Rating Agencies

There was some hope that today's European summit would provide some more clarity for something else than just the local caterer's 2012 tax payment. It wont. Per Reuters: "Germany does not believe that jointly issued euro zone bonds offer a solution to the bloc's debt crisis and will not change its stance despite calls from France and other countries to consider such a step, a senior German official said on Tuesday. "That's a firm conviction which will not change in June," the official said at a German government briefing before an informal summit of EU leaders on Wednesday. A second summit will be held at the end of June. The official, requesting anonymity, also said he saw no need for leaders to discuss a loosening of deficit goals for struggling euro zone countries like Greece or Spain, nor to explore new ways for recapitalise vulnerable banks at Wednesday's meeting." In other words absolutely the same as in August 2011 when Europe came, saw, and did nothing. Yes, yes, deja vu. Bottom line: just as Citi predicted, until the bottom falls out of the market, nothing will change. They were right. As for the summit, just recycle the Einhorn chart from below. Elsewhere, the OECD slashed world growth forecasts and now officially sees Europe contracting, something everyone else has known for months. "In its twice-yearly economic outlook, the Paris-based Organisation for Economic Co-operation and Development forecast that global growth would ease to 3.4 percent this year from 3.6 percent in 2011, before accelerating to 4.2 percent in 2013, in line with its last estimates from late November... The OECD forecast that the 17-member euro zone economy would shrink 0.1 percent this year before posting growth of 0.9 percent in 2013, though regional powerhouse Germany would chalk up growth of 1.2 percent in 2012 and 2.0 percent in 2013." Concluding the overnight news was a meaningless auction of €2.5 billion in 3 and 6 month bills (recall, Bill issuance in LTRO Europe is completely meaningless) in which borrowing rates rose, and a very meaningful downgrade of Japan to A+ from AA, outlook negative, by Fitch which lowered Japan's long-term foreign currency rating to A plus from AA, the local currency rating to A plus from AA minus, and to the country ceiling rating to AA+ from AAA. Yes, Kyle Bass is right. Just a matter of time. Just like with subprime.

Frequent readers know that Citi's Matt King is our favorite analyst from the bailed out firm. Which is why we read his latest just released piece with great interest. And unfortunately for our European readers, if King is right, things in Europe are going to get far worse, before they get better, if at all. Because while one may speculate about political jawboning, the intricacies of summit backstabbing, and other generic nonsense, the one most important topic as discussed lately, is that terminal event that any financial system suffers just before it implodes or is bailed out: full scale bank runs. It is here where King's observations, himself a member of a TBTF bank which would likely be dragged down in any cash outflow avalanche, are most disturbing: "In Greece, Ireland, and Portugal, foreign deposits have fallen by an average of 52%, and foreign government bond holdings by an average of 33%, from their peaks. The same move in Spain and Italy, taking into account the fall that has taken place already, would imply a further €215bn and €214bn in capital flight respectively, skewed towards deposits in the case of Spain and towards government bonds in the case of Italy....Economic deterioration, ratings downgrades and especially a Greek exit would almost certainly significantly accelerate the timescale and increase the amounts of these outflows." That's right: according to Citi there is a distinct likelihood that, all else equal, the domestic bank sector in Spain will see another €215 billion in deposit outflows.

Just when we though that nobody would take advantage of the cover provided by the epic flame out of the FaceBomb IPO and the ongoing market crash, here comes Spain. Because there is nothing quite like a little Friday night action following a market drubbing and an "IPO for the people" shock in which to sneak the news that, oops, sorry, we were lying about all that austerity. Because while it came as a surprise to the market back in December when Spain announced it would post a 2011 budget deficit of 8.5% instead of the previously promised 6%, the market will hardly be impressed that Spain actually overspent by another €4.2 billion, to a brand new total of €95.5 billion of 8.9% of GDP. So Monday now has two things to look forward to: the Spanish bond margin hike on one hand courtesy of LCH.Clearnet earlier, and the fact that despite spending even more than expected, GDP growth has disappointed and the country is now officially in a double dip. Hardly what the country with the record wide CDS needs right now.

A few days ago we suggested that this action by LCH.Clearnet was only a matter of time. Sure enough, as of minutes ago the bond clearer hiked margins on all Spanish bonds with a duration of more than 1.25 years. Net result: the Spanish Banks which by now are by far the largest single group holder of Spanish bonds, has to post even moire collateral beginning May 25. Only problem with that: it very well may not have the collateral.

