http://www.zerohedge.com/news/moodys-downgrades-six-german-bank-groups-and-their-subsidiaries-three-notches
Submitted by Tyler Durden on 06/05/2012 19:27 -0400
Submitted by Tyler Durden on 06/05/2012 10:36 -0400
Submitted by Tyler Durden on 06/05/2012 10:55 -0400
Moody's Downgrades Six German Bank Groups, And Their Subsidiaries, By Up To Three Notches
- Bond
- Capital Markets
- Capital Positions
- CDS
- Commercial Real Estate
- CRE
- CRE
- Credit Conditions
- Credit Default Swaps
- default
- Deutsche Bank
- Germany
- Greece
- Ireland
- Italy
- Market Conditions
- Portugal
- Rating Agency
- ratings
- Real estate
- Risk Management
- Sovereigns
- Stress Test
- Unemployment
- United Kingdom
- Volatility
First Moody's cut the most prominent Austrian banks, and now it is Germany's turn, if not that of the most undercapitalized German bank yet: "The ongoing rating review for Deutsche Bank AG and its subsidiaries will be concluded together with the reviews for other global firms with large capital markets operations."
The full downgrade Matrix:
From Moody's
Moody's takes multiple actions on German banks' ratings; most outlooks now stable
Frankfurt am Main, June 06, 2012 -- Moody's Investors Service has today taken various rating actions on seven German banks and their subsidiaries, as well as one German subsidiary of a foreign group. As a result, the long-term debt and deposit ratings for six groups and one German subsidiary of a foreign group have declined by one notch, while the ratings for one group were confirmed. Moody's also downgraded the long-term debt and deposit ratings for several subsidiaries of these groups, by up to three notches. At the same time, the short-term ratings for three groups as well as one German subsidiary of a foreign group have been downgraded by one notch, triggered by the long-term rating downgrades.
Further to these actions, Moody's has assigned stable outlooks to the ratings of most German banks. The ratings of two groups and of one German subsidiary of a foreign bank carry negative outlooks, reflecting bank-specific vulnerabilities to a possible further deterioration of the environment.
The ongoing rating review for Deutsche Bank AG and its subsidiaries will be concluded together with the reviews for other global firms with large capital markets operations.
Today's rating actions are driven by the increased risk of further shocks emanating from the euro area debt crisis, in combination with the banks' limited loss-absorption capacity. The key drivers of today's rating actions on German banks are:
- Increased risks to asset quality for the banks affected by today's actions due to their exposures to asset classes prone to further deterioration if downside risks from the euro area debt crisis and the weakened global economic outlook materialise.
- Limited loss-absorption capacity, given the comparatively small equity cushions relative to total assets (not risk-weighted) and low pre-provision earnings. As a result, many German banks have limited capacity to absorb losses out of earnings, raising the potential that capital could diminish in a stress scenario.
Moody's notes that several factors have caused the ratings of many German banks to decline by less than for other European banks and also less than the initial maximum guidance communicated on 15 February 2012. One mitigating factor is the comparatively benign operating environment in the German home market, supported by below-average unemployment, low household and corporate debt levels and the general resilience of the German economy. Another critical mitigating factor is the modest funding risk of many German banks, underpinned by broadly matched maturity profiles, recurring access to intra-sector funds (for the Landesbanks and the central institutions of the German cooperative banking sector), and improved liquidity buffers. Moreover, Moody's recognises the steps German banks have taken to address past asset quality challenges; however, as stated above, significant downside risks remain.
Todays' rating actions have no impact on debt issued by Landesbanks that is guaranteed by state governments (grandfathered debt). The ratings for this debt continue to reflect the applicable sub-sovereign long-term and short-term ratings.
Please click on this link (http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_142799) for the List of Affected Credit Ratings. This list is an integral part of this press release and identifies each affected issuer. For additional information on bank ratings, please refer to the webpage containing Moody's related announcements:http://www.moodys.com/bankratings2012.
Moody's has today also published a Special Comment entitled "Key Drivers of German Bank Rating Actions," (http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_142787) which provides more detail on the rationale for these rating actions.
The (asset-weighted) average deposit rating of German banks of A2 now falls in the mid-range for western European banking systems. The average standalone credit assessment of baa3 ranks in the mid-to-lower range compared with European peers. Moody's has not changed its assumptions about the likelihood of support from external sources, such as parent owners, broader sector groups, and governments. Reflecting these support assumptions, many German banks' debt and deposit ratings continue to be positioned several notches above their standalone credit assessments.
