29 July 2010

Is the Risk On trade already Off? Markets are like milkshakes - Frothy !

Banks are all posting morning notes saying things like “the credit frenzy continues unabated”. Beware. That’s banks talking their own books – which they still want to lighten. Talking to real money over last few days it’s clear that although many like the sentiment shift, they aren’t tempted in - yet. Instead, we feel this rally is close to stalled. Volumes remain incredibly thin. Is this the moment it might all turn a bit whoosh again? Is it the real life or is it just fantasy? Only Freddie knows.

How sustained is the rally?

I was delighted y’day when a client emailed me back a copy of the Porridge from earlier this month. Then he thought I was daft to make a bullish call. Although economics and Europe looked bleak, I thought the underlying signals looked better, so said buy credit and financials. I even called an easier Basel III would be a much more important boost for financials than the flawed bank stress tests. I also said it would probably be a short lived uptick. In other words... I am an investment god. (er.... no.. you are not....)

Now, I urge a little caution – be very selective rather than general. Again, if there are positions you don’t want to be worrying about when the inevitable next bear-phase hits, then let’s sell them today. I’m not calling a dramatic correction on the Euro, credit spreads or recent sovereign gains... let’s just say I’ve got a feeling.. (sinister drum roll in background)

Bearish judders....

Couple of issues ‘trigger my mild bearish jitter. Spreads in troubled sovereigns have ratcheted in dramatically – why? What’s changed? I wonder if the gains are sustainable. Economics seems to be taking a back seat – and surely recession and inflation are real risks? The next couple of US economic reports like GDP and next week’s job’s report will be critical and likely raise slowdown fears. And we’re starting to hear more noise from the sidelines.

Bank credit outlooks

In the US, y’day Moody’s put the outlook for BoA, Citi and Wells on negative watch on the basis the Dodd-Frank Wall St Reform Bill will ultimately lead to “lower levels of government support for US banks”. Doink... That will teach politicos to meddle in the ratings morass! But in a very interesting comment CreditSights said it is not going to change its own ratings, but does forseee a possible “attractive spread arbitrage if agency follows through [ie cuts] and risks do not materially change”.   Indeed... the old conundrum: Can governments ever realistically step away from their last resort function? There will always be far too much at stake.

Hostility to easier Basel III

I also read on Bloomberg that these two paragons of financial rectitude: these same US Senators Dodd and Frank, now want to hold hearings on watering down Basel III. They’ve got the senate flock all worried that apparent international agreements to tighten capital standards are being undone and the US of A will be the loser. “I am concerned the recent proposals will result in weak and even non-binding provisions that provide credit for banks for holding forms of capital that have little or no value in absorbing losses” said US Senator Kaufman. Doh!

International agreement on capital was always going to be difficult. Simply too much self interest is at stake. France and Germany are seen to have led calls for weaker proposals... and the Germans are the last holdout having not yet signed up!

Meanwhile, Jim Rodgers – Quantum’s founder alongside George Soros – summed up the frothy mood. He warned it’s not about how well results look today compared with how bleak things were in 2009, but “worry about next year”. He’s somewhat sceptical and predicts a major recession in 2012, which will be worse because Central Banks just don’t have any cash left to throw at the problem.

Austerity vs Spending

In terms of the austerity debate, the breach between the Euro and US approaches to recession continue to widen. The Fed’s approach of keeping the option of throwing cash at the crisis to keep recovery on track may be one of the factors benefitting the Euro and explaining its recent rise. An increasing number of investors are staying in Euro precisely because of the hard-line on stimulus. With the US debt clock ticking steadily higher, it seems dollar bulls are being reined back. However, once the holidays are over, I expect the political pressure on European governments – particularly from organised labour – will rise.

Bank of England Governor Mervyn King seems to have chosen the US camp. He told parliament “not to read too much” into strong GDP figures. He told the Treasury select committee “it’s still about the need for stimulus.... The debate is about the appropriate degree of stimulus... not applying the brakes.”

