European Banking Crisis?

[petec]

All: thanks for one of the most interesting discussions on the board at the moment.  I've had a nagging worry about the Euro-banks for a while but not researched it - this helps.

 

Ni-co: what is your view on the timing of any crisis?  I ask because while I understand each of the individual points you've made, there's a difference between -ve rates and cocos harming share prices on the one hand, and bad loans causing a banking crisis on the other.  Or do you see these things as being so interrelated that they feed off each other to create a vicious spiral?

 

Also, I'm struggling to understand the significance of most bank assets being Euro sovereign bonds.  Isn't this a good thing?  Nice and liquid?  Depending on the sovereign obviously!

 

John - will be very interested to see your atomisation of SAN!

 

SD: Why not own the Latin subsidiaries of SAN?  By the sounds of it that is the part you find attractive.

 

More generally I've been trying to figure out the impacts of -ve rates and this discussion has been useful.  My background here is that I find Austrian economists more plausible than monetarist ones so I have a clear bias, but I think globally we are seeing a lot of unintended consequences of easy money.  As I understand it the idea behind -ve rates is to persuade banks to lend rather than deposit their reserves; and also perhaps to persuade people to spend rather than deposit their savings. 

 

This thread appears to argue the opposite.  If banks don't pass on -ve rates they lose money which weakens T1 capital.  If they do pass -ve rates on to depositors, deposits get withdrawn and loans get called which could actually *shrink* the amount of money in the system - exactly the opposite of what was intended.  Worse, if the called loans are bad, -ve rates might cause a banking crisis (whereas higher rates might have given the banks time to earn enough to cover the bad loans).

 

Do I have this right?

[ni-co]

All: thanks for one of the most interesting discussions on the board at the moment.  I've had a nagging worry about the Euro-banks for a while but not researched it - this helps.

 

Ni-co: what is your view on the timing of any crisis?  I ask because while I understand each of the individual points you've made, there's a difference between -ve rates and cocos harming share prices on the one hand, and bad loans causing a banking crisis on the other.  Or do you see these things as being so interrelated that they feed off each other to create a vicious spiral?

 

Also, I'm struggling to understand the significance of most bank assets being Euro sovereign bonds.  Isn't this a good thing?  Nice and liquid?  Depending on the sovereign obviously!

 

John - will be very interested to see your atomisation of SAN!

 

SD: Why not own the Latin subsidiaries of SAN?  By the sounds of it that is the part you find attractive.

 

More generally I've been trying to figure out the impacts of -ve rates and this discussion has been useful.  My background here is that I find Austrian economists more plausible than monetarist ones so I have a clear bias, but I think globally we are seeing a lot of unintended consequences of easy money.  As I understand it the idea behind -ve rates is to persuade banks to lend rather than deposit their reserves; and also perhaps to persuade people to spend rather than deposit their savings. 

 

This thread appears to argue the opposite.  If banks don't pass on -ve rates they lose money which weakens T1 capital.  If they do pass -ve rates on to depositors, deposits get withdrawn and loans get called which could actually *shrink* the amount of money in the system - exactly the opposite of what was intended.  Worse, if the called loans are bad, -ve rates might cause a banking crisis (whereas higher rates might have given the banks time to earn enough to cover the bad loans).

 

Do I have this right?

 

I tend to agree with your paragraph describing the "thread's argument".

 

My timing view is – to quote Soros: "I am not predicting it, I am observing it." I think that this process has already started because bond/equity market participants anticipate it and banks are essentially cut-off from capital markets. I read in a FAZ article (in German, sorry) – and FAZ is usually well informed – that DB wanted to become "more active" in the credit markets and "was expected" to issue up to €7bn in new bonds (I guess CoCos). Well, this was on 30th January. How well did the market take this message? They won't be able to do it. Now what? So, yes, I see a death spiral in action.

 

That said, when I say "predict/observe" etc. I always mean probabilities. I think it's highly probable that this is what's going on. Since I have no insight into DBs internals I can't know it – and they certainly wouldn't tell anybody (see their latest statement; what else can they say?).

 

Re Euro sovereign bonds: Are they really "nice and liquid"? Who is the potential buyer (especially for the riskier ones) if there wouldn't be ECB QE?

