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While the “developed” world scrambles to find a way to provide Ukraine with a bailout in such a way that Russia doesn’t turn off the gas, Ukraine is doing some scrambling of its own to assure the local banks, which have been plagued by both bank runs and a collapse in the currency to record lows over the past few days, that it will be there to provide funding on a business as usual basis. Itar-Tass reports that “Ukrainian banks will be provided with necessary liquid assets, including cash.” But there is a condition: the funding will only come “if they will remain under open control of the National Bank of Ukraine, the newly-appointed NBU Chairman Stepan Kubiv is quoted as saying on the bank’s official website.”
“Financial and payment systems, which are of vital importance, operate normally, as well as the open market operations do. The situation is under control. We are getting feedback from all of the country’s banks, regardless their size”, he said.
Kuvib stressed that the National Bank’s gold reserve includes high-liquidity assets. He mentioned such priorities of the Ukrainian banking system as the protection of clients’ interests, as well as the resumption of negotiations with external creditors, the International Monetary Fund in the first place, right after the country’s new government is formed and elaboration of a strict new plan for economic and financial reforms.
“We are very determined regarding the measures, which will be applied to those who break the mandatory requirements and are involved currency speculations. I am certain the National Bank’s measures will calm the markets and the people and ease devaluation fears”, the bank’s chief said.
In other words, any and all banks that want to continue operating must pledge allegiance to the brand new central bank governor Kubiv, who previously did not work for Goldman Sachs, but instead was one of the commendants for the EuroMaidan demonstrations. That is not say he has no banking experience at all: previously he used to be head of Kredbank. Who is Kredbank? As it turns out, it is the bank with the largest Polish investment in banking institution in Ukraine. Kredobank national network contains central branch and 130 outlets throughout Ukraine. Today, European investment is 99.6% in the share capital of Kredobank, Ukrainian capital is 0.4%.
At least it is clear where the Ukrainian central banker’s allegiances lie, and under whose “open control” suddenly the entire Ukrainian banking sector has fallen under. And just like that, Europe knows everything these is to know about all assets held within the Ukrainian banking system by the local population.
HAA HAA: Will Another Creditanstalt Be Revealed Once The Hypo Alpe Aldria “Black Box” Is Opened? | Zero Hedge
Recall that the bank which precipitated the first Great Depression was Austria’s Creditanstalt, which declared bankruptcy on May 11, 1931 and which resulted in a global financial crisis, after its failure waterfalled into the chain-reaction of bank failures that marked the first systemic financial collapse. As part of CA’s rescue, Chancellor Otto Ender distributed the share of bailout costs between the Republic, the National Bank of Austria and the Rothschild family (and as a bit of historic trivia, following the Austrian Anschluss to Nazi Germany in 1938, Creditanstalt-Bankverein was targeted for a variety of reasons, leading to the arrest of Louis Nathaniel Rothschild and his imprisonment for the losses suffered by the Austrian state when the bank collapsed. Aggrieved, he emigrated to the US in 1939 after more than one year in custody).
A little over 80 years later, while the world is knee deep in explaining how snow during the 4th warmest January on record is the culprit for an abrupt and dramatic slowdown in world growth, and is following the geopolitical developments out of Crimea with great attention, the real action may once again be taking place in the small, quaint and quiet central European country, where yet another bank may be sowing the seeds of further financial mayhem.
Presenting Hypo Alpe Aldria (or “HAA” although certainly not funny as in funny HAA HAA: more shortly), a bank which in reality has been in the news for years following its nationalization in 2009 by the Austrian government to prevent a bank collapse. In fact, just last week, Austrian Chancellor Werner Faymann said the government is right to avert the collapse of Hypo Alpe-Adria-Bank International AG, as he cited the precedent of Creditanstalt, whose crash helped trigger the 1930s depression. “The crash of Creditanstalt in 1931 caused economic meltdown,” Faymann told parliament’s lower house in Vienna today. “There was a consensus in 2009 to act where necessary, to avoid the mistakes of the 1930s, to avoid a collapse by nationalizing and by installing protection measures at the European level.”
As a follow up, as Bloomberg also reports, the fate of HAA – whatever it ends up being – may have significant political consequences for the Austrian government. Again Bloomberg reports that “support for Austria’s ruling coalition is slipping five months after it won a narrow majority as inaction over the nationalized Hypo Alpe-Adria Bank International AG lifts backing for protest parties. Latest polls suggest voters are losing trust in Social Democratic Chancellor Werner Faymann and People’s Party Vice Chancellor Michael Spindelegger and warming to the euro-skeptic Freedom Party before May’s European Parliament elections. The Green and Neos parties also stand to gain, said Hubert Sickinger, a political scientist at the University of Vienna.”
“The ruling parties have a problem,” Sickinger said in an interview. “They postponed the Hypo Alpe ‘dead bank’ problem hoping that the economy would change but they’ve known since early 2013 that this wouldn’t help.”
One party that has been quite vocal on the issue of HAA is the Austrian Freedom Party nationalists, who seek to restrict immigration, and which has the most to gain from detouring the status quo as they would finish first in the EU parliamentary election, according to a Feb. 14 Gallup poll commissioned by the Oesterreich newspaper. The Freedom Party under deceased leader Joerg Haider helped build Hypo Alpe from a regional lender into one of the biggest banks in the Balkans.
