As readers may recall, we wrote in late October about the growing problem euro area banks are facing with respect to eligible collateral that can be used to obtain funding from the ECB (see 'The Euro Area Crisis May Be Coming To A Head' for the details).
In addition to this problem, banks are also faced with grave challenges regarding their long term funding requirements. In short, no-one wants to buy their bonds, but they actually need to roll over hundreds of billions in maturing debt next year. As the FT reports on this point:
“The worsening sovereign debt crisis in Europe has alarmed investors in eurozone bank debt. Many have simply backed away from funding the region’s lenders, stoking fears of a self-fulfilling funding squeeze. Even run-of-the-mill depositors – who historically have acted as a ‘sticky’ or safe form of funding for banks – are becoming more fickle.
Unicredit’s plea to the ECB in Frankfurt, on behalf of Italy’s banks, is “a sign that there are significant funding difficulties for European banks and they are escalating,” says Suki Mann, Société Générale credit strategist. He says that European banks have raised just €10.5bn of euro-denominated debt since July, a fraction of their usual financing needs.
With public markets effectively closed or prohibitively expensive for many European banks, lenders are having to look at different financing options. These include issuing more secured debt, such as covered bonds, or striking private funding deals. Banks can also attempt to increase their deposits, or tap the ECB for fresh loans.
The scale of refinancing is immense. Europe’s banks have raised about €295bn in the capital markets so far this year, according to Dealogic data. At the same time, the banks have €485bn of debt due to mature next year, meaning Europe’s lenders will have to scramble simply to replace their bonds.”
[…]
European authorities have also recognised the problem, promising to come up with a fix for the region’s funding woes at last month’s European Union summit. An EU-wide guarantee for bank debt might help thaw the market. But the EU has yet to announce details of its proposed plan and co-ordinating any such programme is likely to be difficult.
[...]
With investors backing off, Europe’s banks are left with two other options. They can turn to the ECB for funding or simply shrink their balance sheets; cutting unprofitable lending or exiting some businesses altogether.
(emphasis added)
A chart depicting the financing needs of euro area banks, via the FT – click for higher resolution.
We would add to this that the 'they can turn to the ECB' option runs into the problem that the 'striking of private funding deals' has denuded the banks of unencumbered assets they can pledge to the central bank. In spite of the fact that eligibility rules for collateral have been relaxed considerably, it has become increasingly evident that the assets still available for this purpose may not suffice to see the banks through. This means that 'shrinking their balance sheets' will soon remain as the sole alternative. A massive credit crunch is thus preordained. As to the fact that the “EU has yet to announce details of its proposed plan”, this is par for the course. There isn't a single plan in the context of the current crisis for which 'the details' have been hammered out yet. The only things that seem to be moving forward at a fast pace are various obstacles aimed at restricting financial market activity, such as the just passed 'naked CDS' trading ban.
As the WSJ reports, the scramble for collateral is beginning to take on potentially dangerous facets:
“Sometimes the end really is near. As the Journal’s David Enrich reports in this A1 story, European banks are resorting to liquidity swaps of dubious value to come up with the billions of euros worth of assets they need to pledge as collateral to secure ECB loans. This mad dash for collateral highlights how traditional sources of funding have dried up on concerns that lenders are sitting on “huge piles of risky government bonds and loans to shaky borrowers,” Enrich reports. It’s gotten so bad that, in a case of man bites dog, some corporate borrowers are balking at doing business with their banks.
And the U.K.’s Financial Services Authority has ominously warned that liquidity swaps have the potential to “create a transmission mechanism by which systemic risk across the financial system may be exacerbated.”
As we have pointed out yesterday, euro basis swaps have moved to new crisis wides, plunging below a previous shelf of support. The dollar swap agreement between the Fed and the ECB allows the banks to tap the ECB for dollar funding, however most have so far refrained from making use of this facility for two reasons, namely the stigma associated with it and more importantly, the price attached to this funding avenue. The ECB is charging the Fed Funds rate plus 100 basis points for dollar funding. Hence, as long as euro basis swaps remained at a level that was below the cost of the ECB's dollar funding facility, it made no sense to tap it – except for banks that are completely shut out from the wholesale and interbank funding markets.
This is now changing with the break of euro basis swaps to new wides, so we can likely expect an explosion in ECB dollar funding for euro area banks in coming weeks, especially if the situation in the swaps market worsens further. According to Reuters:
“The dollar funding issues for European banks have been well publicised over the past few months. Fearful of the worsening Eurozone crisis, vital sources of dollar liquidity like US money market funds reduced their exposure to European banks in the third quarter. Many European banks reacted by selling dollar assets and entering into secured funding transactions to alleviate their funding stress. At the same time, coordinated central bank action announcing the introduction of new dollar swap lines in mid-September helped to significantly ease markets.