1.) RATINGS RATIONALE -- STANDALONE CREDIT STRENGTH
Today's rating actions are driven by the increased risk of further shocks emanating from the euro area debt crisis in combination with the banks' limited loss-absorption capacity. This has weakened the standalone credit strength of the affected banks. All banking groups are affected, to varying degrees, by the key adverse drivers and mitigating factors noted above. On balance, these factors have reduced the standalone credit strength of those German banks whose ratings have been downgraded.
FIRST ADVERSE DRIVER -- RISKS TO ASSET QUALITY
German banks' lending operations include activities that are exposed to the risk of a worsening euro area debt crisis and to the difficult overall European and international operating environment.
Asset-side vulnerabilities include exposure to (i) the global shipping sector, which is also vulnerable to weakening economic growth and faces structural overcapacity; (ii) international commercial real estate (CRE) markets, with CRE exposures of several German banks being concentrated in markets that saw falling prices, such as the US, the UK and Spain; (iii) legacy holdings of structured credit products; and, (iv) securities of and other exposures to stressed euro area countries (Greece, Ireland, Italy, Portugal, Spain, or GIIPS). According to Moody's estimates, the German banks affected by today's rating actions had combined exposures of approximately three times their Tier 1 capital in higher-risk asset classes at year-end 2011 after hedges and estimated write-downs and provisions (source: company information, Moody's Investors Service estimates).
While Moody's recognises that German banks have taken actions in recent years to address asset quality challenges, the rating agency believes that banks have only partially incorporated the downside risks posed by the ongoing euro area debt crisis and evolving global economic trends. As such, they may record further significant losses, if such downside risks materialize.
Positively, Moody's sees limited challenges arising from German banks' domestic loan books amidst stable economic conditions. Some elevated risks are, however, contained in exposures to export-driven German manufacturers and in domestic CRE loans.
SECOND ADVERSE DRIVER -- LIMITED LOSS ABSORPTION CAPACITY
Moody's believes the capital positions of several German banks are vulnerable to erosion under stress, given (i) their above-described exposure to asset classes that are likely to be impacted by a worsening operating environment in Europe, (ii) elevated risks from the ongoing euro area crisis, and (iii) their low pre-provision earnings.
While most German banks have significantly improved their regulatory capital ratios, as well as the quality of their capital, this is more than offset in Moody's opinion by the elevated, and rising, risk of external shocks and losses that may arise from the evolving European debt crisis. With only 4.0% of their assets backed by equity at year-end 2011 (source: company information), the simple balance-sheet leverage displayed by rated German banks remains lower than that of many European peers. While simple leverage does not capture the risk content of assets, it complements regulatory ratios based on risk-weighted assets (RWAs). The latter can be misleading, given differences in regulatory rules and also given that some assets with very low risk weights have caused massive losses in recent years, including for German banks.
Moreover, Moody's expects German banks' pre-provision profitability to remain low on an international comparison. This outlook is driven by Germany's highly competitive banking market and, for some banks, also by ongoing restructuring and franchise adjustments that leave them below their full earnings potential.
MITIGATING FACTORS -- BENIGN DOMESTIC ENVIRONMENT AND MODEST FUNDING RISK
The magnitude of today's rating actions has been limited by the benign domestic operating environment for German banks, especially when compared with that of the more stressed euro area countries. Germany currently enjoys low unemployment and sustained, albeit slowing, economic growth, although the economy's interconnectedness with other euro area countries poses downside risks. Another mitigating factor is the modest funding risk for many German banks, despite sizeable reliance on wholesale funds. These funds are often provided by less confidence-sensitive sources, for example by parent funding, or intra-sector flows from deposit-rich local savings banks (for Landesbanks) and local cooperative banks (for central institutions of the cooperative banking sector).
2.) RATINGS RATIONALE -- LONG- AND SHORT-TERM DEBT AND DEPOSIT RATINGS
The downgrade in German banks' long- and short-term debt ratings was driven by downgrades of their standalone credit assessments. Moody's has not changed its assumptions regarding the availability of support from a bank parent, cooperative group or regional or local government, or the central government. The senior debt and deposit ratings of many German banks are positioned several notches above their standalone credit assessments, reflecting Moody's expectation that they would have access to several sources of external support if necessary.