“The European elections will be payback day” over the government’s handling of Hypo Alpe, said Franz Schellhorn, director of Agenda Austria, a Vienna-based research group.
“Anger is growing,” Schellhorn said in an interview today. “This black box has to be opened to see what is going on inside.”
It is the “opening of this black box” that suddenly has the entire investment community on edge, even if most of them hope the story simply goes away as it has for the past five years. Only this time it may be impossible to once again kick the can, er, box.
And while the legacy story of the post-bail out HAA may be known, it is the recent developments that are largely unknown and where the risks lie. This can be seen in the recent dramatic drop in HAA bond prices.
So why should people care about HAA? Bank of America explains:
The real surprise of the Hypo Alpe Adria (HAA) situation is not that bondholders may lose money, but the sight of the third richest country in Europe by per capita income apparently looking for ways out of paying what are clearly guaranteed debts of a 100% nationalized bank, for HAA debt is guaranteed by the Austrian State of Carinthia under a deficiency guarantee. The Austrian Finance Minister may be targeting a contribution from bondholders, according to reports on Bloomberg on Friday, We would consider it an astonishing turn of events if this actually ever came to pass, with wide-ranging negative implications for investors in not just Austria but potentially Europe as a whole.
What are the other implications from a potential HAA fallout? Here are the cliff notes:
- Direct impacts: other Austrian banks?
Erste Bank and RBI will likely trade as proxies in any negative newsflow which could pressure their spreads. They aren’t really affected, though, in our view.
- Indirect: negative for marginal banks
The Carinthia guarantee is a throwback to a very different banking world – when banks enjoyed implicit and explicit institutional support. Those days are over. We underline
that we have moved to a bail-in regime where investors will contribute to the costs of bank clean-up. This has implications for other very marginal banks e.g. the Cooperative Bank in the UK which we think is struggling.
- Why the fuss? Who pays for HAA?
The European Commission in its decision on State Aid (dated 3rd Sept 2013) puts the capital need at €5.4bn in a stressed scenario. Liquidity needs are put at up to €3.3bn, meaning that the total outlay could be as high as an extra €8.7bn, in addition to the billions that have already been committed by the current and former shareholders. HAA’s total assets as of June 2013 were ‘only’ €31.3bn, recall.
- What kind of outcomes for HAA?
We struggle to see how those positing bondholder losses get around the guarantee from Carinthia and all that implies. However, with lower cash prices in many of the bonds, perhaps the way forward opens up for e.g. substitution (of Austria for Carinthia) at a discount. There may also be the time value of return of principal to factor in.
- Negative outcomes: maybe tough to do
If the Austrian Government decides to be tough, then the negative scenarios for HAA bondholders are potentially many. The Government may be somewhat hampered however by the fact that HAA bonds under the 2006 Prospectus are issued under German Law.
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For the extended, and must read, notes on what Hypo may lead to, here is the full note from Bank of America’s Richard Thomas:
Funny HAA HAA or funny peculiar? Implications of Hypo Alpe Adria
HAA – the implications
The emerging crisis re: how to resolve Austria’s Hypo Alpe Adria (HAA) looks like it’s already one destined for the textbooks.
It has been rumbling around in our ‘bank peripheral vision’ for years as a problem child but now seems to be coming to a head because of what appears to be increased political pressure for a solution that potentially involves the imposition of senior bondholder losses in the mix. As such, we need to look at it to see what read-across, if any, there is to other European banks, as it seems to represent a hardening of attitudes to bank resolution amongst one of Europe’s richest countries.
We do not express an opinion or investment recommendation on the securities of HAA itself. Using conventional bank analysis, we believe that HAA is potentially uninvestable not only because of its evident non-viability and the lack of appetite to save it but also because of the allegations of past misconduct, as widely reported in the press, and what appears to be ongoing incompetence e.g. leasing invoicing ‘irregularities’ in Italy provided against as recently as in 1H13 numbers. The outcome for bondholders will ultimately be based on Austria’s view of its obligations and how it deals with the Carinthia guarantee, in our view. We expect that prices will therefore trade according to the last comment from someone important – highly unpredictable. For example, they were down on Friday following comments from the Austrian FinMin, but up this morning on comments over the weekend from the Head of the Austrian Central Bank. A final decision on what happens could be many months out.
For us, the shock of the current situation is not so much about bail-in being applied in the case of a failed bank – like most credit investors, we are used to this by now. The real surprise of the situation is the sight of the third richest country in Europe by per capita income apparently trying to manoeuvre out of paying what are clearly guaranteed debts (HAA debt is guaranteed by the State of Carinthia). We would consider it an astonishing turn of events if this actually ever came to pass, with wide ranging negative implications for investors in not just Austria but Europe as a whole.
The read across from HAA to other banks is weak, in our view. However, there are a few implications to highlight which may impact spreads.
- The most directly impacted bank would seem to be Bayerische Landesbank (BYLAN), former owner of the bank and where there is still some outstanding exposure. BofAML analyst Jeroen Julius talked about this in his note on BYLAN last week here. We remain Underweight-70% the BYLAN 5.75% T2 bonds. There is still an outstanding line of €2.3bn from BYLAN to HAA of which we understand €1.8bn was due at end 2013 – by March (if not sooner) then this will need to move to an impaired classification. HAA is saying that these monies are an equity substitute and are trying to claw back €2.3bn already repaid. Our view is that BYLAN may sacrifice some of the outstanding amount in any settlement but seem unlikely to have to pay back the repaid amount. In the meantime, it seems that they do have a say in some of the levers which Austria may want to use in resolving HAA, so their negotiating stance looks solid.