However, as the UK’s Debt Management Office spectacularly demonstrated earlier this week with its new UK Index-lined gilt (over £9bln demand for a £6bln issue – who said there wasn’t sufficient demand for gilts), there is a substantial appetite for Linkers. I read a pundit from a well known fund stating the downright bleeding obvious: “demand to hedge inflation is there.” I’d add it’s likely to grow.

Meanwhile... back at the ranch...

Over the next weeks we’re going to be thinly staffed with folk out on holidays. I’ll be in most of next week, but will be taking some time out to do a few days racing yachts at Cowes.. everyone needs a hobby! There will always be at least one of us on the desk – and don’t hestitate to use the mobile.

Best! BB

28 July 2010

Buy buy buy... byebye..

Every blog I’ve seen this morning has a variation of “buy, buy, buy” writ large across it. Bull market. Corporate debt tighter. Risk Trade back on; proclaim the headlines. Whoa! Take deep breath. Step away. Stop. Look. Listen. Buy when it is safe to do so.

Indices, ITraxx and CDS may be tighter, but don’t be seduced by the current credit rally. Eyes wide open. There has been a real sentiment switch, but it’s been very fast and pretty narrowly founded. Bonds are tighter, but on extremely thin real volumes. Sentiment is much better but inventory held by street banks, or otherwise available for sale, is very light. The result is we are seeing a disproportionate amount of tightening based on relatively small volumes.

The action is attracting interest and lots of frothy comment. There is real demand out there, and more buyers are emerging – which means these low inventories of paper actually available to sell tighten even more. But thin markets are easily stalled – witness the buying stopped in US last night after week consumer numbers.

A new issue binge in August? Perhaps? There is no reason why not. That the City goes to sleep in August is a myth propounded by the bankers.

The reality, however, is banks will simply try to rack prices higher on their remaining inventory. Moreover, I don’t expect them to be willing to go long to rebuild inventories. There is nothing the banks like better than a good summer rally to flatten their risk profiles. Then they can sit back and look to September – to either rebuild inventory cheaper as this rally fades and prices cheapen, or to flood the market in new issue supply.

For smarter debt holders, this is an opportunity to sell. Not necessarily to de-risk, but to change the shape of overall risk. Switch the profile on sovereign risk by selling some of these implicit state risk bonds you have nagging doubts about, or the banks where you have a nagging fear about their ability to refinance. Or that corporate that just doesn’t seem to have caught the same market buzz. Nice time to do some portfolio tidy up.

When the market is on a rally like this, it’s well to remember the threats. First of these is economic. If we can forget double dip then how quickly do we factor back in higher rates. Second threat is a renewed assault on Europe. I read a remarkable piece on Greece y’day praising the Greek government for its swift austerity actions and success in reining back spending. Really? Stopping paying the monthly bills doesn’t mean you are suddenly solvent again! I suspect the market is going to wake up to the austerity rally sooner than later.

Banks

Meanwhile, yesterday’s big stock story was bank stocks rising 5% plus on the back of a number of positive factors. The more lenient Basel III proposals catalysed the whole market – turning the positive slant after the Bank Stress Tests and decent bank results into a buying frenzy. Banks have turned from undervalued and low rated, back into overweight. (We will have an analyst note on banks and Basel III effects later this week.)

However, there are still hurdles to overcome. The major one is restoring bank paper liquidity and funding. Although we are seeing a substantial number of new bank deals come to the senior and subordinated market, the range of names investors will buy remains very selective.

This morning we’ve new deals from Credit Suisse in T1, and yesterday’s 50-yr sterling Rabo deal must have gone straight to the pension funds.

China Local Lending Bubble?

Yesterday, I deliberately avoided commenting on a story in FT about local government lending risks in China. If I had, I’d have been deluged in emails from some of our China-watching clients telling me nothing is wrong, and “stop commentating on things you know nothing about!” I’d have been chastised for falling for “hype” and have drilled into my thick skull that the risks of a hard China landing are minimal.