And.... roundtrip.

• From March 13: Fitch upgraded Greece's credit rating by one notch to B- following a successful debt swap finalised this week that erased some €100 billion from the country's crippling debt
• From May 17: Fitch Ratings-London-17 May 2012: Fitch Ratings has downgraded Greece's Long-term foreign and local currency Issuer Default Ratings (IDRs) to 'CCC' from 'B-'. The Short-term foreign currency IDR has also been downgraded to 'C' from 'B'. At the same time, the agency has revised the Country Ceiling to 'B-'. The downgrade of Greece's sovereign ratings reflects the heightened risk that Greece may not be able to sustain its membership of Economic and Monetary Union (EMU). The strong showing of 'anti-austerity' parties in the 6 May parliamentary elections and subsequent failure to form a government underscores the lack of public and political support for the EU-IMF EUR173bn programme.

It would be laughable if it wasn't so... nevermind, it is laughable.

Just because it is never boring after hours:

• MOODY'S DOWNGRADES ITALIAN BANKS; OUTLOOKS REMAIN NEGATIVE

EURUSD sliding... even more. But that's ok: at some point tomorrow Europe will close and all shall be fixed, only to break shortly thereafter. And now.... Margin Stanley's $10 billion collateral-call inducing 3 notch downgrade is on deck.

Big Ben starved the banks trying to save them, hence they got more aggressive in hunting for food (yield)! That being the case, don't believe only JPM was overreaching for yield.

Update: now S&P is also one month behind Egan Jones: JPMorgan Chase & Co. Outlook to Negative From Stable by S&P. Only NRSRO in pristinely good standing is Moodys, and then the $2.1 billion margin call will be complete.

So it begins, even as it explains why the Dimon announcement was on Thursday - why to give the rating agencies the benefit of the Friday 5 o'clock bomb of course:

• JPMorgan Cut by Fitch to A+/F1; L-T IDR on Watch Negative

What was the one notch collateral call again? And when is the Morgan Stanley 3 notch cut coming? Ah yes:

So... another $2.1 billion just got Corzined? Little by little, these are adding up.

We have presented our opinion on the JPM prop trading desk repeatedly, in fact starting about a month ago. Last night, Senator Carl "Shitty Deal" Levin also decided to join the fray, which is to be expected: the man needs air time. And now, in a surprising twist, competing banks, all of whom have more than enough skeletons in their own prop desk trading closet, are starting to speak up against the bank that should not be named. Enter Deutsche Bank's Jim Reid and his take on the Fail Whale.

The last time a French trader delivered a bomb this big (Jerome Kerviel), the Fed cut the discount rate by 75 bps. As for this particular Frenchman, his best epitaph is his Bloomberg profile page. Recall:

"Chuck is french ; champion of 'kick it', walking over water and humble.. yes"

You can now add "fired." Oh, and it is all Egan Jones' fault of course, who downgraded JPM on April 13, while all the other rating agencies were posturing for the highest possible bribe to keep their mouths shut.

Last week, looking at Third Point's best performing positions we noticed something odd: a big win in Portuguese sovereign bonds in the month of April. We further suggested: "We suspect the plan went something like this: Loeb had one of his hedge-fund-huddles; the cartel all bought into Portuguese bonds (or more likely the basis trade - lower risk, higher leverage if a 'guaranteed winner'); bonds soared and the basis was crushed; now that same cartel - facing pressure on its AAPL position (noted as one of Loeb's largest positions at the end of April) - has to liquidate (reduce leverage thanks to AAPL's collateral-value dropping) and is forced to unwind the Portuguese positions. A quick glance at the chart below tells the story of a Portuguese bond market very much in a world of its own relative to the rest of Europe this last month - and perhaps now we know who was pulling those strings?" Since the end of April, both AAPL and Portuguese bonds have tumbled, and Portugal CDS is +45 bps today alone, proving that circumstantially we have been quite correct. Today, we have the full Long Portugal thesis as explained by Loeb (it was a simple Portuguese bond long, which explains the odd rip-fest seen in the cash product in April). There is nothing too surprising in the thesis, with the pros and cons of the trade neatly laid out, however the core premise is that the Troika will simply not allow Portugal to fail, and that downside on the bonds is limited... A thesis we have heard repeatedly before, most recently last week by Greylock and various other hedge funds, which said a long-Greek bond was the "trade of the year", and a "no brainer." Sure, that works, until it doesn't: such as after this past weekend, in which Greece left the world stunned with the aftermath of what happens when the people's voice is for once heard over that of the kleptocrats, and the entire house of cards is poised to collapse.