3.) OVERVIEW AND RATINGS RATIONALE -- SUBORDINATED DEBT AND HYBRID RATINGS
Moody's has today also downgraded the subordinated and hybrid debt ratings of German banks by up to three notches. The downgrades reflect changes in the banks' underlying creditworthiness, as Moody's had previously removed assumptions of government (or systemic) support from this debt class.
TODAY'S RATING ACTIONS CONCLUDE THE REVIEWS OF GERMAN BANKS ANNOUNCED ON 15 FEBRUARY 2012
Today's rating actions conclude the review for downgrade of German banks, which had been initiated alongside reviews for downgrade of many other European financial institutions (see press release "Moody's reviews Ratings for European Banks" (http://www.moodys.com/research/Moodys-Reviews-Ratings-for-European-Banks--PR_237914) on 15 February 2012. Some of the bank ratings downgraded today had already been placed on review for downgrade on other dates.
WHAT COULD MOVE THE RATINGS UP/DOWN
Rating upgrades for German banks are unlikely over the near term in view of today's actions and the negative rating outlooks for some banks. Nevertheless, a limited amount of upward rating pressure could develop if a bank substantially improves its credit profile and resilience to current conditions, for example, if improved standalone strength were to be achieved by bolstering capital and liquidity buffers, thereby reducing exposures to higher-risk asset classes, or by recording significant growth in earnings.
Several factors could result in further downward rating changes. These include (i) a further deterioration of the euro area crisis leading to asset quality deterioration beyond current expectations; (ii) deteriorating earnings and capital levels; and (iii) increasingly restricted access to the debt capital markets.
RESEARCH REFERENCES
For further detail please refer to:
- List of Affected Issuers (http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_142799), 6 June 2012
- Special Comment: Key Drivers of German Bank Rating Actions, 6 June 2012
- Press Release: Moody's Reviews Ratings for European Banks, 15 Feb 2012
- Special Comment How Sovereign Credit Quality May Affect Other Ratings, 13 Feb 2012
- Special Comment: Euro Area Debt Crisis Weakens Bank Credit Profiles, 19 Jan 2012
- Special Comment: European Banks: How Moody's Analytic Approach Reflects Evolving Challenges, 19 Jan 2012
Moody's webpages with additional information:
The methodologies used in these ratings were Bank Financial Strength Ratings: Global Methodology published in February 2007, and Incorporation of Joint-Default Analysis into Moody's Bank Ratings: Global Methodology, published in March 2012. Please see the Credit Policy page onwww.moodys.com for a copy of these methodologies.
BANK SPECIFIC RATING CONSIDERATIONS (listed alphabetically, by group)
This section discusses bank-specific rating considerations. Please click on this link (http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_142799) for the List of Affected Credit Ratings. This list is an integral part of this press release and identifies each affected issuer.
COMMERZBANK AG (deposits A3, BFSR D+ / BCA baa3)
The confirmation of Commerzbank's standalone credit assessment takes account of the recent progress the bank has made in restoring its regulatory capitalisation to the level required by the European Banking Authority (EBA), as well as progress in its efforts to de-risk and downsize its balance sheet. The deposit ratings were downgraded by one notch each to A3/Prime-2, which reflects the prior downgrade of Commerzbank's standalone credit assessment on 18 January 2012 (see press release "Moody's reviews for downgrade long and short-term ratings of Commerzbank AG & subsidiaries",http://www.moodys.com/research/Moodys-reviews-for-downgrade-long-and-short-term-ratings-of--PR_234783). On 18 January, Moody's had lowered Commerzbank's standalone credit assessment and kept it on review for further downgrade. At the same time, Moody's had placed the long-term and short-term ratings on review for downgrade, but not yet downgraded them, given the uncertain outcome of the pending review of the standalone credit assessment, as well as Moody's review of short and long-term support considerations. Following today's confirmation of the standalone credit assessment at baa3, the reviews of the long-term and short-term ratings have been concluded with one-notch downgrades. The senior ratings incorporate unchanged, high systemic support assumptions. The outlook on the ratings was changed to negative, as vulnerabilities remain in the areas of Commerzbank's large sector and single-borrower risk concentrations and sizeable exposures to borrowers in Europe's periphery, and also given the uncertain outlook for European financial markets.