However, I also spotted a story on Bberg from our new best Chinese friend, the remarkable Gaun Jianzhong, chairman of Dagong, the Chinese rating agency. He says China local authority lending is “very dangerous”. (Dang(ong).. that is worth noting.)

The agency says the AA and better credit ratings assigned to yaun-denominated bonds issued by local governments are misleading and don’t reflect all the risks. It notes Local Authorities have been setting up AA financing vehicles to fund projects due to their own limited access to cash. “Whoever gives them a better rating gets the business” says Mr Gaun. However, although Dagong expects defaults on bank loans taken up by these AA vehicles, “there won’t be a risk to the banking system as regulation has improved”, he says.  

In the news:

The Torygraph carries a comment the Bank of England has lost £5.5 bln on it Quantitative Easing book – according to its Feb 09- Feb 10 report. Expect it to turn positive for next report.

Out of time…

27 July 2010

Bullish – but for how long?

The market certainly feels in a very constructive and buoyant phase. We’ve seen corporate paper tighten to new highs, and bank bonds bid up. But volumes are incredibly light – perhaps a reflection of people away on holiday, but more likely most players choosing to remain sidelined until now. We’re seeing buyers start to emerge across a range of “troubled” assets: Portugal, Spain, Spain Banks and more. After the gloom and uncertainty of Q2, it does look like Q3 is ripe with bond issue opportunities. But will the positive glow be maintained through to September?

Stronger – almost surprising – US housing starts numbers demonstrate how sensitive the market is to economic data. Up on good read of numbers and down when the revisions were taken into account. Our guess is the double dippers may be over-exaggerating what is more likely a down blip in the US economic recovery. But many analysts remain resolutely negative, anticipating post summer that the scale of government cuts to come and the austerity calls will inevitably impact business and consumer sentiment, thus making the double dip self fulfilling. Let’s see.

After the European bank stress tests.. what next? The big challenge for banks is refinancing. Estimates say some $250 bln of bank paper needs refinanced in coming months. One aim of the tests was to create a mood the confidence around banks, showing they are sufficiently well capitalized to survive, and thus allowing them to re-enter the funding market.

Even though the tests were bodged – and there is enough colour in  the press, it does feel that the mood is turning more positive towards the banking sector.

The FT carries a Citicorp report estimating if the CEBS stress tests had tested banks entire sovereign debt holdings rather than just their trading book investments, then some 24 (rather than 7) would have failed – requiring a further Euro 15 bln of new capital. Banks in the 24 group include AIB, Monte dei Paschi, Greek banks, more Cajas and 2 German Landesbanks. That’s not actually that bad.

Another factor that may help banks is confirmation the Basel committee is going to be lenient on new Basel III capital standards, (something we prefigured and anticipated a few weeks ago). It will ease some general concerns. Banks will be allowed to maintain minority interest in their capital calculations, plus it looks like timing on leverage ratios will be extended.

There’s is a great editorial comment in the FT warning about how regulators are succumbing to bank pressure to water down the rules – but I’ll stick to my unfashionable view that a laizez-faire approach and less regulation is better than more! Simple is workable. We’ll do a fuller analysis of the effects of Basel III on banks as we collate more data.

Meanwhile, investment banks are in the news this morning. Nomura sees a slump in trading and investment banking revenues. UBS numbers look good – even after a high gain on its own credit, and a 16.4% Tier 1 ratio look smugly high!  (Looking at a raft of banks will high Tier 1 ratios reminds me of the old adage, “only one thing worse than too little capital, and that’s too much!” High capital levels may entice banks to do “silly” things.)

Deutsche Bank’s numbers were less strong. It’s taken a decline in investment banking and trading – but not any worse than comparable bulge bracket IB players However, we understand head man Anshu Jain gave the troops a rousing speech last night and explained his plans to advance the bank outside its core European base. DB is one of the few banks that came out the crisis intact and able. It’s been able to retain and develop key skills through volatile markets. Its franchise is certainly strong enough and has the gravitas to penetrate deeper in Asia.