- Other widely traded banks where spreads could come under pressure are Erste Bank and RBI. We will likely see these banks trade as proxies in any negative newsflow which could pressure their spreads – their illiquid CDS is probably already trading some 10-15bps wider in senior and ~13bps wider in sub CDS. These banks should be much more sensitive to negative news from Central and Eastern Europe rather than Austria though, in our view, given their focus on emerging economies.
- RBI’s exposure to Austria reflects its domicile and the corporate ties between Austrian companies and the EE corporates where most of RBI’s operations are placed. It does not have direct exposure to the Austrian complex in the way that e.g. BAWAG or Erste Bank have. The RBIAV 6% is probably down a point from its highs in the last week or so. We see the impact on RBI as quite tangential: if Austria takes a tough stance with bondholders, it’s more negative for sentiment on the banks, given that it implies a reduced sovereign exposure – so hardly negative for the sovereign from e.g. higher debt levels, albeit lower contingent liabilities.
- About half of Erste Bank’s credit risk exposure is to Austria. It is therefore more of an ‘Austrian’ bank than RBI but that’s not really the problem here, in our view.
- We are still very comfortable with RBI at this point, especially given the recent capital increase. However, we recommend reducing risk by switching into lower cash priced bonds versus higher cash price bonds. That means out of e.g. the 6.625% bond with a cash price of about €113 into lower cash priced bonds like the 6% (€106.5) or the 5.163%, though this is a much more illiquid security. We downgrade the 6.625% bonds to Underweight-30%.
The wider implications of what happens in the HAA case include:
- If we do move to some kind of forced loss imposition from Austria on these bonds, then it probably isn’t a good moment for bank risk (or indeed European risk). However, as we explain, in this case loss imposition is rather tricky to do, given the existence of the guarantees from Carinthia.
- Whatever happens, we see the HAA situation as reflecting a growing impatience with marginal and near-failing banks and that a hard line is likely to be followed in resolving them. It underlines that we have moved to a bail-in regime where investors will contribute to the costs of bank clean-up. This has implications for other very marginal banks e.g. the Cooperative Bank in the UK which we think is struggling. Underweight-70% the 11% T2 bonds of the Coop Bank at £123.
- The Carinthia guarantee is a throwback to a very different banking world – when banks enjoyed implicit and explicit institutional support. Those days are over. Such support often allowed excessive expansion on the back of cheap funding – we can point to the continued need for adjustment in the Landesbank sector for evidence of that.
- One final point: in our view there would be a negative read-across to the German Landesbanken more generally if a way was found around the deficiency guarantee in this case. The Landesbanken heavily rely on State guarantees. For example, HSH Nordbank has a €10bn guarantee (that helps its capital position) form Hamburg and Schleswig- Holstein.
Funny HAA HAA or funny peculiar?
A special case?
We think there is a good argument for saying that HAA is a special case amongst European banks. One can read its downfall and subsequent full nationalization as a familiar juxtaposition of overexpansion (in the former Yugoslavia) without sufficient risk controls being in place as a result of too cheap funding, owing to its funding guarantee from the Austrian State of Carinthia (currently rated A2 by Moody’s). Yet the narrative is worsened by allegations of serious past misconduct involving money laundering, fraud and possibly murder. See for example The Economist, Sept 9th 2010 or the New York Times, October 20th 2010.
Whilst mismanagement may well have been a feature of some European banks before the crisis; we would hesitate to attribute this level of alleged misconduct, however, to even many of the most stressed European banks. The nature of the allegations, in our view, serves to underline Austrian public antipathy for taxpayers having to pay for the continuing losses at the bank. It also differentiates it sharply from other European, and of course Austrian, banks. HAA’s situation and alleged misconduct is simply too severe to have systemic implications for other Austrian banks, in our view.
Could there be a haircut? Wait!
Bloomberg reports that two thirds of the Austrian public is against the use of further public monies being used to prop up the bank. With such a powerful consensus against such a move and elections next year, it’s not surprising that recently the rhetoric has turned firmly towards finding solutions for HAA that involve imposing losses somewhere – anywhere – other than at the door of the Austrian taxpayer. Hence, the comments from the Finance Minister Spindelegger on Feb 21 that Austria was looking at ways to get bondholders to contribute.
So far, so straightforward: the only problem is that the bulk of HAA senior bonds enjoy a deficiency guarantee from the State of Carinthia. This complicates the burden sharing. We note, by the way, that the EC ruling on State Aid for HAA made no mention of senior bondholder losses at all. Is it really possible to get around the deficiency guarantee and impose losses?
Our understanding is that the deficiency guarantee is not quite like other guarantees. It’s this ‘gap’ that allowed Moody’s to downgrade HAA to Baa2 from A1 on Feb 14. It means that a creditor must have attempted in vain to satisfy his or her claims against (in this case) HAA first before he can use the guarantee, though not if bankruptcy proceedings were already started. Non-payment alone may not be sufficient to invoke the guarantee, absent due process. Even so, it still looks to us that it’s just a matter of time before creditors could ask Carinthia to satisfy their claims. It seems doubtful that the State could afford to perform on the guarantee however with the €12.3bn or more of bonds being many multiples of Carinthia’s income, according to Moody’s. It seems hardly credible that we could be looking at bankruptcy of a Federal State of one of the richest countries in Europe.