- COMMERZBANK EUROPE IRELAND PLC (deposits A3, BFSR D+ / BCA baa3)
The confirmation of the standalone credit assessment of this Irish entity and the one-notch downgrade of its deposit rating follow the rating actions for its parent bank, Commerzbank AG, and the unchanged approach to align all ratings of the subsidiary with those of its parent. This approach is based on the legal obligation of Commerzbank as majority stakeholder, based on the "unlimited company" status of the Irish bank, to make good any shortfalls of funds in liquidation. All ratings carry a negative outlook, reflecting the outlook on the ratings of Commerzbank AG.
- COMMERZBANK INTERNATIONAL S.A., LUXEMBOURG (CISAL, deposits Baa1, BFSR C- / BCA baa1)
The two notch decline of CISAL's standalone credit assessment to baa1 takes account of the inter-linkages between its credit profile and the weaker standalone profile of its parent, which was downgraded by one notch on 18 January 2012. Moody's believes that CISAL's franchise remains dependent on the overall Commerzbank group, given the subsidiary's limited strategic and financial autonomy. As such, the weakening of the parent's credit profile adversely affects CISAL. The baa1 standalone credit assessment for CISAL is now positioned two notches above Commerzbank's, reflecting the linkage to the parent, as well as CISAL's solid standalone wealth management franchise and its sound liquidity and capital. While Moody's principally acknowledges a high probability of parental support, this does not lead to any uplift for CISAL's deposit rating. The outlook on CISAL's ratings is negative, in line with its parent.
- DEUTSCHE SCHIFFSBANK (deposits A3, BFSR D / BCA ba2 - Ratings Withdrawn)
Following the legal merger of Deutsche Schiffsbank into Commerzbank, which took effect on 23 May 2012, Moody's has today confirmed the bank's long-term ratings and then withdrawn Deutsche Schiffsbank's standalone credit assessment and the long-term ratings at their current level. Please refer to the Moody's Investors Service's Policy for the Withdrawal of Credit Ratings, available on its website, www.moodys.com.
- EUROHYPO AG (deposits Baa2, BFSR E / BCA caa1)
The one-notch lowering of the standalone credit assessment was driven by the impairment of the bank's franchise and the recent decision by the European Commission that Eurohypo has to discontinue its business, relinquish its brand name and be unwound by its parent bank, Commerzbank AG. In line with earlier guidance, Moody's has downgraded the senior unsecured debt and deposit ratings by two notches.
DEKABANK DEUTSCHE GIROZENTRALE (DekaBank, deposits A1, BFSR C- / BCA baa2)
The two notch decline of DekaBank's standalone credit assessment reflects Moody's concerns regarding the bank's wholesale-based commercial banking activities and associated risk profile. In Moody's view, DekaBank's sizeable banking activities lack the breadth and client franchise of its domestic peers and carry relatively high risk concentrations to financial intermediaries. These exposures are material in relation to the bank's earnings power and capital and better reflected in the lower standalone credit assessment at baa2, down from a3. While earnings from core asset management activities remain a key supporting factor for DekaBank's standalone profile, Moody's considers high volatility in capital markets and declining investor confidence as a challenge for these activities which could lead to additional pressure on earnings in the future. The one notch downgrade of DekaBank's debt and deposit ratings to A1 reflects the lowering of the bank's standalone credit assessment and Moody's assessment of a very high probability of external support from Sparkassen-Finanzgruppe (S-Finanzgruppe; corporate family rating Aa2, stable).
DZ BANK DEUTSCHE ZENTRAL-GENOSSENSCHAFTSBANK AG (DZ BANK, deposits A1, BFSR C- / BCA baa2)
The one notch decline of DZ BANK's standalone credit assessment is driven by the bank's vulnerability to tail risks in a highly adverse scenario, based on Moody's capital stress test simulations, given its high leverage and sizable exposure to countries in Europe's periphery. Nevertheless, Moody's considers DZ BANK's capital position to be sufficient to cope with a deteriorating operating environment in Europe in a base case scenario, although DZ BANK may require additional capital to cope with the transition to Basel III depending on details of the emerging regulation. Moody's considers DZ BANK's liquidity position to be comfortable, also in light of the strong deposit intake of the cooperative sector banks throughout the financial crisis. Moody's maintains its assumption of a high support probability from Germany's cooperative banking sector (unrated) given DZ BANK is firmly embedded in the sector. Moody's also assumes that a degree of support for DZ BANK would be available from the government if needed.