But, the bank suffers from a split personality –global ambition is great, but it still behaves like a small town German. Deutsche took considerable flack and saw its stock underperform when it declined to release details of its sovereign exposures as part of the stress tests last week. The FT said the following: “In spite of Deutsche’s strong performance in the test, coming through with a 10.3 per cent tier-one capital ratio, the fact that the bank did not disclose enough to produce a sovereign debt stress result did not sit well with the market. It was the most heavily sold big continental bank when European markets opened on Monday.”

Today, it has U-turned and is going to rush out the details. Our Bank Analyst Andrew Lim ran them though his box and concludes they aren’t bad: “The amount of peripheral European sovereign debt held in the banking book is much less than that held in the trading book. This means that the warning sign stemming from the large impact on the trading book as a result of the “sovereign shock” in the CEBS stress test is more of a red-herring.”

Not releasing the numbers last Friday may sum up Deutsche’s quandary: does it try to be a good German (standing alongside other German banks that were resisting releasing the data), or does it become a truly global institution and in play in tune with the global financial market rather than being a big fish in the German Finanzplatz?  

Enough… Out of time…

26 July 2010

Bank Stress tests: providing employment for otherwise useless teenage scribblers (Mr Lim excepted of course...)

Before the inevitable tirade, what’s the story for the next few days? We are definitely into the summer, and the markets are thinner than a particularly busy fashion model. The markets are being seduced by the positive economic picture coming out of Europe (by which we mean Germany – reaping the benefits of its competitive dominance of Europe), while the business news out of the US is far less frothy. As a result the Euro is on an uptick – but one I reckon has pretty unsteady legs. The reversal, and it will come, will be sudden.

Bank Stress Tests

I have attached our Andrew Lim’s comment on the stress tests. Well worth a read. Please feel free to contact him directly.

So what blistering incisive comment can I make about the European Bank Stress Tests? What rib-tickling witticism are you expecting to set the bond market gently rocking on their chairs this morning? Nothing. The stress tests are irrelevant, therefore no reason to comment further on them. Pants.. is my considerably considered judgement.

Dang… I can’t resist taking a pop at them.

Unfortunately - they do matter. They are yet another confirmation that the European banking system not only is broken, but that it is being overseen by fools. To paraphrase the classic Battle of Britain line: “You can teach monkeys to regulate better than that….” (Name the two famous actors for 5 points each.)

Anything that doesn’t acknowledge the possibility of sovereign mayhem is worthless.  Although enough has already been writ, and every reader already knows I’m going to be dismissive and cynical, let’s just look at what others have said:

“Unconvincing”. “Predictable”. “Disappointment”. “Failed to address the Achilles heel.” “An obviously non-credible test.” “Not impressed”. “Yet to pass the stress test of market confidence.” “Nicely manufactured nonsense”. “Fudged stress tests and fudged Grand Prix”.

On the upside: “better disclosure than we expected”.. and that’s about it.

“German banks renage on a deal to publish full details of their sovereign debt holdings.” FT quotes CEBS secretary-general, Arnoud Vossen, saying he “needs to have a chat” with them about that. Perhaps the time to have had a chat was a while ago. All I can add is to remind readers Germany was rumoured to have promised its’ banks would not dump sovereign assets into the ECB at the time of the rescue package. Other countries did not. Funny how French banks report limited exposures.  

Interesting to note Andrew Lim’s comment about Deutsche Bank – which did not provide a breakdown. He concludes: “This implies that the amount of sovereign debt that Deutsche Bank owns in its trading book is substantial, and in its banking book it should be even greater.”

Meanwhile: the FT quotes Mr Vossen saying his measures of success include bank share prices rising, (they probably will on the basis of how successfully they’ve made supervisors look like eejits, and hence limited new capital needs), and on “banks in certain countries, notably Spain” being able to access interbank funding. I’ll let you know if anyone calls up and says they’re an overnight convert and want to buy Spanish bank paper. Not exactly deluged in calls… yet.