Hence, the dilemma. This really would be a new departure for a European country – we’ve had bondholder haircuts before, but not on instruments guaranteed by a governmental entity like Carinthia.
What’s the size of the hole at HAA?
The European Commission in its decision on State Aid (dated 3rd Sept 2013) puts the capital need at €5.4bn in its stressed, or worst case, scenario. Similarly, the liquidity needs are put at €3.3bn in the stressed scenario, assuming that the above capital is provided in cash, meaning that the total outlay could be as high as €8.7bn, in addition to the billions that have already been committed by the current and former shareholders. HAA’s total assets as of June 2013 were ‘only’ €31.3bn, remember, and of this, €3.5bn was already earmarked as for disposal – giving a pro forma number of €27.8bn. To put this in further context, existing capital resources at HAA (equity plus sub debt) are €3bn, and provisions existing already are €3.5bn. Loans net of provisions are ~€17bn.
The now former Chairman of the Bank, Mr. Liebscher, has previously commented that HAA could require up to €4bn of further capital (‘only €400mn a year over 10 years’). Capital needs could vary considerably if assets were transferred out of the regulatory capital environment e.g. to an asset management company, since these require much less capital. We note too that Weiner has reported that the loss for the year at HAA may have grown to €1.8bn (from the €0.8bn at half year 2013) – we think it’s likely that is already reflected in the EC’s numbers though we’re not completely sure.
The €5.4bn of capital needs calculated by the EC could be higher or lower therefore but let’s use it as a basis for thinking about outcomes. Are there any offsets? Certainly,
HAA believes so. It is claiming that €4.6bn of funds extended to the bank in 2008 by BayernLB is an equity substitution under Austrian Law. €2.3bn of this is still outstanding (it’s not being serviced by HAA) but HAA has applied to the Munich Regional Court for a return of amounts that they’ve already paid back. Our core case is that BayernLB will lose some of this money (if only to settle the case) but we have no real idea how much they and HAA would settle at, of course, or if they will settle at all.
How (much) could bondholders pay?
Is it conceivable that the senior bondholders could be expected to contribute a sizeable chunk of the €5.4bn? As of end-June 2013, issued bonds at HAA totaled €11.1bn (we exclude Pfandbriefe); we don’t have data for any redemptions in 2H13. We do however know that there is a very substantial redemption of senior debt on March 17th of €750m (the HAA 3.75% bond). Again, the interim financials showed a cash balance of €2.6bn at the bank which on its own should comfortably cover the repayment. We are more skeptical about HAA’s liquidity, given the continued deterioration of its financial position implied by the reported further €1bn loss in 2H13. Perhaps it is this that is focusing the attention of Austrian policymakers on bondholders.
Repaying this bond would be a substantial cash outflow from the bank and bondholders would be getting par – these bonds are currently quoted at a mid-cash price of ~€96 but the bid/offer is something like 5 points, underlining the huge uncertainty. But it would also probably be taken as a pointer towards future treatment of bonds and so, if repaid, would likely positively impact prices.
The €5.4bn additional capital need would imply a forced senior bondholder haircut of anything from 20% upwards in our view depending on what is considered the pool of bailin-able liabilities, though admittedly we find it quite hard to believe this will be the actual outcome at this point. This number could be kept down not least by any settlement with BayernLB – and we can’t really imagine that Austria will make a zero contribution here. Even the €5.4bn total capital needs number calculated by the EC is ‘only’ about 2% of Austrian GDP.
We also struggle to see how those positing bondholder losses get around the guarantee from Carinthia and all that implies. It’s this, we think, that is the really interesting part for European bank bondholders. We have seen headlines suggesting that the Republic of Austria would substitute itself as guarantor for the bonds, subject to bondholders agreeing to a substantial haircut.When the bonds were at par, that looked really unlikely, but with e.g. the 2016 and 2017 bonds having traded down so dramatically in the last few days (currently quoted with a cash price at around €85-86), perhaps the conditions are beginning to evolve for this type of liability management.
Ultimately, we think it’s unlikely that Carinthia could pay back bondholders and remain solvent itself – as Moody’s highlights in its downgrade of the State on Feb 14 2014, the debt outstanding is some six times Carinthia’s 2013 budgeted operating revenue. Recall that HAA is 100% owned by the Republic of Austria – it seems unlikely that the shareholder would enforce the insolvency of a regional State without acting itself.
We also wonder if there is some leeway in terms of the timing difference implied by the final payment under the deficiency guarantee – how prompt might this be? Months? Years? Longer? If it could be demonstrated that bondholders would have to wait many years before getting any of their principal back, then perhaps there is the basis for an offer that gives investors liquidity today, albeit at a discounted price.
What could induce bondholders to agree to any changes?
We suspect that this is currently under consideration – there likely is little limit to the scenarios that could be conceived, but it all depends on the view the Republic takes of itself in the markets and its concerns about any likely fallout from its actions. Freezing the liabilities of the bank and the guarantee? Rescission of the guarantee? Anything is possible but perhaps some of these worst scenarios are not the most probable. However, what is clear is that the outcome for bondholders, as we have seen before in these haircut scenarios, is highly unpredictable and politicized.