- DVB BANK S.E. (DVB, deposits Baa1, BFSR D- / BCA ba3)
The three notch lowering of DVB's standalone credit assessment was driven by its high vulnerability to capital pressures, based on Moody's stress tests, as a result of its large exposures to global transportation finance activities. Another key driver was the bank's limited independent funding franchise. The downgrade of DVB's long-term debt and deposit ratings reflects the lowering of DVB's standalone credit strength and Moody's assumption of a very high probability of parental support from DVB's majority shareholder, DZ BANK.
- DZ BANK Ireland plc (DZ BANK Ireland, deposits A3, BFSR C- / BCA baa2)
DZ BANK Ireland is a highly integrated and harmonized institution with its parent, DZ BANK. As such, its standalone credit assessment is aligned with DZ Bank's and has therefore been lowered in line with the parent. As a foreign subsidiary, DZ BANK Ireland's senior unsecured ratings continue to benefit from two notches of uplift, reflecting Moody's assumptions about the availability of (indirect) support from the cooperative banks in Germany (unrated), but not from any uplift due to government (or systemic) support.
LANDESBANK BADEN-WUERTTEMBERG (LBBW, deposits A3, BFSR D+ / BCA ba1)
The one notch decline of LBBW's standalone credit assessment to ba1 was driven by concerns about tail risk, as LBBW's relatively high leverage and concentration risks imply vulnerability to unexpected losses in a scenario of highly adverse market conditions. Continued pressure on profits represented another important factor for the rating decision. Moody's also took account of a number of counterbalancing factors, including the bank's improved regulatory capitalisation and modest funding risks.The one notch downgrades of LBBW's senior long-term and short-term debt ratings to A3/Prime-2 reflect the lower standalone credit strength.
LANDESBANK HESSEN-THÜRINGEN (Helaba, deposits A2, BFSR D+ / BCA baa3)
The one notch lowering of Helaba's standalone credit strength to baa3 was driven by the assessment that the bank's large exposure to international commercial real estate markets could make it vulnerable to capital pressures in a highly adverse scenario, based on results of Moody's capital stress test simulations. At the same time, Moody's considers Helaba's track record of satisfactory risk management and comfortable funding profile as important risk mitigating factors. The one notch downgrades of Helaba's senior long-term debt ratings to A2 reflect the lower standalone credit strength.
NORDDEUTSCHE LANDESBANK GIROZENTRALE GZ (NORD/LB, deposits A3, BFSR D / BCA ba2)
The two notch decline of NORD/LB's standalone credit assessment reflects concentration risks in its wholesale-based banking activities, in particular in commercial real estate, ship finance and public sector finance activities. Another key risk driver is the declining creditworthiness of European banks in the context of NORD/LB's sizeable bond holdings and credit default swaps (CDS, protection sold) positions referenced to banks. The aforementioned exposures leave NORD/LB vulnerable to pressures on capital under adverse conditions, based on Moody's capital stress test simulations (even when taking into account recently-announced capital strengthening measures). The long-term ratings reflect Moody's assumption of a very high probability of external support from multiple sources, providing five notches of uplift to NORD/LB's senior long-term ratings.
- NORD/LB LUXEMBOURG (NLBL, deposits Baa3, BFSR D / BCA ba2)
NLBL is a highly integrated and harmonized institution with its parent, NORD/LB. As such, its standalone credit assessment is aligned with NORD/LB's and has therefore been lowered in line with the parent. As a foreign subsidiary, NLBL's long-term ratings benefit from two notches of uplift, reflecting Moody's assumption of a very high probability of support from NORD/LB.
- BREMER LANDESBANK KREDITANSTALT OLDENBURG GZ (BremerLB, deposits A3, BFSR D+ / BCA baa3)
The two notch lowering of BremerLB's standalone credit strength reflects its vulnerability to capital pressures under adverse credit conditions (based on Moody's capital stress tests) in the context of its exposures to the cyclical ship finance sector, but also its CDS (protection sold) positions referenced to European banks. The bank's announcement that it will strengthen the quality of its capital by converting all of its existing hybrid capital notes into common equity by the end of June 2012 is an important mitigating factor in Moody's assessment of the bank's capitalization. The one notch downgrade of BremerLB's long-term debt ratings reflects the lowering of its standalone credit assessment and Moody's assumption of a very high probability of parental support from its parent, NORD/LB. The parental support-driven ratings uplift for BremerLB also (indirectly) incorporates the availability of support from other sources, as typically available to Germany's public-sector banks.
