Wednesday, February 24, 2016

7 year of Emergency Policy -- how's it looking now?

Headlines last week -- Japan's stores run out of safes!  Turns out that the Japanese have a simple solution to negative interest rates; buy a safe!  Some have tried to paint the removal of the Euro 500 note and the "rumoured" desire by the Feds to kill the US$ 100 as a way of killing cash (which may be true).  But right now people have decided that the banks are doing a terrible job -- are in precarious position, and that interest rates are so low that you may as well keep cash at hand.  If you are not paid for a risk, why take it.

By the way it reminds me a long long time ago (ok late '90s) I had to purchase a plane ticket with cash (like that would be possible now) the airline insisted that I use cash...this was two round the world tickets -- about S$ 6,000 for the two tickets -- so I go to my bank and ask for $6,000 in cash. The cashier tells me that I can have whatever denomination I want.  So like a smart ass that I am I say, can I have a $5,000 and $1,000 note.....  She comes back two minutes later with 6 $1,000 notes -- unfortunately they were out of $5,000 (BTW in those day USD and Singapore dollar were near parity).  They had $10,000 notes but just not any $5,000 notes.  

Back to our story.  From Japan to Switzerland interest rates have been negative for nearly 12 months. For the Swiss the outcome has been strange, local banks offering mortgages should normally have offered zero interest mortgage, but in fact they too changed their methods, once interest went below zero they didn't feel bound by the same price of money connection -- and so mortgage rates in Switzerland have been rising!

The stock market (S&P 500) has been going up and down, but really not doing anything over the past 12 months would have seen only a very small reduction in the value of your portfolio.  Again, timing is the key, for while prices have not moved much the volatility has gone trough the roof.  Look at oil price, in the past 10 days they've gone from $26 to $33 -- that's nearly a 30% price change.  The daily swings have often been of 5-10%.  

So now what.  There's a feeling in the market that ECB is about to pull another -- we will do whatever it takes,move to keep the European experiment working; Greece, Spain and many other are in trouble.  Lets not forget Deutsch Banks;  If DB is on the ropes the European experiment is in real trouble -- as are most of the world's banks.

Enough with my rosy perspective!

Monday, February 15, 2016

The energy complex

A few weeks ago I said that it was possible that oil had finally found its floor, well the market made a fool out of me, from $30 it fell all the way down to $26 (its back around $29 now).  But it remains that the oil and gas sector are having a difficult time -- really it's bad!

The US non-conventionals have been using the debt high yield market to finance their operations, it was for a long time much cheaper than the equity markets, in fact 2012/14 saw massive issuance in the high yield market -- somewhere between 20% and 30% of all HY instruments are related to the energy sector.

Rumours a few weeks ago emerged that the Feds were encouraging banks to play nice with the borrowers -- as they say that was then, this is now, and now is looking distressed.  M&A bankers buddies have told me that the restructuring of the E&P sector was was long though to go via sale of business has moved to debt reorg.  The equity has been wiped out, and  good chunk of the debt too (watch out pension funds).

There is no doubt that in the 26/30 range most producers are underwater for their fixed costs, but now it appears that even their variable costs are no longer covered, because the WTI is light and sweet and the stuff out of non-conventional is not light and sweet, there are issues with storage and the price for the non-con production is apparently closer to $15 (someone told me near $12...) that around $30.  That's because there is such a glut of crude in the system, pricing is difficult.

So lenders (who played the game) and FI book that "spiked their yield" with some good old fashion HY debt instruments are finding their books in trouble.  On top of everything, these HY instruments were covenant lite, so that there was no way for lenders to take action until interest payments are delinquent.

So debt write down are about to start (maybe already started), and borrowers are looking at Chapter 11 or maybe even chapter 7 liquidation... the road is going to be difficult.  Now not to add to all these problems but now even China is starting to get unconventional with its bad debt.  Rumours of Chinese NPL entering the US distressed market have emerged in the past few weeks...

Thursday, February 4, 2016

European banks are not in good shape

So a few months ago, bad vibes started coming out of Italy; the banking sector was on edge, the Italian government has "decided" that it would create a Bad bank in which all the troubled loans, held by Italian banks, will be parked and eventually liquidated -- one small problem, the Italian government doesn't have the cash at hand to capitalise the bad bank...

Stories (and they are just that) that the new bad banks -- so that it doesn't break the new EU rules on bail-outs, would only capture 40% of the bad loans.  This new deal has been in serious discussion (with real details) and the impact is that Italian banks share have resumed their general decline (as can be seen below) [Startfort]

So that's Italy!  What about the rest?  Well DB came out a few days ago with truly mind blowing bad numbers:  7 billion , revenues are down -- in IB which is serious because IB and asset management are the two key core activities of the bank.  Turns out that yesterday total derivative exposure (gross) was also rather impressive with nearly $64 trillion (something in the order of 20x Europe GDP).  All along we though the bad guy was JP Morgan.  Then the other shoe dropped this morning, UBS just announces some massive losses too -- for a bank in the middle of a re-org, the news could not have been worse.

So some of the heaviest hitters in the European banking industry are having a truly horrible time, the implication for the European global economy cannot be good, for although I don't have much respect for the modern banking sector -- 2008 should have been a cleansing of the financial market -- the opposite occurred "Too big to fail, insured that the players could do anything.  They knew they would always escape prosecution.  Still it remains that the world is interconnected and when a firm like DB is in trouble, all bets are off. 

It doesn't take a genius to wonder what is going on.  I've seen North American bank numbers and the stories are far from being horrible.  Income from IB is up, capital market too -- and 2016 should be a great year with higher volatility.  Bond desks are not having fun, but still yields keep on dropping, so the trades are still interesting.  So its seems that NA banks are doing fine (granted the E&P sector could cause some serious headaches -- now if DB is in real trouble the risk of contagion is high -- as one punter said, Gross exposure is only a problem whey one of your counterparty fails (e.g. AIG) otherwise net exposure is a reliable risk barometer...which is crock! 

My gut instinct is that there is something up in the European banking sector.  The problems are very serious and will impact the "real economy" sooner than later.  Not sure how it will change things in NA, but it remains that troubled times are at hand.