In spite of the Austrian Finance Minister’s comments to the contrary, we are of the view that most HAA bonds are still with the original, investment grade, investor base. We believe that the rotation into ‘trader’ or ‘hot money’ hands is probably only still at the beginning – only recently have we heard that blocks of bonds have been coming out, rather than the trading of very small amounts. This could change rapidly in the coming weeks if Austria decides to step up the bondholder loss rhetoric of course but at this point, it would be ordinary money managers, we think, who would be absorbing most of the losses, not hot money or speculators.
As an added twist, we note that HAA bonds issued under the August 2006 Prospectus are under German Law (rather than Austrian). Again, this points in the direction of either repayment of the bonds under the guarantee, or a negotiated settlement with bondholders, rather than the imposition of an arrangement by the Austrian Government, since legally they may not have the flexibility to do much else.
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In conclusion all we have to add is that it would indeed be supremely ironic if the “strong” foreign law bond indenture would be tested, and breached, not by Greek bonds, as so many expected in late 2011 and early 2012, but by one of the last contries in Europe which is still AAA-rated. We would find it less ironic if the next leg of the global financial crisis was once again unleashed by an Austrian bank: after all history does rhyme…
Disturbing Trend: Average Foreign Purchases Of US Securities Take Out Lehman Bottom, Hit All Time Low | Zero Hedge
As we reported earlier today, for whatever reason China sold the second biggest amount of US Treasurys in December. However, that was only part of the story. In fact, as we also noted, while the two largest US foreign creditors were net sellers, total foreign bond holdings actually rose in the last month of 2013 and as the chart below confirms, when it comes to Long-Term Treasury paper, foreigners were actually buyers of some $18 billion in Treasurys. It is everything else that they sold in the month when the S&P hit its all time high: specifically, foreigners were net sellers of Agency securities ($15.4 billion), Corporate Bonds ($7.5 billion) and Corporate Equities ($13.7 billion) something which hardly fits with the narrative of the record stock market high generating confidence in even more buying down the line.
In the chart above it is the black line – gross purchases of US long-term securities – that is the most troubling, as its trend is hardly anyone’s friend.
So what happens when one smooths out the line to normalize for monthly fluctuations? This:
The chart is very disturbing: it shows that as the S&P rises higher and higher (on ever declining volumes), foreigners are buying fewer and fewer US securities. In fact, on a 12 Month Moving Average basis, foreigners bought less long-term US securities than they did when Lehman crashed!
Luckily we live in a New Normal when price is no longer determined by simple supply and demand (and certainly not from retail investors who have long since given up on the fraudulent, broken US capital “markets”) but Fed jawboning of a record $2.5 trillion in bank excess reserves, corporate buybacks and HFT algos spurring momentum ignition and buying because others are buying.
And so we have come full circle, because while, understandably, nobody had any appetite for US securities around the Lehman crash when until the Fed stepped in and singlehandedly took over the US capital markets it was unclear if there even would be a US capital markets, now that five years later the S&P has risen to a level nearly three times the March 2009 lows thanks entirely to the Fed’s $4.1 trillion balance sheet backstop, the interest in US securities is… lower than it was in the days just after Lehman!
China Sold Second-Largest Amount Ever Of US Treasurys In December: And Guess Who Comes To The Rescue | Zero Hedge
While we will have more to say about the disastrous December TIC data shortly, which was released early today, and which showed a dramatic plunge in foreign purchases of US securities in December – the month when the S&P soared to all time highs and when everyone was panicking about the 3% barrier in the 10 Year being breached and resulting in a selloff in Tsy paper – one thing stands out. The chart below shows holdings of Chinese Treasurys (pending revision of course, as the Treasury department is quite fond of ajdusting this data series with annual regularity): in a nutshell, Chinese Treasury holdings plunged by the most in two years, after China offloaded some $48 billion in paper, bringing its total to only $1268.9 billion, down from $1316.7 billion, and back to a level last seen in March 2013!
This was the second largest dump by China in history with the sole exception of December 2011.
That this happened at a time when Chinese FX reserves soared to all time highs, and when China had gobs of spare cash lying around and not investing in US paper should be quite troubling to anyone who follows the nuanced game theory between the US and its largest external creditor, and the signals China sends to the world when it comes to its confidence in the US.
Yet what was truly surprising is that despite the plunge in Chinese holdings, and Japanese holdings which also dropped by $4 billion in December, is that total foreign holdings of US Treasurys increased in December, from $5716.9 billion to 5794.9 billion.
Why? Because of this country. Guess which one it is without looking at legend.
That’s right: at a time when America’s two largest foreign creditors, China and Japan, went on a buyers strike, the entity that came to the US rescue was Belgium, which as most know is simply another name for… Europe: the continent that has just a modest amount of its own excess debt to worry about. One wonders what favors were (and are) being exchanged behind the scenes in order to preserve the semblance that “all is well”?
Plain vanilla bank runs are as old as fractional reserve banking itself, and usually happen just before or during an economic and financial collapse, when all trust (i.e. credit) in counterparties disappears and it is every man, woman and child, and what meager savings they may have, for themselves. However, when it comes to shadow bank runs, which take place when institutions are so mismatched in interest, credit and/or maturity exposure that something just snaps as it did in the hours after the Lehman collapse, that due to the sheer size of their funding exposure that they promptly grind the system to a halt even before conventional banks can open their doors to the general public, the conventional wisdom is that this is a novel development (and one which is largely misunderstood). It isn’t.