If French Fitch, which will first be Egan-Jonesed than downgrade France from its unmovable AAA rating is starting to say that the unthinkable, namely the departure of Greece from the Eurozone, would be "bearable", then things are about to get once again exciting, as this is merely setting the stage for the next leg down. Among the other google translated gibberish said by Fitch chief Taylor, here is the argument: Germany would merely soak up the damage caused by a Greek departure: "Greece's exit does not mean the end of the euro. Above all, Germany has a fundamental interest in preserving the common currency remains. Would the D-mark re-introduced, they would add value compared to other currencies strong. The export industry, that is: would the engine of the German economy, damaged. This will not allow Germany - even if one or more countries leave the single currency area." How about Italy's exit? Or Portugal's? Or Spain's? At what point does it become unbearable for German taxpayers to burn their wealth to preserve a system that virtually nobody but a few select career politicians demand?

Even as the SEC is hell bent on destroying Egan Jones as a rating agency, in the process cementing its status as an objective, independent, and honest third party research entity, the firm is just as hell bent on milking its still existing NRSRO status for all it's worth. Because while Egan Jones was the first entity to cut Spain two weeks ago, only to be followed by Spain, it just did so again minutes ago.

The good news: Spanish Q1 GDP printed -0.3% on expectations of a -0.4% Q/Q decline. Unfortunately this is hardly encouraging for the nearly 25% of the labor force which is unemployed, and for consumers whose purchasing habits imploded following record plunges in retail sales as observed last week. The bad news: Spain now joins at least 10 other Western countries which have (re) entered a recession. Per DB: "Spain will today likely join a growing list of Western Developed world countries in recession. Last week the UK was added to a recession roll call that includes Greece, Italy, Portugal, Ireland, Belgium, Denmark, Holland, Czech Republic, and Slovenia. Debt ladened countries with interest rates close to zero have limited flexibility to fight the business cycle and this impotency will continue for many years." Alas, the abovementioned good news won't last: from Evelyn Hermman, economist at BNP - "The Pace of Spain’s economic contraction may increase in coming quarters as austerity measures bite more sharply." Of course, it is the "good news" that sets the pace each and every day, as the bad news is merely a further catalyst to buy, buy, buy as the ECB will allegedly have no choice but to do just that when the time comes. And something quite surprising from DB's morning comment: "If it were us in charge we would allow more defaults which would speed up the cleansing out of the system thus encouraging a more efficient resource allocation in the economy at an earlier stage." Wait, this is Deustche Bank, with assets which are nearly on par with German GDP, saying this? Wow...

Three weeks ago we discussed the ultimate-doomsday presentation of the state of Spain which best summarized the macro-concerns facing the nation and its banks. Since then the market, and now the ratings agencies, have fully digested that meal of dysphoric data and pushed Spanish sovereign and bank bond spreads back to levels seen before the LTRO's short-lived (though self-defeating) munificence transfixed global investors. However, the world moves on and while most are focused directly on yields, spreads, unemployment rates, and loan-delinquency levels, there are two critical new numbers to pay attention to immediately - that we are sure the market will soon learn to appreciate. The first is 5%. This is the haircut increase that ECB collateral will require once all ratings agencies shift to BBB+ or below (meaning massive margin calls and cash needs for the exact banks that are the most exposed and least capable of achieving said liquidity). The second is 10%. This is the level of funded (bank) assets that are financed by the Central Bank and as UBS notes, this is the tipping point beyond which banks are treated differently by the market and have historically required significant equity issuance to return to regular private market funding. With S&P having made the move to BBB+ this week (and Italy already there), and Spain's banking system having reached 11% as of the last ECB announcement (and Italy 7.7%), it would appear we are set for more heat in the European kitchen - especially since Nomura adds that they do not expect any meaningful response from the ECB until things get a lot worse. The world is waking up to the realization that de-linking sovereigns and banks (as opposed to concentrating that systemic risk) is key to stabilizing markets.