- DEUTSCHE HYPOTHEKENBANK AG (Deutsche Hypo, deposits Baa2, BFSR E+ / BCA b1)
The two notch decline of Deutsche Hypo's standalone credit assessment reflects the bank's vulnerability to capital pressures, based on Moody's capital stress tests, as a result of its leveraged business model that focuses on CRE and public-sector finance, and including sizeable CDS positions (protection sold) referenced to European sovereigns. The potential for unexpected losses from these exposures in combination with the bank's limited loss-absorption capacity may require additional capital support in a deteriorating economic environment. The long-term debt and deposit ratings reflect Moody's assessment of a very high probability of parental support from NORD/LB, also given Deutsche Hypo's high degree of integration into the group.
UNICREDIT BANK AG (UCB, deposits A3, BFSR C- / BCA baa2)
The one notch lowering of UCB's standalone credit strength reflects the operational interconnectedness with its parent bank, UniCredit SpA (deposits A3, BFSR C- / BCA baa2), even though direct exposure to its Italian parent is monitored and partly collateralized. Supporting factors for the standalone credit assessment include UCB's robust credit profile in combination with its high loss-absorption capacity from earnings and capital, as reflected in Moody's capital stress tests. The downgrade of UCB's long-term and short-term ratings to A3/Prime-2 follow the lowering of the standalone credit assessment and incorporate Moody's unchanged external support assumptions, such as i) a very high likelihood of parental support from UniCredit SpA; and ii) a high likelihood of systemic support in case of need. The outlook on UCB's ratings is negative, reflecting UCB's focus on corporate and investment banking activities which add a degree of opacity and tail risk to its credit profile, particularly in the current environment.
- UNICREDIT LUXEMBOURG S.A. (UCL, deposits Baa2, BFSR C- / BCA baa2)
The one-notch lowering of UCL's standalone credit assessment follows the rating decisions taken for its parent bank, UCB, and the unchanged approach to align the standalone credit rating of the subsidiary with that of its parent (based on Moody's treatment of highly integrated subsidiaries). The outlook on UCL's ratings is negative, in line with its parent.
WGZ BANK AG (WGZ BANK) (deposits A1, BFSR C- / BCA baa2)
The standalone credit assessment of WGZ BANK was confirmed at baa2 in recognition of the bank's comfortable liquidity position and relatively low-risk credit profile. However, the negative outlook on the ratings reflects WGZ BANK's vulnerability to a further deterioration of the economic situation in European peripheral countries to which the bank's majority-owned WL Bank (unrated) has significant exposures. The negative outlook further reflects the modest profitability of WGZ BANK's core franchise, implying limited ability to absorb losses out of earnings. Moody's maintains its assumption of a high support probability from Germany's cooperative banking sector (unrated) given WGZ BANK is firmly embedded in the sector.
- WGZ BANK Ireland plc (WGZ BANK Ireland, deposits A3, BFSR C- / BCA baa2)
WGZ BANK Ireland is highly integrated and harmonized with its parent, WGZ BANK. As such, its standalone credit assessment is aligned with WGZ Bank's and was therefore confirmed at the parent bank's level. As a foreign subsidiary, WGZ BANK Ireland's senior debt and deposit ratings continue to benefit from two notches of uplift, reflecting Moody's assumptions about the availability of (indirect) support from the cooperative banks in Germany (unrated), but not from systemic support-driven uplift. All ratings carry a negative outlook, in line with those of its parent.
and.....
http://www.zerohedge.com/news/schadenfreude-german-word
Schadenfreude Is a German Word
Via Peter Tchir of TF Market Advisors,
Is the German Pot Calling the PIIGS Kettle Black?
We seem to get the daily barrage of messages and soundbites out of Germany demanding that countries stick to existing plans and that “austerity” is the only way forward. Germany continues to love to point the finger at the other countries and accuse them of borrowing too much and that these countries need to suck it up and pay what they owe. For now we will ignore the fact that Germany itself was one of the first countries to break the Maastricht Treaty. What Germany seems to be forgetting is that they jeopardized their own credit quality. With bunds at record lows, this may not be obvious, but for the past 2 years, Germany has been throwing around guarantees and commitments like they meant nothing.