Spanish regulator says… “a demanding exercise… restores confidence in the Spanish financial system”. You wish. Another interesting point Mr Lim highlights is 151% of BBVA’s Tier 1 capital is exposed to Spanish Sovereign Debt.

‘If you tried to test the safety of cars or children’s toys using the same method the European Union applied in its stress tests on banks, you would end up in jail”, says Wolfgang Munchau in the FT. Munchau also asks why state financial institutions were not not in testing line. He specifically asks why KFW: “the German state-owned institution that is legally not a bank but carries out bank-like functions – such as accumulating lots of toxic assets” wasn’t tested? Interestingly.. we’ve seen sellers of KFW recently. Which I why I’m a buyer of Rentenbank!

What really scares me is CEBS…who are these people? Sadly… they are going to become even more “relevant” as the European Union’s mission to civilise us becomes a crusade: next year CEBS becomes the European Banking Authority. Oh feth. “In future we will have much less of a co-ordinating role,” says Mr Vossen. ““Instead, since we have binding standards, we will be more prescriptive.” You have been warned. Someone shoot me now….

Otherwise… what did you think of the show Mrs Lincon?

Oh.. and lots of other things are also happening in the market.. and I suppose I should really comment on them… tomorrow..

Bank Stress Tests 2

For those of you who won’t read Andrew’s note: key points: He does an analysis based on a (reasonable) 50% Greek, 30% Portuguese and 20% Spain haircut. Not pretty.

• UK banks have limited exposure to European Sov risk.

• Italy may be least vulnerable PIIG, but Italian banks very exposed to the sovereign.

• Nordic banks have very almost no peripheral European exposure – best safe have plays.

Postscript..

Just to show I don’t show favouritism to certain banks: Things were so thin on Friday I even had time to peruse the pages of Euroweek. I joined Euroweek in 1987 as a cub reporter and within a few weeks was news editor of the thing. Everyone else had resigned. Happy days…

But what was particularly interesting were the investment banking revenue tables on the back pages. This week they were for Asia Pacific business. Something shocked me. On the “All Investment Banking Revenue” League Table in the region, the firm you expect to see wasn’t there. Even on the DCM revenue table, that certain firm only came 12th.

I’ve been accused of being a mouthpiece for a certain megabank recently… if they aren’t winning the lions’ share of Asian business why do we rate them so highly? If you can’t work out who is missing from Asian Investment Banking business … give me a call.

Massively out of time…

23 July 2010

Bank Stress Testing: take them all up to the top of a tall building and see which ones bounce, and which don’t…..  Simples

European bank stress test day. These have taken on a life of their own – the relevance of which probably fades around 5pm this evening. We’ll maybe make a market around 7-8 fails – that’s assuming one German and 6 Spanish banks. However, credit markets will react – and that’s worth anticipating. The market is in a bright mood on the back of strong economic data, and we’re expecting more good stuff from UK this morning.

Stress Tests – Under starters orders..

Yesterday was great fun – lots of rumours:  the main one being the timing of the releases would be brought forward to avoid market moving news when Europe is closed while the US is still open. (There can’t be any shocks contained in the report, because timings haven’t changed.) More intriguing was talk German banks were trying to limit the amount of information they would disclose about their bond holdings – what they got to hide then?

Of course we still don’t know the methodology, stress rationale and assumptions that underlie the tests. Transparency? Don’t make me laf. That means nothing very interesting will be written tonight. I won’t be staying late for the announcement to analyze the results as they come out – Nope, I will ruthlessly plagiarize our very smart young bank analyst Andrew Lim’s thoughts over the weekend.

The tests are designed to show whether European banks can survive another crisis. However, it’s what that crisis will be that’s causing the problems. The tests can’t acknowledge what the EU can’t admit may happen – the risk of a European sovereign or Euro meltdown. The EU no-bailout rule has morphed into a bailout- any-at-any-cost mantra – currently Euro 750bln and counting. It would be an EU double-plus thought crime to even consider a scenario whereby further pressure on the Euro stresses the political structures of the EU to breaking point. (Ok – they may let Hungary and others go to the wall, but their fault for not being in the Euro…) The likelihood of Greece restructuring isn’t even considered as it would severely test the credibility of the Union.