[ni-co]

One additional thought re European sovereign bonds: Why did they rescue Greece? I think the real reason is: bond holders, which are European banks. If they had been forced to write-off Greek sovereign debt, banks would have undershot capital requirements immediately, triggering a death spiral. Well, they still own the Greek bonds, so everything is fine – alright?

[prevalou]

for instance DB Greece sovereign gross debt exposure is $ 0

[ni-co]

for instance DB Greece sovereign gross debt exposure is $ 0

 

So?

[prevalou]

https://www.db.com/ir/en/download/DB_Interim_Report_3Q2015.pdf

 

page 40

[petec]

Thanks for your replies ni-co, and I'll watch more carefully.

 

Also agree with you re: why they bailed out Greece.

 

Only comment is that I would think there will be ECB QE to buy sovereign bonds off the banks if needed.

[ni-co]

https://www.db.com/ir/en/download/DB_Interim_Report_3Q2015.pdf

page 40

 

Yeah, I didn't say I don't believe you. But it doesn't really matter in which European bank they are. Btw. I wouldn't like to own any of those "certain eurozone countries'" sovereign bonds listed on this very page.

 

Only comment is that I would think there will be ECB QE to buy sovereign bonds off the banks if needed.

 

I agree with that. However, the ECB ending up with all the problematic European sovereign bonds can't be qualified as a (long-term) solution – at least not in my mind  :)

[Phaceliacapital]

Deutsche Bank Says It Can Pay Coupons in Sign Jitters Mount (3)

2016-02-09 09:03:08.253 GMT

 

 

By Michael J. Moore, Nicholas Comfort and Edward Robinson

    (Bloomberg) -- Deutsche Bank AG became the largest lender in at least four years to feel compelled to reassure investors and employees that it has enough funds to pay coupons on its riskiest debt.

    Germany’s biggest bank said in a statement Monday that it has more-than-sufficient means to meet obligations on its additional Tier 1 notes both this year and in 2017. Deutsche Bank also published a note to employees from Chief Financial Officer Marcus Schenck that said the firm’s “capital and risk position remains strong.”

    The cost of protecting Deutsche Bank’s debt against default has more than doubled this year, while its stock trades at about one-third of the company’s liquidation value. Co-Chief Executive Officer John Cryan has failed to generate confidence in his plan to cut costs and build capital as volatile markets threaten revenue and outstanding regulatory probes raise the specter of continued legal charges.

    “There are plenty of reasons to be critical about Deutsche Bank, but the idea of them missing a coupon payment was pretty unrealistic,” Michael Huenseler, who helps manage about 17 billion euros ($19 billion) including the bank’s bonds at Assenagon Asset Management, said by phone from Munich. “They’re in a very uncomfortable place with the stock hitting lows and it’s looking like we’re in the financial crisis, but the situation is very different.”

    The shares jumped as much as 5.4 percent, the biggest intraday gain since October, and were up 2.7 percent at 14.20 euros as of 10:01 a.m. in Frankfurt.

    Deutsche Bank and European rivals including Credit Suisse Group AG and Barclays Plc are getting walloped by a global market rout just as they embark on ambitious overhauls of their securities units. The selloff, as investors seek safety from China’s slowdown and falling oil prices, is complicating that task by reducing revenue from investment banking and making parts of the business more expensive to exit, hampering efforts to ultimately plow more earnings into capital.

 

                        ‘Bad Year’

 

    January marked the worst start to a year for underwriting bonds in Western Europe since 2008, while high-yield bond fees slumped 78 percent from last year, data compiled by Freeman & Co. show. Stock sales in Europe, the Middle East and Africa dropped 60 percent so far this year, data compiled by Bloomberg show. Shares of the three investment banks have tumbled at least

25 percent since that month began, putting them in the bottom half of the 39-company Bloomberg Europe Banks and Financial Services Index.

    “It’s going to be a really bad year,” said Lutz Roehmeyer, who helps manage about 11 billion euros at LBB Invest in Berlin, which holds shares of lenders including Deutsche Bank. European banks “can essentially scrap any goals they had set themselves for this year.”

    Deutsche Bank said Monday that it still has room to pay about 1 billion euros in 2016, enough to cover about 350 million euros in Additional Tier 1 coupons due in April. The estimated payment capacity for 2017 is about 4.3 billion euros, boosted in part by proceeds from the announced sale of a stake in Huaxia Bank Co., the Frankfurt-based lender said. The 2017 estimate is before any effect from 2016 profit or losses.