I have argued since the beginning that all these guarantees were dangerous. Guarantees are more dangerous than CDS since it is truly impossible to figure out how much debt has been guaranteed or how likely the guarantees are to be honored. Zerohedge and Mark Grant (amongst others) have done a lot of work on the true size of various countries’ obligations. Here is an estimate of what Spain's read indebtedness is. <http://www.zerohedge.com/news/fighting-spanish-windmills-or-how-spains-debtgdp-ratio-double-what-reported> I don’t completely agree with the numbers, but the point is extremely valid. Looking at just the debt outstanding for these countries is very misleading. Some account of their off-balance sheet, unfunded commitments and obligations needs to be taken into account.
Which brings us to Germany. Germany is the ultimate backstop and seems to have forgotten that debt exists in two states.
Debt is either Repaid or It Isn’t
There are only two outcomes when you lend money. You either get repaid what you lent based on the original contract or you don’t. It doesn’t matter why you don’t get paid what you expected, whether it is because of forced redenomination, restructuring, or default. What matters is that you don’t get paid.
So while Germany is drawing a line in the sand, they seem to have forgotten the borrowers have two choices. Germany seems to be under the impression that no matter what they say or do these other countries will pay their debt. That Germany can cave in and let the other countries spend and grow and let the ECB provide immense liquidity and get paid. Or that Germany can remain firm on austerity and a deal is a deal rhetoric and still get paid back. But what if they are wrong?
What if at some point Greece, or worse, Spain or Italy finally say they have had enough of the finger pointing and blame game and are going to redenominated and stop certain payments altogether?
How much is Germany on the Hook For at the ECB?
If countries are leaving the Euro and the ECB is no longer going to be their central bank, the bonds held by the ECB in the SMP portfolio will be hit. With over €200 billion of SMP bonds, a 40% loss due to redenomination seems reasonable. That is an €80 billion hit to the ECB. The ECB cannot handle a loss of that size without either printing massive amounts of money or making a capital call on the member states. It would be ironic and nonsensical to print money to fund the loss, since the ECB could have printed less money and not had the loss in first place. On the capital call side, obviously the PIIGS aren’t making it. I think a lot of the other smaller members may choose not to as well, since the ECB is joint and several. I’m not sure even France would participate. The uproar in France that Germany drove the situation to this point may be enough to get them to demand that Germany pick up the lion’s share of the tab?
Then what happens to all the bonds being held at the ECB via LTRO and other facilities? The ECB holds government bonds, they hold bank bonds guaranteed by the government, and may even hold bank bonds outright. They will need to make margin calls on these facilities. Will all the banks be able to meet the margin calls? No. The weakest banks have already used the LTRO more than other banks. They are extremely leveraged and have no money left to meet those margin calls. If any governments had provided guarantees on their debt, now would be a great time to revoke those. Why take more losses for a bank that’s going down, when you can change the law and jam the loss onto the ECB?
I find it hard to believe that the losses at the ECB won’t be at least €100 billion and could easily be more. The liabilities are joint and several but could fall heavily on Germany.
How much is Germany on the Hook For via the EFSF and EU and IMF?
The EFSF has €110 billion of debt outstanding. That money in theory has been lent out to various countries. The EFSF will have losses and I expect those losses would be greater as a % of notional than the ECB’s since more of the EFSF exposure is to Greece where the losses will be highest. In theory Germany is only obligated to make good on their “portion” of the debt. But if they do that, will other countries honor their commitments? I cannot imagine Spain and Italy will make payments on the debt that is outstanding even though they are guarantors, once they have gotten to the point of leaving the Euro.
While Germany may decide to pay the ECB money regardless of the cost, it might be easier to let EFSF bond holders take losses rather than adding more debt and taking on more responsibility than they are legally obligated to pay. The EFSF bonds remain horribly over rated as they don’t account for how likely the guarantees are likely to be revoked or not paid when called upon. The EFSF will only make calls against guarantees once the situation has turned nasty, so the rating should reflect that. If you believe the countries are going to leave the EU, the EFSF bonds are a great short.