However, signs of dollar funding stress have returned over the past fortnight, as the Eurozone crisis once again stepped up a gear. The three-month EUR/USD basis swap is currently trading at 129bp below Euribor, compared to around 103bp below three weeks ago.
[..]
"The way that the market is going, pressure is increasing for people to start tapping the ECB dollar line, both because the FX forward markets and the cross currency markets are drifting in the wrong direction making it more expensive to roll funding in the open market through the FX forwards, and because the banks themselves in Europe are under increased funding pressure as time goes by," said Nick Hallett, head of cross currency swaps at Barclays Capital.”
(emphasis added)
Meanwhile, Jonathan Weil has published an interesting observation in the wake of Unicredit's recently announced huge loss. As Weil notes, there is a good reason why bank stocks trade at a huge discount to their stated book value. Their books values are vastly overstated by accounting items that have little bearing on tangible value. Among those there are large 'deferred tax assets' (which only are of value if one actually makes a profit) and generous dollops of 'goodwill'. In the case of Unicredito the numbers are staggering, but the same is true for many other banks – including US banks:
“About 12 billion euros, or 23 percent, of UniCredit’s equity consisted of deferred-tax assets. Basically, this number represents the money UniCredit believes it will save on taxes in the future, assuming it will be profitable. Trouble is, in a crisis, those assets are pretty much useless.
On top of that, UniCredit’s balance sheet still showed 11.5 billion euros of the intangible asset known as goodwill, even after the bank wrote this down by 8.7 billion euros last quarter. Goodwill isn’t a salable asset. It’s the ledger entry a company records when it pays a premium price to buy another. The asset exists only on paper. (For what it’s worth, European banks are allowed to count deferred-tax assets as part of their regulatory capital, unlike goodwill.)
Add up the goodwill and deferred taxes, and that’s 23.5 billion euros of junk assets right there, which is more than the company’s market capitalization.
Hence, the problem: The numbers don’t make sense, at least not in the real world. And this is from a bank that would seem to be a beacon of candor by European standards, considering that no one else reported such huge third-quarter losses at a time when Europe is on the verge of disaster.
The French lender Credit Agricole SA, for instance, showed 19 billion euros of goodwill as of Sept. 30. That’s 7.4 billion euros more than its current market cap. Dexia SA (DEXB), the French- Belgian lender, took a government bailout in October, only three months after passing European regulators’ stress tests. Lack of faith in big banks’ numbers isn’t strictly a European problem, either. In the U.S., Bank of America Corp. shows .8 billion of goodwill, about billion more than its market cap.
(emphasis added)
In so many words, all these banks are really worth zilch. Anyone buying their shares is an incurable optimist. This underlines an observation of Murray Rothbard's, who once noted (paraphrasing) that 'fractionally reserved banks are always teetering on the edge of insolvency'.
As an aside to the above, Unicredito has announced that it plans to raise € 7.5 billion in new capital. Consider in this context that the bank has assets valued at € 950 billion.
Meanwhile, in today's trading, government bond yields of Italy and France came in a little bit following a successful French bond auction and more (rumored) ECB intervention in Italian bonds. However, Spanish bond yields have continued to shoot up and sit at 6.77% at the time of writing, still influenced by the after-effects of yesterday's disastrous auction, in which the government had to agree to pay yields of almost 7% – causing Spain's prime minister Zapatero to plead for 'immediate action to stem the crisis' from the ECB. “That’s why we transferred to them a great part of the powers of each central bank,” Zapatero said.
The press has lately taken note of the deep troubles faced by Spain's banks – something we wrote about in great detail many months ago already (scroll down to 'The Accounting Tricks of Spain's Banks' for details). Bloomberg now reports that Spain's banks are under threat from 'unsellable real estate':
“Spanish banks, under pressure to cut property-backed debt, hold about 30 billion euros ( billion) of real estate that’s “unsellable,” according to a risk adviser to Banco Santander SA (SAN) and five other lenders.
“I’m really worried about the small- and medium-sized banks whose business is 100 percent in Spain and based on real- estate growth,” Pablo Cantos, managing partner of Madrid-based MaC Group, said in an interview. “I foresee Spain will be left with just four large banks.”
Spanish lenders hold 308 billion euros of real estate loans, about half of which are “troubled,” according to the Bank of Spain. The central bank tightened rules last year to force lenders to aside more reserves against property taken onto their books in exchange for unpaid debts, pressing them to sell assets rather than wait for the market to recover from a four- year decline.
Land “in the middle of nowhere” and unfinished residential units will take as long as 40 years to sell, Cantos said. Only bigger banks such as Santander, Banco Bilbao Vizcaya Argentaria SA (BBVA), La Caixa and Bankia SA are strong enough to survive their real-estate losses, he said.”
(emphasis added)
It is becoming difficult to keep track of the many fires that are now burning in the euro area's banking landscape. Not surprisingly, EU president Barroso now speaks of a 'systemic crisis' being faced by the euro-area.