As the NY Fed’s blog (whose historical narratives are far more informative and accurate than its attempts to “explain away” the labor force participation collapse) recounts, the first tremor in the shadow banking system took place not in 2008 but some 250 years ago… during the Commercial Credit crisis of 1763, whose analog today is the all too shaky and largely unregulated core shadow banking system component: Tri-Party Repo.
From the NY Fed blog, by James Narron and David Skeie:
Crisis Chronicles: The Commercial Credit Crisis of 1763 and Today’s Tri-Party Repo Market
During the economic boom and credit expansion that followed the Seven Years’ War (1756-63), Berlin was the equivalent of an emerging market, Amsterdam’s merchant bankers were the primary sources of credit, and the Hamburg banking houses served as intermediaries between the two. But some Amsterdam merchant bankers were leveraged far beyond their capacity. When a speculative grain deal went bad, the banks discovered that there were limits to how much risk could be effectively hedged. In this issue of Crisis Chronicles, we review how “fire sales” drove systemic risk in funding markets some 250 years ago and explain why this could still happen in today’s tri-party repo market.
Early Credit Wrappers
One of the primary financial credit instruments of the 1760s was the bill of exchange—essentially a written order to pay a fixed sum of money at a future date. Early forms of bills of exchange date back to eighth-century China; the instrument was later adopted by Arab merchants to facilitate trade, and then spread throughout Europe. Bills of exchange were originally designed as short-term contracts but gradually became heavily used for long-term borrowing. They were typically rolled over and became de facto short-term loans to finance longer-term projects, creating a classic balance sheet maturity mismatch. At that time, bills of exchange could be re-sold, with each seller serving as a signatory to the bill and, by implication, insuring the buyer of the bill against default. This practice prevented the circulation of low-credit-quality bills among market participants and created a kind of “credit wrapper”—a guarantee for the specific loan—by making all signatories jointly liable for a particular bill. In addition, low acceptance fees—the fees paid to market participants for taking on the obligation to pay the bill of exchange—implied a perceived negligible risk. But the practice also resulted in binding market participants together through their balance sheets: one bank might have a receivable asset and a payable liability for the same bill of exchange, even when no goods were traded. By the end of the Seven Years’ War in 1763, high leverage and balance sheet interconnectedness left merchant bankers highly vulnerable to any slowdown in credit availability.
Tight Credit Markets Lead to Distressed Sales
Merchant bankers believed that their balance sheet growth and leverage were hedged through offsetting claims and liabilities. And while some of the more conservative Dutch bankers were cautious in growing their wartime business, others expanded quickly. One of the faster growing merchant banks belonged to the de Neufville brothers, who speculated in depreciating currencies and endorsed a large number of bills of exchange. Noting their success (if only in the short term), other merchant bankers followed suit. The crisis was triggered when the brothers entered into a speculative deal to buy grain from the Russian army as it left Poland. But with the war’s end, previously elevated grain prices collapsed by more than 75 percent, and the price decline began to depress other prices. As asset prices fell, it became increasingly difficult to get new loans to roll over existing debt. Tight credit markets led to distressed sales and further price declines. As credit markets dried up, merchant bankers began to suffer direct losses when their counterparties went bankrupt.
The crisis came to a head in Amsterdam in late July 1763 when the banking houses of Aron Joseph & Co and de Neufville failed, despite a collective action to save them. Their failure caused the de Neufville house’s creditors around Amsterdam to default. Two weeks later, Hamburg saw a wave of bank collapses, which in turn led to a new wave of failures in Amsterdam and pressure in Berlin. In all, there were more than 100 bank failures, mostly in Hamburg.
An Early Crisis-Driven Bailout
The commercial crisis in Berlin was severe, with the manufacturer, merchant, and banker Johann Ernst Gotzkowsky at the center. Gotzkowsky’s liabilities were almost all in bills of exchange, while almost all his assets were in fixed capital divided among his silk works and porcelain factory. Berlin was able to mitigate the effects of the crisis when Crown Prince Frederick imposed a payments standstill for several firms. To prevent contagion, the prince also organized some of the first financial-crisis-driven bailouts after he examined the books of Gotzkowsky’s diverse operations. Ultimately, about half of Gotzkowsky’s creditors accepted 50 cents on the dollar for outstanding debts.
Meanwhile, banks in Hamburg and the Exchange Bank of Amsterdam tried to extend securitized loans to deflect the crisis. But existing lending provisions restricted the ratio of bank money to gold and silver such that the banks had no real power to expand credit. These healthy banks were legally limited in their ability to support the credit-constrained banks. To preserve cash on hand, Hamburg and Amsterdam banks were slow to honor bills of exchange, eventually honoring them only after pressure from Berlin. The fact that Amsterdam and Hamburg banks re-opened within the year—and some even within weeks—provides evidence that the crisis was one of liquidity and not fundamental insolvency.
The crisis led to a period of falling industrial production and credit stagnation in northern Europe, with the recession being both deep and long-lasting in Prussia. These developments prompted a second wave of bankruptcies in 1766.