 

                      Credit-Default Swaps

 

    The statement did little to reverse a selloff in credit markets. The cost to protect against losses on the bank’s riskiest debt continued to climb, reaching the highest level since the height of the European debt crisis in 2011, according to data compiled by Bloomberg.

    The cost of protecting Deutsche Bank’s subordinated debt rose for an eighth day. Credit-default swaps increased 13 basis points to 452 basis points, the highest since November 2011, according to data compiled by Bloomberg.

    The statement came after Simon Adamson, an analyst at CreditSights Inc., signaled concern about the bank’s ability to pay coupons in 2017 if operating results disappoint or litigation costs are higher than expected. A loss in 2015, driven by legal costs and writedowns of goodwill, and declining revenue from the firm’s biggest business in the fourth quarter narrowed the room for error.

    Doubts about Deutsche Bank’s ability to pay coupons on Additional Tier 1 debt fueled a selloff in the bank’s bonds and shares this year, with the stock losing about 39 percent of its value. The contingent convertible bonds -- also known as CoCos -

- have turned in a similar performance as the cost of protecting the company’s subordinated debt from default for five years using credit-default swaps more than doubled since the end of 2015.

    Deutsche Bank’s core long-term returns will be affected either by significant balance-sheet deleveraging or by raising capital, Berenberg analysts wrote in a note to clients Monday.

 

                        Dividend Plans

 

    Cryan has scrapped the dividend for 2015 and 2016 and said the firm doesn’t need to raise additional capital. Credit Suisse, also under pressure to strengthen its balance sheet, tapped investors for 6 billion Swiss francs ($6.1 billion) to bolster capital last year.

    U.S. lenders including Bank of America Corp. and Morgan Stanley took steps in 2011 to reassure investors amid market volatility tied to the European sovereign-debt crisis. Bank of America announced a $5 billion investment from Warren Buffett to shore up capital in August of that year, while Mitsubishi UFJ Financial Group Inc. issued a statement in October reiterating its alliance with Morgan Stanley.

 

--With assistance from Shannon D. Harrington, Sridhar Natarajan, Ambereen Choudhury, John Glover and Shelley Smith.

 

[prevalou]

https://www.db.com/ir/en/download/DB_Interim_Report_3Q2015.pdf

page 40

 

Yeah, I didn't say I don't believe you. But it doesn't really matter in which European bank they are. Btw. I wouldn't like to own any of those "certain eurozone countries'" sovereign bonds listed on this very page.

 

Only comment is that I would think there will be ECB QE to buy sovereign bonds off the banks if needed.

 

I agree with that. However, the ECB ending up with all the problematic European sovereign bonds can't be qualified as a (long-term) solution – at least not in my mind  :)

 

Euro banks sovereign Greece debt exposure is minimal, it is my point

[Phaceliacapital]

[petec]

 

I agree with that. However, the ECB ending up with all the problematic European sovereign bonds can't be qualified as a (long-term) solution – at least not in my mind  :)

 

It is if you don't mind destroying the currency.

 

I feel very lucky that the UK never joined the Euro (and frankly I hope we get out of the EU).

 

Going to be an interesting few years.

[SharperDingaan]

SD: Why not own the Latin subsidiaries of SAN?  By the sounds of it that is the part you find attractive.

 

We’ve just being overly conservative. Agreed we could do better if we stayed with just the Latin entities, but we would also take on the volatility as they deal with periodic sovereign defaults. The performance drag is not meaningful.

 

Negative rates.

 

Ordinarily, a corporation will maintain a minimum +ve balance in its account after the end-of-day sweep, & put the balance into the overnight market. Now they model the size of the optimum –ve balance, against the available spread. The bank makes additional spread (small amount) on this new overdraft, but loses spread (large amount) on the loans that the deposit would otherwise have permitted. The banks NIM gets bled, & the higher the leverage – the greater the bleed.

 

The modeling is because the term structure favours a borrower. Buy the banks paper &/or preferred, & use it to secure the overdraft. The banker cannot challenge as to do so is to question their own solvency, and their paper is getting an artificial liquidity boost from the nightly roll-over process.

