Wednesday, 09 November 2011 05:58

How Long Does It Take For Losing Money To Result In Lost Money? The Effects Of Rampant Bond Selling on Devalued Sovereign Debt Featured

I am working on an interesting project closely connected to the issue that European (and now American) banks are facing. The firs of several reports should be available to paid subscribers in about a week. In the meantime, let's make a few observations that may or may not have been lost on market participants.

Paid subscribers should reference the quarterly results of the bank that was illustrated in our most recent forensic report - Haircuts, Derivative Risks and Valuation. Yes, BoomBustBlog has hit the skin off the ball once again. I will be available in the private forums to discuss this, as well as provide links for those who have not seen the news yet.

Summary: For years I have warned of the impending European collapse. Now, as it is happening, we still have banks getting away with nonsensical 60% writedowns on essentially worthless debt. Loss Given Default > 100+% - You ain't seen the worst of it, not by a long shot!

From the BNP Paribas earnings press release:

Rather than implementing the agreement reached on 21 July, EU authorities formulated a new Greek assistance package on 27 October. As a result of this plan, whose implementation is still shrouded by uncertainty, BNP Paribas set aside a provision for 60% of the full amount of all Greek sovereign debt it holds, which equates to further provision of 2,094 million euros for the banking book and of 47 million euros for the insurance portfolio. Furthermore, the effect of the additional impairment of Greek bonds on associated companies was negative to the tune of 116 million euros.

The Group's revenues, which totalled 10,032 million euros, were down 7.6% compared to the third quarter 2010. They grew in Retail Banking (+2.2% at constant scope and exchange rates with 100% of the domestic networks' private banking businesses, excluding PEL/CEL effects), and Investment Solutions (+2.5%) but fell 39.8% at Corporate and Investment Banking due to very challenging market conditions and losses on sales of sovereign bond debt (-362 million euros). Corporate Centre revenues were affected by two exceptional items related to the valuing of long-term assets and liabilities at market price (+786 million euros in own debt revaluation and -299 million euros in additional impairment on the equity investment in AXA).

This seems to be glossed over, but the equity impairments and revaluation of liabilities are a big deal, particularly in entities that are bond rich (well, now poor).

... With the additional provision set aside for Greek government bonds, the cost of risk was 3,010 million euros.

Excluding this effect, it continued its downward trend (-28.9%) in all the business units, coming in at 869 million euros, or 50 basis points of outstanding customer loans compared to 72 basis points in the third quarter 2010.

This is nonsense. They are speaking as if the devaluation is a one time event, when in reality it is the beginning of a long string of events. You lose credibility when you play your audience for fools...

The Group reported 541 million euros in net profits (attributable to equity holders) (-71.6% compared to the third quarter 2010). Excluding the Greek debt provision, net profits were 1,952 million euros, up 2.4% compared to the same period a year earlier.

For the first nine months of the year, the Group's revenues totalled 32,698 million euros, a limited decline compared to the first nine months of 2010 (-2.6%). Thanks to CIB's flexible costs, and despite the effect of the bank levies, operating expenses edged down 1.0% (-1.7% excluding the bank levies). Gross operating income was down 4.8% at 13,260 million euros and net income (attributable to equity holders) down 16.0% at 5,285 million euros. Excluding the impact of the provision set aside in connection with the Greek assistance programme, the cost of risk was down 28.5% during the period and net income (attributable to equity holders) totalled 7,034 million euros, up +11.8% compared to the first nine months of 2010.

Click to expand...


But including losses on Spanish, Italian, Irish and Portuguese capital losses realized upon disposition, and the ongoing losses on Greek debt, what then????

You see, the truly under appreciate problem here is that the private banks rampant selling is driving down the prices of already highly distressed and rapidly devaluing bonds. Reference Bloomberg's European Banks Selling Sovereign Bond Holdings Threatens to Worsen Crisis.

In the news now, exactly as I anticipated European Stocks Drop as Italian Bond Yields Jump as well as:

No surprises here:Wednesday, 03 August 2011 - France, As Most Susceptble To Contagion, Will See Its Banks Suffer

These events are quite relevant for I warned several times over that the true risks are in Italy's funding fragility, its size, and its direct ties into France who, if caught the contagion, would invalidate any Pan-European rescue scheme. That is why "The French Banks Are The First To Accept a Voluntary Greek Restructuring". Well, here we are! Another point that is oft overlooked is that while all of the these private holders are dumping European bonds en mass, who is buying them. Well, I addressed this last year and early this year as well.. Over A Year After Being Dismissed As Sensationalist For Questioning the ECB's Continued Solvency After Sovereign Debt Buying Binge, Guess What! Keep in mind that Italy has already accepted IMF supervision over its finances, which means that it has in essence already given up its sovereign financial independence. We all know what the next step is, don't we? The IMF injects funds under strict austerity and calls the shots, just like it does with (other?) third world nations. There are ramifications here that are simply lost on most, but I will help most find it! Please continue reading...

The ECB as well as many local banks and pension schemes are being forced to buy these bonds to maintain a facade of a bid in a near bidless market (at least bidless from the perspective of avoiding total price collapse), but what does that portend for the entities doing the buying if the sellers are losing so much money and the yields are still flying through the roof? Well I addressed that in early 2010, reference  How Greece Killed Its Own Banks!.


Yes, it's ugly, and it gets even uglier! Nouriel Roubini Tweets this morning "Italian yields at Ponzi levels: having to borrow more just to finance the interest on debt leading to vicious unsustainable debt dynamics." I respect this man's opinion, but he is just scraping the surface. Look back to last year when I really started bringing up the case of defaults, liquidations and recoveries in the iconic piece How the US Has Perfected the Use of Economic Imperialism. Warning, this is going to piss off many an oligarch! As excerpted...