Which means the tests are pretty binary. If you believe in the Trinity of the Euro, the ECB and the EU – these will be useful tests. They will demonstrate Europe’s banks can survive another mid-sized financial conflict like the one we just survived. And that’s good.

If you are a Euro Heretic, then these tests are meaningless as they won’t test the full apocalyptic nuclear winter that could follow a riven Euro. And for the great majority of us who believe in Europe, but reckon it’s seriously flawed, then they’ll still be wondering how a likely Greece restructuring would change the stress test light results. Just tell me how many German and French banks fail if we see a 60% Greek haircut. Please.

So, as a mild heretic I’ll plump for the stress tests as a bit of fairly interesting analysis. It might even move markets positively by refocusing investor attention on how much recapitalization and restructuring has already been achieved! Stress test score cards could significantly relieve the credit tension on certain banks: Ireland where the process to recapitalize the bands and move bad assets is nearing completion. Spain, where FROB is sufficient well funded to recapitalize a restructured Caja sector. Landesbanks already benefit from bad bank guarantees on distressed assets. I’d be a selective buyer in these sectors. However, you’ve got to remain skeptical on other German and Greek banks.

And just to show they are still relevant, the Swiss will announce UBS and CS have both passed their stress tests – which the Swiss central bank says is “twice as tough” as the EU. So there.. ya boo sucks.

Meanwhile… back at the ranch..  

Lots of other stuff happening. The EC has called for global austerity – a day after the US Fed took a neutral course leaving open further stimulus potential. The FT carries what it calls a “strident” article from M. Trichet arguing the case for austerity. I tried to read it – twice – but both times my bullsh*t failsafe kicked in and put me asleep before the self-destruct programme kicked in. (I did spot M. Trichet sees the fulcrums of global finance as across The Atlantic, The Channel and The Pacific..  like that..)

Bank of Ireland reopens PIGS funding

Big round of applause to Bank of Ireland – our top Irish bank pick. They successfully launched a 2.5 year CHF 325mm Government Guaranteed Bond (GGB) yesterday reopening the funding market for Irish banks. As we said immediately following the Irish downgrade on Monday – it was a “buy-the-fact” moment. With Ireland on stable outlook we’d think investors would be increasingly keen on the Irish GDV Bank sector – spreads are very “incentivizing”!

This deal simply wouldn’t have happened a few months ago, but paid off for the bank after visiting Switzerland earlier this year. Next challenge will be for an Irish bank tap the fixed rate Euro market for a decent size GGB – that would be a clear demonstration market sentiment has truly turned. With the NAMA absorbing the bulk of the banks’ troubled assets and the clean-up well underway – Irish banks? Are they undervalued? Is this the moment to be a cheeky buyer ahead of them successfully reopening the funding doors?

I read an analyst report noting that not a single non-Italian PIGS bank has successful raised new funding over the past month – BOI is a clear step in tight direction.

Bank of England Loan Window

I nearly the missed the fact the Bank of England has decided to accept syndicated loan collateral from UK banks at its discount window. Smart thinking. Not only does it increase potential liquidity, but should gently encourage banks to extend credit to the corporate sector. Not sure what the haircuts are..

Buy Scandy Bank LT2 – it will likely be called.

Good to report some positive developments in LT2 capital. Not only has Swedbank exercised calls on its UT2 deal in October – a move which should reflect positively across other top Scandy banks – but it has announced a buy-back of Lower Tier 2 paper with calls in 2011 and 2012. No tender prices – but they will post prices.. happy to assist with any clients looking to sell – we know Swed well! They’re not replacing the capital with new LT2, but will be managing their core capital – which already stands an impressive 12.7%.

Again out of time... have a great weekend. I will spend it hunched over the Stress Tests for your delectation (Nonsense.. I’m going sailing... Mr Lim will do the work..)