 

DB

 

We look at Barclays & find it highly unlikely that DB wasn’t doing much the same; the big differences are that DB enjoys Bundesbank protection, & it has been used as a conduit to support various bail-outs. Even if the Sh1t has been contained, the condoms have to be pretty full, & there have to be a lot of them.

 

Assuming the toxics moved to the Bundesbank book, DB is still exposed to much of the MTM; on bail in - the CoCos would ramp up the share count, & the Bundesbank may well match the share ramp us well; to offset the control loss to the CoCo holders. Severe share dilution.

 

Of course, the establishment will swear it cannot happen! The market seems to think around 50% dilution. Pure guess as to who’s right, but carrying an umbrella might be pragmatic.

 

SD

 

[ni-co]

The DB CoCos wouldn't be directly dilutive because they are not converted but written down in a trigger event. However, regulators could inject additional capital in this event, or DB would have to raise additional equity on its own. 

[ni-co]

Two things: DB just announced is rumored to "consider" [edited] to buy back some of its senior bonds. I see why they do it but not how that changes anything. At least they can book a profit for the delta to the par value.

https://next.ft.com/content/d2e01b1e-cf57-11e5-92a1-c5e23ef99c77

 

Then there is this letter of a DB credit analyst that ZH (I know…) just published. It's interesting because it gives a bit of an inside view of DB momentarily:

http://www.zerohedge.com/news/2016-02-09/deutsche-bank-terrified-here-what-needs-be-done-its-own-words

 

 

[John Hjorth]

Deutsche Bundesbank : Europe at the crossroads

 

Guest contribution by François Villeroy de Galhau, Governor of the Banque de France, and Jens Weidmann, President of the Bundesbank published in Le Monde and in Süddeutschen Zeitung on 8 February 2016 :

 

https://www.bundesbank.de/Redaktion/EN/Standardartikel/Press/Contributions/2016_02_08_weidmann_galhau.html?startpageId=Startseite-EN&startpageAreaId=Teaserbereich&startpageLinkName=2016_02_08_weidmann_galhau+361962

[CorpRaider]

The DB CoCos wouldn't be directly dilutive because they are not converted but written down in a trigger event. However, regulators could inject additional capital in this event, or DB would have to raise additional equity on its own.

 

So contingent convertibles have no conversion feature?  Makes sense.

[ni-co]

The DB CoCos wouldn't be directly dilutive because they are not converted but written down in a trigger event. However, regulators could inject additional capital in this event, or DB would have to raise additional equity on its own.

 

So contingent convertibles have no conversion feature?  Makes sense.

 

They are converted into the bank's T1 equity but not into ordinary shares. Bond holders lose the principal (gets written down – here with the chance of getting written back up again with future profits) and T1 equity capital goes up. However, there is no change in the share count and therefore no immediate dilution. It's different with other banks like SAN or CS where CoCos are converted into ordinary shares. You really have to look closely at every prospectus.

 

I'd argue that the situation is comparable anyway because the market won't give DB the money for a second round of CoCos once it has written down the first round. They will be forced to issue equity after that. So, this is not a repeatable thing in a banking crisis. They are only shifting the problem around.

[SharperDingaan]

The buyer would really have to be an idiot to buy this DB piece of junk, & the seller would need a very well bribed vendor to push it…

The buyer takes all the risk, but only gets paid interest IF the Tier 1 does not fall < 5.125, AND the Bundesbank allows it

 

We have the right, in our sole discretion, to cancel all or part of any payment of interest, including (but not limited to) if such cancellation is necessary to prevent our Common Equity Tier 1 capital ratio pursuant to Article 92 (1) (a) CRR or any successor provision, determined on a consolidated basis (which we refer to as our “Common Equity Tier 1 Capital Ratio”) from falling below 5.125 per cent or to meet a requirement imposed by law or our competent supervisory authority

 

The buyer is never getting their principal back, & agrees to lose the entire investment.

 

Accordingly, we are not required to make any repayment of the principal amount of the Notes at any time or under any circumstances, and as a result, you may lose part or all of your investment in the Notes. In addition, you may not receive any interest on any interest payment date or at any other times, and you will have no claims whatsoever in respect of that cancelled or deemed cancelled interest.

