes?) as it forces the banks who took the collateralized loans to come up with more 'precious' cash or assets (unwind existing profitable trades such as sovereign carry, delever further by selling assets, or subordinate more of the capital structure via pledging more assets - to cover these collateral shortfalls) or pay-down the loan in part. This could very quickly become a self-fulfilling vicious circle - especially given the leverage in both the ECB and the already-insolvent banks that took LTRO loans that now back the main Italian, Spanish, and Portuguese sovereign bond markets.
Of course, it gets worse... What can't be pawned off to the ECB in exchange for harsh margin calls merely days later has been pushed into insurers. Below is a sensitivity analysis of Generali's (a highly leveraged Italian insurer, subscribers see Exposure of European insurers to PIIGS) sovereign debt holdings.
As you can see, Generali is highly leveraged into PIIGS debt, with 400% of its tangible equity exposed. Despite such leveraged exposure, I calculate (off the cuff, not an in depth analysis) that it took a 10% hit to Tangible Equity. Now, that's a lot, but one would assume that it would have been much worse. What saved it? Diversification into Geman bunds, whose yield went negative, thus throwing off a 14% return. Not bad for alleged AAA fixed income. But let's face it, Germany lives in the same roach motel as the rest of the profligate EU, they just rent the penthouse suite! Remember, Germany is not in recession after a rip roaring bull run in its bonds, and I presume the recession should get much deeper since as a net exporter it has to faces its trading partners going broke. Below you see what happens if the bund returns were simply run along the historical trend line (with not extreme bullishness of the last year).
Companies such as Generali would instantly lose a third of their tangible equity. This is quite conservative, since the profligate states bonds would probably collapse unless the spreads shrink, which is highly doubtful. Below you see what would happen if bunds were to take a 10% loss.
That's right, a 10% loss in bunds translates into a near 50% loss in tangible equity to this insurer, which would realistically be 60% plus as the rest of the EU portfolio will compress in solidarity. Combine this with the fact that insurers operating results are facing historically unprecedented stress (see You Can Rest Assured That The Insurance Industry Is In For Guaranteed Losses!) and it's not hard to imagine marginal insurers seeing equity totally wiped out. On that note, here's some info on a very large, very well respected and very diversified European insurer. Before reviewing this, make sure you have read So, What's Next Step Towards The Eurocalypse? and understand the concepts behind Contagion Should Be The MSM Word Du Jour, in particular the potential and paths for contagion, nominally... What happens when you take the raw public debt exposure and you massage it for reality? Well, BoomBustBlog subscribers already know. Here's a sneak peak of just one such scenario...
(Click to enarge)
- Sovereign Contagion Model - Retail - contains introduction, methodology summary, and findings
- Sovereign Contagion Model - Pro & Institutional - contains all of the above as well as a very detailed methodology map that explains what went into the model across dozens of countries.
You see, Greece getting away with bondholder murder can easily kick off an interest rate shit storm. If so, it really won't look pretty - not nearly as pretty as Lehman, at least! Ask this big EZ insurer that would immediately get $11B chopped off of equity nearly instantaneously...
Subscribers are well served to review this report released in December. This opportunity is driven from the possibility of a Euro sector sovereign meltdown. Thus far, every step leads in that direction. I'm not saying its guaranteed, but everything has been happening according to plan thus far, D day looks to be that much closer...
- Insurer Report_122511 - Professional/Institutional edition
(Insurers, Insurance & Risk Management)
- Insurer Report_122511 -Retail edition
The same situation is evident in banks and pension funds as well as real estate entities dependent on financing in the near to medium term - basically, the entire FIRE sector in both European and US markets (that's right, don't believe those who say the US banks have decoupled from Europe).
Reggie Middleton Explains the Travails of the F.I.R.E. Sector on CNBC
- Reggie Middleton on CNBC StreetSigns Sees 2012 As Reluctant/Manipulated Continuation of Q1 2009
- Reggie Middleton Sets CNBC on F.I.R.E.!!!
- First I set CNBC on F.I.R.E., Now It Appears I've Set Sell Side Wall Street on F.I.R.E. As Well!!!
Next up I release the latest (and very interesting) Apple research to subscribers, and the effects of this sovereign stuff on British banks and US CRE.
As is usual, you can reach me via BoomBustBlog or by the following means...