There are EU direct loans. More losses for Germany and France. There are costs of running the EU, to the extent one still exists. More of those expenses will have to be picked up by the remaining members (somehow it feels like there won’t be any remaining members once this process starts).
The IMF is likely to come out best in terms of any loss on existing holdings, partly because they have been more conservative in their lending practices, but mostly because the countries will need them to provide additional loans after they exit.
almost forgot the EIB and EBRD. Hard to believe that this won’t create more demands for money from Germany? Possibly small, but the hits against Germany are starting to add up pretty quickly.
How bad will German Bank Losses Be?
The partially state owned bad bank, Commerzbank had big write-downs in Greece. Hard to imagine that they avoided even taking bigger exposures in Spain and Italy. Then there are the German worse banks or Landesbanks. They had some of the largest exposures to Greece. It would be simply shocking if they didn’t have even bigger exposures to Spain and Italy.
These banks had enough “capital” or government support to make it through the Greek PSI process, but can they withstand hits of 10%-50% on their Spanish and Italian holdings? I highly doubt that without another huge infusion from the German government.
Then what about Deutsche Bank? By far in the best shape, but maybe you remember they were the first bank that Spain provided verbal guarantees in respect of regional debt. Why would Spain possibly honor that guarantee when they are abandoning the Euro and need all the money they can spare? What is Deustche Bank going to do? Repossess Catalonia?
The PIIGS will all walk away from any guarantees they have made. That is even easier than stopping payment on bonds or forcing through a new currency. This will hit banks more than countries, but the losses may be so big that it makes it back up to the country level.
How bad is the Target2 hit?
I have read a decent amount on this and remain confused. At one end, are arguments that the risk is massively overstated and losses would be minimal. Frankly I have found those article rely too much on the same hope that was evident during PSI, where ECB bonds get paid par, because that’s what they get. I think once countries are in full on exit mode, niceties like that will be thrown out the window. At the other extreme is arguments that the full size of Target2 balances would be at risk. Those articles honestly seem to be more realistic.
Target2 could cause more massive losses, and at the same time could force trade to grind to a halt. I think the trade disruptions in any case will be critical and the Target2 system breaking down would add to that problem.
Countries in Glass Houses Shouldn’t Throw Stones
No wonder Josef Ackermann came out in favor of more support for Europe. He has the good sense to see how bad this is. I have focused on Germany here since they alone seem to believe that they can push the situation to the brink, get paid, and have no trouble, but if the defaults start (whether payment defaults or currency redenomination) then France and the other countries will be hit hard. France has its own set of Dexia guarantees and who knows what exposure their banks have to Spain and Italy?
and.....
http://www.zerohedge.com/news/der-elefant-das-room-germany-ultimate-doomsday-presentation
Der Elefant In Das Room: Germany - The Ultimate Doomsday Presentation
* Please stop emailing us: we know the German is gramatically incorrect. That was not by mistake.
Two months ago, Carmel Asset Management came out with what we dubbed "Spain: The Ultimate Doomsday Presentation." Since that day Spanish yields have exploded, the domestic (and global) stock market has collapsed, and as of hours ago, Spain for the first time requested an official bail out from its European partners. But Spain was easy - only Nobel prize winning economists and TV anchors could not foresee the final outcome for the country. Today, we redirect our attention toreal elephant in the room: Germany. Recall that it was right here on Zero Hedge where we warned, just under a year ago, that "the cost of the euro not plunging today as a result of the ECB not proceeding with outright monetization, is that Germany is now the ultimate backstopper of all of Europe's risk... Germany has directly onboarded the risk associated with terminal failure of this latest and riskiest "bailout" plan and in doing so may have jeopardized anywhere between 32% and 56% of its entire annual economic output. One wonders if the risk of runaway inflation is worth offsetting the risk of a plunge into the worst depression in the nation's history?" Simply said: Germany's opportunity cost to preserving the status quo right now, is at a cost of hundreds of billions in the future, yet even that pales to the cost of letting it all fall apart. But this was a year ago, and out of headlines means out of mind. Today, we are happy to remind readers of just this dilemma, once again courtesy of Carmel. And if the hedge funds' predictive ability is gauged by the response in the Spanish market (and economy), Germany should be worried. Very worried.
In summary:
To summarize, as we inquired on July 21, 2011:
- The Cost to Save the Euro is Much Less Than to Let It Fall Apart, but Do the Germans Have the Political Will?
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