 

Upon the occurrence of a Trigger Event, a write-down will be effected pro rata with all other Additional Tier 1 instruments within the meaning of the CRR (Additional Tier 1 capital), the terms of which provide for a write-down (whether permanent or temporary) upon the occurrence of the Trigger Event. For such purpose, the total amount of the write-downs to be allocated pro rata will be equal to the amount required to restore fully our Common Equity Tier 1 Capital Ratio to 5.125 per cent.

 

For which the buyer will earn a spread of just 5%, which CAN BE REDUCED, on future roll-overs.

 

For the period from (and including) the First Call Date a rate which will be the Reference Rate plus an initial credit spread of 5.003% per year. We describe the Reference Rate in “Description of the Notes—Interest Payments on the Notes” below.

 

If I have 1.5B, & am desperate to hold DB, why would I not just buy the preferred?

 

You have to be desperate to try this. It suggests that DB must have at least a 1.5B hit to capital coming, & that the Bundesbank is tightening the rope around their neck.

 

SD

 

[petec]

Desperate?  No, you just have to live in a world that's been really, really fucked up by central bankers out to prove pet theories.

[ni-co]

Yes. I couldn't believe it either when I had a look at the prospectus. Well, they got away with it so far. But, as should be clear for everybody by now, this won't work anymore. Next time DB needs equity (rather sooner than later), it will be through share offerings or forced capital infusions.

 

I really can't understand the people today who are rushing out to buy DB shares because they are rumored to "consider" the – really stupid – idea of buying back some of their senior bonds. Two weeks ago DB was still talking about issuing 5bn in CoCos until 2020 now they rather buy back some senior bonds? And the market takes it as a sign of strength. I take it as a sign of ultimate desperation. They succeeded in what I think was the purpose of this rumor: hindering the share price from going below the 2009 lows (in EUR) which would have resulted in a huge press feast.

[John Hjorth]

Desperate?  No, you just have to live in a world that's been really, really fucked up by central bankers out to prove pet theories.

 

Petec,

 

I'm not entitled to reply on behalf of SharperDingaan - he is certainly capable of doing that for himself. I'll just mention here, that personally I read SharperDingaan's last post in this topic as a reference to the terms of the bonds, that DB is rumored to be buying back at the moment [most likely at a loss for the sellers], compared to buying DB preferred - at an earlier moment.

[SharperDingaan]

It smells a lot like there's such a large loss coming up, that its going to change the risk profiles across the board.

Friends of the Bundesbank being bought out of their Senior Bond Holdings with CoCo proceeds - so that they will not experience a loss?

 

SD

[petec]

Desperate?  No, you just have to live in a world that's been really, really fucked up by central bankers out to prove pet theories.

 

Petec,

 

I'm not entitled to reply on behalf of SharperDingaan - he is certainly capable of doing that for himself. I'll just mention here, that personally I read SharperDingaan's last post in this topic as a reference to the terms of the bonds, that DB is rumored to be buying back at the moment [most likely at a loss for the sellers], compared to buying DB preferred - at an earlier moment.

 

Oh so did I and I agree with everything he wrote.  My point (poorly expressed perhaps) is that I see the extraordinary reaching for yield that drives demand for these daft securities (what SD referred to as desperation) as being purely down to some incredibly poor government/central bank policy. 

 

And yes, before anyone asks, that does mean I think we need to take some deflationary (in the broad bubble sense, not the narrow CPI sense) pain and central banks need to allow that.

[John Hjorth]

Desperate?  No, you just have to live in a world that's been really, really fucked up by central bankers out to prove pet theories.

 

Petec,

 

I'm not entitled to reply on behalf of SharperDingaan - he is certainly capable of doing that for himself. I'll just mention here, that personally I read SharperDingaan's last post in this topic as a reference to the terms of the bonds, that DB is rumored to be buying back at the moment [most likely at a loss for the sellers], compared to buying DB preferred - at an earlier moment.

 

Oh so did I and I agree with everything he wrote.  My point (poorly expressed perhaps) is that I see the extraordinary reaching for yield that drives demand for these daft securities (what SD referred to as desperation) as being purely down to some incredibly poor government/central bank policy. 

 

And yes, before anyone asks, that does mean I think we need to take some deflationary (in the broad bubble sense, not the broad CPI sense) pain and central banks need to allow that.

 

Petec,

 

Thanks for elaboration, I understand your position on this now.