Distressed Fire Sales and the Tri-Party Repo Market
From this crisis we learn that it is difficult for firms to hedge losses when market risk and credit risk are highly correlated and aggregate risk remains. In this case, as asset prices fell during a time of distressed “fire sales,” asset prices became more correlated, further exacerbating downward price movement. When one firm moved to shore up its balance sheet by selling distressed assets, that put downward pressure on other, interconnected balance sheets. The liquidity risk was heightened further because most firms were highly leveraged. Those that had liquidity guarded it, creating a self-fulfilling flight to liquidity.
As we saw during the recent financial crisis, the tri-party repo market was overly reliant on massive extensions of intraday credit, driven by the timing between the daily unwind and renewal of repo transactions. Estimates suggest that by 2007, the repo market had grown to $10 trillion—the same order of magnitude as the total assets in the U.S. commercial banking sector—and intraday credit to any particular broker/dealer might approach $100 billion. And as in the commercial crisis of 1763, risk was underpriced with low repo “haircuts”—a haircut being a demand by a depositor for collateral valued higher than the value of the deposit.
Much of the work to address intraday credit risk in the repo market will be complete by year-end 2014, when intraday credit will have been reduced from 100 percent to about 10 percent. But as New York Fed President William C. Dudley noted in his recent introductory remarks at the conference “Fire Sales” as a Driver of Systemic Risk, “current reforms do not address the risk that a dealer’s loss of access to tri-party repo funding could precipitate destabilizing asset fire sales.” For example, in a time of market stress, when margin calls and mark-to-market losses constrain liquidity, firms are forced to deleverage. As recently pointed out by our New York Fed colleagues, deleveraging could impact other market participants and market sectors in current times, just as it did in 1763.
Crown Prince Frederick provided a short-term solution in 1763, but as we’ll see in upcoming posts, credit crises persisted. As we look toward a tri-party repo market structure that is more resilient to “destabilizing asset fire sales” and that prices risk more accurately, we ask, can industry provide the leadership needed to ensure that credit crises don’t persist? Or will regulators need to step in and play a firmer role to discipline dealers that borrow short-term from money market fund lenders and draw on the intraday credit provided by clearing banks? Tell us what you think.
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Fast forward to today when we find that the total collateral value in the Tri-Party repo system as of December amounts to $1.6 trillion.
… or 10% of US GDP. What can possibly go wrong.
First, the Obama administration showed during the course of the GM and Chrysler bankruptcy proceedings, that when it comes to Most Preferred Voter classes, some unsecured creditors – namely labor unions, and the millions of votes they bring – are more equal than other unsecured creditors – namely bondholders, and the zero votes they bring. Five years later we are about to get a stark reminder that under the superpriority rule of a community organizer for whom “fairness” trumps contract law any day, it is now Detroit’s turn to make a mockery of the recovery waterfall. As it turns out, bankrupt Detroit is proposing to favor pension funds at roughly double the rate of bondholders to resolve an estimated $18 billion in long-term obligations, according to a draft of a debt-cutting plan reviewed by The Wall Street Journal.
The breakdown to unsecured stakeholders would be as follows: 40% recovery for pension funds, 20% for unsecured bondholders – all this to the same pari class of unsecured creditors. Because just like in Europe when cashing out on CDS in insolvent nations is prohibited as it would suggest that the entire Eurozone experiment is one epic farce, regardless of how much “political capital” Goldman Sachs has invested in it, so in the US municipal creditors are realizing that in the worst case scenario, they will be layered first and foremost by all those whose votes are critical in keeping this crony administration in power.
According to the WSJ the plan calls for recovery to be divided among the unsecureds amounting to $4.2 billion, more than the originally planned $2 billion to settle claims which included about $11 billion in unsecured debt, including $6 billion in health and other benefits for retirees; $3.5 billion for retiree pensions; and about $530 million in general-obligation bonds.
There is a possibility that final “math” in the Plan of Reorg is changed before the final draft.
It was unclear from the plan reviewed by the Journal whether the city is using all of the same estimates for the money owed to unsecured creditors in its draft plan. A person familiar with the draft plan said the recovery rate for the pension funds could end lower than the balance sheet shows.
Details of the plan sent to creditors on Wednesday have been kept under wraps as the city and its debtholders continue to talk in closed-door mediation. The city sent its working draft to creditors in the hopes that the plan with a richer payout might spur some of them to settle with the city individually or, in the least, offer their own suggestions toward modifying the overall proposal, according to another person familiar with the matter.
The formal plan is expected to be filed in federal court in Detroit within two weeks, officials said. Creditors will vote on the plan, but the final decision rests with the court.
Still, the probability is that Kevyn Orr has finally gotten cold feet on playing hard ball with the unions. “The proposed plan provides the road map for all parties to resolve all outstanding issues and facilitate the city’s efforts to achieve long-term financial health,” Detroit Emergency Manager Kevyn Orr said in a statement Wednesday. Mr. Orr’s spokesman declined Thursday to comment on the plan’s details. Several creditors, who were opposed to the city’s early plans to offer creditors, including bondholders and pension funds, less than 20 cents on the dollars owed to them, also declined to comment.”
One can only imagine the amount of “Steve Rattnering” that must have gone on behind the scenes, and how much more is still set to happen, for such a skewed plan to pass the bankruptcy judge over creditor objections. Which it will once the president makes a phone call.