How many of those Greek, Portuguese, Irish and Spanish bondholders have factored the near guaranteed "additional" haircut (/scalping) they will receive having to stand behind the IMF in the event of a (probably guaranteed) default or restructuring? Do you think the investors of European banks (that includes central banks) that are holding/and currently still buying a boat load of these bonds have factored this into their valuations?

The IMF, like many other international institutions, asserts that it has a "preferred creditor status", and this has been a practiced convention in the past. Thus, IMF has de facto seniority rights over private creditors despite the fact that there is no legal or treaty-based foundation to support this claim and this seniority of rights for IMF will continue under the recent EU rescue plan announced as well as it has not been noted otherwise implicitly nor explicitly. This is the reason why Sarkozy said it is a said day when the EU has to accept a bailout from the IMF (aka, the US). The EU now, and truly, contains a significant parcel of debtor nations.

To add fuel to this global macro tabloidal fire, the Euro members’ loan will be pari passu with existing sovereign debt i.e. it will not be considered senior. Although there is no written, hard evidence to support this claim, it is our view that otherwise there will be no incentive for investors to hold the debt of troubled countries like Greece, which will ultimately defeat the whole purpose of the rescue package. Moreover, there are indications that support this idea. As per Dutch Finance Minister Jan Kees de Jager, “We are not talking about a special preference for the eurogroup loans, that’s not possible because then you would have the situation that already-existing rights of creditors at the moment would be harmed.” (reference Of course, if more investors did their homework and ran the numbers, that same disincentive can be said to exist with the IMF's super senior preference given the event of a default and recoverable collateral after the IMF has fed at the trough.

The above-referenced article is a must read and an eye-opener to all of those who think that those 60% haircuts that BNP et. al. are taking are anything near sufficient. And on that note, what haircut is sufficient to mark Greek debt to market for these big banks and funds? Stay tuned boys and girls, I answered this question last year...

And in the End, What Does It All Mean?

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

Take note that this update will include several American banks and the risks they face from writing nearly all of the richly priced CDS purchased by said European banks. This is an interesting and complicated story because all of those IMF/EU bailouts, besides adding more debt to already debt laden countries, have considerably subordinated the claims of the stakeholders involved. The following was written over a year ago, and has proven to be quite prescient:

The year 2013, with a IMF-proclaimed debt ratio of a tad under 150%, is the time when Greece will have to refinance the debt to pay the IMF. However, since the current debt raised by Greece is at fairly high rates, new debt will only be available at much higher rates (as markets should price-in the risk of high debt rollover) unless there is some saving grace of a drastic plunge in world wide interest rates and a concomitant plunge in the risk profile of Greece. At a 150% debt ratio, historically low artificially suppressed global interest rates that have nowhere to go but higher and prospective junk ratings from the US rating agencies, we don’ t see this happening. Thus, the cost of borrowing for in 2013 is likely to be much higher in the market than the nearly five percent for the existing debt. Greece will either be unable to fund itself in the markets at all, and will have to convince the Euro Members and the IMF to extend the three-year lending facility just announced (reference What We Know About the Pan European Bailout Thus Far) or, it will get the debt refinanced at very high rates. In both cases the total debt as a percentage of GDP will continue to rise, and this is not a sustainable scenario over the longer-term. In addition, if it accept the EU/IMF package and there is an event of default or restructuring, the IMF will force a haircut upon the private and public debtors beyond what would have normally been the case. This essentially devalues the debt upon the involvement of the IMF, a scenario that we believe many sovereign bondholders (particularly Greek, Spanish and Irish) may not have taken into consideration. This also leaves the possibility of a significant need for many banks to revalue their sovereign debt – particularly Greek sovereign debt – holdings.

As illustrated above, there is a higher probability for a Greek sovereign debt restructuring in 2013, which will definitely not hurt IMF (since it has a preferred right) but the Euro Members and other investors who will be holding the Greek debt.


LGD: Loss Given Default... ~100%???

We're talking damn near complete wipeouts boys and girls. There are practicaly no entities holding this debt at par that are leveraged under 30x. The starting point in case of default for Greece is between roughly 48% to 52% of par. You've seen the math on BoomBustBlog many a time - Over A Year After Being Dismissed As Sensationalist For Questioning the ECB's Continued Solvency After Sovereign Debt Buying Binge, Guess What!

I will have some more goodies along these lines that still HAVE NOT been broached by either the pop media or the sell side for BoomBustBlog subscribers very soon.

Tools for tracking the ever elusive path of contagion for BoomBustBlog subscribers:

 Additional posts on the topic of Bank Runs

  1. The Mechanics Behind Setting Up A Potential European Bank Run Trade and European Bank Run Trading Supplement
  2. What Happens When That Juggler Gets Clumsy?
  3. Let's Walk The Path Of A Potential Pan-European Bank Run, Then Construct Trades To Profit From Such
  4. Greece Is Fulfilling Our Predictions Of Default Precisely As Predicted This Time Last Year
  5. The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!
  6. The Fuel Behind Institutional “Runs on the Bank” Burns Through Europe, Lehman-Style!
  7. Multiple Botched and Mismanaged Stress Test Have Created The Makings Of A Pan-European Bank Run
  8. Observations Of French Markets From A Trader's Perspective
  9. On Your Mark, Get Set, (Bank) Run! The D…

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