You never know what worse luck your bad luck has saved you from...

Mint – Bill Blain’s Morning Porridge  - March 26 2013

You never know what worse luck your bad luck has saved you from...

Before I launch into yesterday’s “interesting” day in the markets, and what it all meant, just a moment of reflection as Q1 2013 wends towards a weary close. We’ve seen spectacular gains, but also much to be nervous about as growth signals remain fractured. The euro remains critical. In the face of such a strong Q1, I’m thinking slower start next week to the Q2 markets. Let’s see what’s through the round window...(a reference to a BBC children's TV show, Play School, one of whose presenters was a chap called Brian Cant)...back to Yoorp! 

Contradictory bluster or a moment of genius?

Dutch finance minister and Eurogroup leader Jeroen Dijsselbloem shocked markets with his "this is the template for future crisis" comments. He didn't pull any punches making clear sovereigns and depositors bear the costs from here on in. He has since attempted to mellow his comments with a twitter retraction, but whether he intended it or not, they could become a moment of blinding clarity in the muddled history of the euro sovereign crisis.

European banks took a hammering from France across Spain to Italy. Even names like

HSBC were pulled lower. The positive market reaction to the Cyprus fudge was quickly replaced by risk off as rumours swirled of a Russian reactive impoundment of German assets or an Italy downgrade. Italy and Spain bonds wider. The implications of "exchange controls" are just being figured out... that should have been a bolt-gun to the back of the head for the euro.  

By pulling the rug from under Europe's busted banks Dijsselbloem has squared the circle and allowed the EU to close out the moral hazard aspects of too-big-to-fail banks. He's made clear eurozone sovereigns have to live with the consequences of unreconstructed banks. Remember, Dijsselbloem was behind the brutal but necessary quietus for sub debt holders in SNS a few weeks ago. This man means business. Subtle he is not. Wake up and smell the coffee Ireland and Spain.

His comments should not have been a surprise - Europe has long been working towards a Crisis Management Directive to resolve banking wobbles, and to reduce the size of Europe's financial sector. But it was a “courageous” call to say Europe will not mutualise any banking bailouts so loudly and publicly. Banking union dead on a word. ESM bailouts consigned to posterity. It was the emperor's naked moment - wiping clean at a stroke any remaining illusions Europe's banking crisis has been resolved, let alone effectively addressed.

What's wrong with closing banks and making uninsured depositors pay the consequences? In the case of Cypriot depositors - why did they think they were entitled to 4.5% deposit yields without assuming greater risk?

The Icelanders simply closed their bust banks and now their economy is on the mend - but people are bound to argue they are a special case. (And it did cause some distinct unpleasantness!) However, Danish bank resolution legislation has repeatedly closed insolvent banks. When it happened, investors in Danish banks were shocked and many retreated. Depositors were generally treated fairly. Now it looks prudent.

The vast majority of European banks remain delusional, over-levered, unreconstructed and tremendously vulnerable to the imaginary marks in their banking books. Compare European banks to US banks. Not a fair comparison at all. US banks are effectively fixed and are financing growth and driving asset appreciation - which makes everyone feel better. European banks have yet to take the medicine. Which is not going to help resolve Europe's miserable economic position.

European bank investors saw their remaining illusions shattered yesterday. Which means I really do need to immediately update Blain's bad bank list to reflect the new banking reality. I'll be giving additional points to the systemically important financial institutions (SIFIs), but off the top of my head (as I write this on the train), my list of good European banks includes one UK name and a couple of Scandinavians.

All the rest of Europe’s banking dross are vulnerable to market consequences - ongoing deleverage, another close-off in non-central bank funding, and European recession (which will be deepened, in part, but the non-availability of bank lending caused by...go to top of this and start reading again.) So a new round of banking capitalisation? Yesterday's comments probably create the worst capital funding environment since 2008. Let’s just assume Europe's banks go back to square one.

To illustrate Europe’s bad banks: Bloomberg has a rather good article ahead of Monte dei Paschi’s numbers later this week. They suggest the recipient of a recent €4bn rescue will still see a net loss of €2.3bn, and soaring NPLS. Poor profits, poor credit quality, poor risk control and massive overexposure to sovereign debt are not fixed. The article says there are over €126bn of bad loans at Italian banks. MPS NPLs account for 12% of lending while it holds €22bn of European government debt. It owes over €29bn to the ECB. Oops. Makes you think….  

On the other hand, if there is a big sell off in bank paper, then there will be bargains worth thinking about. Just because the banks are bad does not mean they are all bust. Yes, there will probably be more banking casualties, but more European banks are likely to muddle through and survive – which means there is great value out there if prices cheapen in senior and sub debt. More than happy to put bids on any bank paper this morning.

So in answer to my question at the start of this porridge - bluster or genius? The latter I think, but it’s a very high stakes game and weak hand.

Housekeeping matter: I’m a tad concerned the number of porridge readers who called or wrote yesterday telling me my opening quote was wrong.. “Was it over when the Germans bombed Pearl Harbour?” and informing me it was actually the Japanese who attacked the Honolulu port… NSS.. The quote was taken from the late 70s film Animal House…a classic John Belushi moment…

On the basis that nothing is ever new...the point of my morning top line quote is to try and sum up the market in a single pithy comment taken from song, book, film, theatre or whatever. For instance: Classic Star Wars...“These are not the droids you are looking for” neatly sums up the delusion that is the single currency...but I can’t use it every single day…I need to find something new. Writing the porridge takes moments...trying to remember an appropriate quote is the difficult bit.

Points are awarded each morning for identifying the quote and context, and points… points mean prizes…(a reference to a dreadful TV game show hosted by a chap called Bruce Forsythe, who, now in his 80s and despite a lack of any discernible talent, has made an extremely good living out of Britain's variety and TV industry

Out of time and back to markets.. Bank debt anyone?

Bill Blain

0207 786 3877

[email protected]

[email protected]