Then again, with contract law abrogated as was made very clear with this administration’s first steps into the “Fairness Doctrine” back in 2009 and the bankruptcy of GM and Chrysler, nothing can, or should, surprise one any more.
Greece Is Back: Germany, France, Creditors Hold Secret Meeting Due To Greek Bailout “Mounting Concerns” | Zero Hedge
There was a time – roughly between May 2010 and the spring fall of 2011 – when all the world had to worry about was Greece. Then the realization finally dawned that since a Grexit from the Eurozone would kill the EUR and the European integration dream with so much “political capital” invested, crush Deutsche Bank, and bring back the much dreaded (by German exporters) Deutsche Mark, it became clear that there is no fear that Greece, which is now a decrepit shell of a country with a collapsed economy and society in shambles, has now become a slave state to European bureaucrats, business and banks (in Nigel Farage’s words), will never be formally kicked out of Europe and only an internal coup would allow it to finally break free from the clutches of unelected European tyrants. And then the world moved on to more important things: like Japan, China Emerging Markets and how they are all enjoying the Fed’s taper. Sadly, we have to report, that Greece is once again baaaaack.
According to the WSJ, “top officials peeled away from colleagues after a euro-zone finance ministers meeting in Brussels Monday evening for a secret meeting to discuss mounting concerns over Greece’s bailout.
High-level officials from the International Monetary Fund, the European Commission, the European Central Bank, senior euro-zone officials and the German and French finance ministers were present, according to people with direct knowledge of the situation. They spoke on condition of anonymity because they aren’t authorized to talk to the press.
They were trying to figure out how to tackle two issues threatening to unsettle the fragile economic recovery in Greece and the broader euro zone.
They discussed how to press the Greek government to forge ahead with unpopular structural reforms; and second, how to scramble together extra cash to cover a shortfall in the country’s financing for the second half of the year, estimated at €5 billion-€6 billion ($6.81 billion-$8.17 billion).
Of course, this being Europe, nothing was decided: “The meeting was inconclusive, the people familiar with the situation said. Talks with the Greek authorities continue remotely—though representatives of the three institutions, known as the troika, have put on hold their plans to travel to Athens. Concerns are growing because Greece faces a large maturity of government bonds in May of €11 billion. The IMF hasn’t disbursed any aid to Greece since July and is €3.8 billion behind in scheduled aid payments. The IMF insists on having a clear view of the country’s finances 12 months ahead, and this condition hasn’t been met.”
And so the posturing resumes, with the Troika pretending it won’t hand over the funds unless Greece “reforms”, and Greece promising the “reform” as soon as it gets the funds. Nothing new here. What is new, is that finally the facade of Greek sovereignty and independence was stripped away as decisions regarding Greece took place… without
Greece: “Greek Finance Minister Yiannis Stournaras, who was briefing the
press in the same building at the time, wasn’t invited.”
Which is right – after all when a nation is enslaved and has no sovereignty, it doesn’t deserve to have a voice in its future.
Europe is recovering, right? Wrong. As Nigel Farage raged last night, things are not what they seem and even the IMF is now beginning to get concerned again (especially after Lagarde’s call yesterday for moar from Draghi and every other central banker). As Bloomberg’s Niraj Shah notes, it’s not just the PIIGS we have to worry about (or not), Denmark, Finland, Norway and Poland have been added to the IMF’s list of countries with the potential to destabilize the global economy.
Via Bloomberg’s Niraj Shah ( @economistniraj ),
The IMF’s decision means the four nations will be subject to mandatory financial sector assessments. The total number of countries on the list has risen to 29 from 25. The IMF’s decision may further undermine the safe-haven status of the Nordic nations, where rising household debt imposes a financial risk.
Ballooning Household Debt
Household debt and government-imposed austerity measures are deterring consumers from spending in the Nordic region. Denmark’s financial regulator is considering curbing banks’ lending policies to address the record household debt load. Danish households owe creditors 321 percent of disposable income, the OECD says. Norway’s household debt reached a record 200 percent of disposable income in 2011.
Austerity Triggered by Rising Government Debt
Finland’s debt-to-GDP ratio will almost double to 60.5 percent by 2015 from 33.9 percent in 2008, the IMF forecasts. The fund estimates the Finnish economy shrank 0.65 percent last year. Polish government debt reached 57.6 percent of GDP last year. A clause in the country’s constitution states that breaching a 55 percent ceiling triggers mandatory austerity measures.
Competitiveness at Risk
Denmark has dropped to 15th place in the World Economic Forum’s global competitiveness report from third in 2008. Labor costs rose 9.1 percent between 2008 and 2012, compared with an EU average increase of 8.6 percent in the period. Norway has the highest labor costs in Europe at 48.3 euros per hour in 2012, compared with 30.4 euros in Germany. That may undermine competitiveness and the growth outlook.
Most Financially Interconnected Countries
The inclusion of three Nordic nations for mandatory assessment is the result of a new methodology by the IMF that gives more weight to financial interconnectedness. The U.K. is the most financially linked nation in the world, followed by Germany. Seven of the top 10 most interconnected financial nations are in the euro-area.
So as the world congratulates itself (most notably Ben Bernanke today), the IMF seems concerned that this could all get worse again very quickly. Think they are all too small to worry about? Remember Lehman?