Impact of bank’s banking books on haircuts

EU banking book sovereign exposures are about five times larger than trading book. The table below gives sovereign exposure of major European countries for both trading and banking book. The EU trading book has €335bn of exposure while banking book has €1.7t exposure towards sovereign defaults. EU stress test estimated total write-down’s of €26bn as it only considered banks trading portfolio. This equated to implied haircut of 7.9% on trading portfolio with losses equating to 2.4% of Tier 1 capital. However, if the same haircuts (7.9% weighted average haircut) are applied to banking book then the loss would amount to €153bn equating to 13.8% of Tier 1 capital.

We have also presented an alternative scenario since we believe that EU stress test had failed not only to include banks HTM books but also the loss estimates were highly optimistic, as has much of the economic and financial forecasting that has come from the EU. It is highly recommended that readers review Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse! for a detailed view of a long pattern of unrealistically optimistic forecasting. Here's and example...

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Revisions-R-US!

Now, enter the sovereign entity of default to be known as Portugal!

Portugal has just illustrated the worst of the potential path to contagion - runaway free market rates. Thier latest debt auction results reveal... The yields on their 6 Month bill literally spiked from 2.984% three weeks ago to 5.117%. People, that is nearly double their funding cost from just THREE WEEKS ago. This is the definition of unsustainable. The 12 Month jumped from 4.311% to 5.902%.

Putting this into perspective, Portugal will pay 20.2 basis points more to issue 1 year debt in its own name than it would pay to borrow 5 year debt from the EFSF (European bail out credit facility). You don't need me to tell you that this is a bailout or default waiting to happen – and very, very soon.  Here's the post where I laid it out on the line: Portugal Is On The Verge Of Tapping Out, UFC Style – You Knew It Was Coming, Here’s The Analysis!Remember, I included a full

Attention subscribers: A new subscription document is ready for download The Inevitability of Another Bank Crisis

Portugal bond haircut analysis for all to peruse. This is the time that it's most useful, and if anything it is on the optimistic side.  There’s actually a chance a credit event may occur by the time I give my Gloom and Doom speech in Amsterdam (www.seminar.ingref.com). Many people have asked me if there is chance CRE will pull through since many pockets are showing improvements. It's as simple as your belief in whether CRE can thrive in a stagflationary environ with sharply spiking interest rates amid shaky and collapsing banks. I've made my viewpoints clear:

• Inflation Misconceptions Hide A Downright U-G-L-Y Real Estate Landscape! – Part 1 Friday, April 1st, 2011
• The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance
• Reggie Middleton ON CNBC’s Fast Money Discussing Hopium in Real Estate
• In Case You Didn’t Get The Memo, The US Is In a Real Estate Depression That Is About To Get Much Worse
• The Inevitable Has Finally Been Admitted In Europe: The Macro Experiment Has Ignited Inflation Without Commensurate Growth & Rates Will Spike
• The Coming Interest Rate Volatility, Sovereign Contagion, Geo-political Unrest & Double-Dip Recessions: Here’s The Answer To Valuing Global Real Estate Through This Mess

Greece and Ireland are in very similar boats, despite being post bailout. And as all know, I have warned thoroughly about both of these nations through ample analysis. Instead of going through each and every one of my posts that fill the bill, look at the early work (with subscription material) or my latest European opinion and analysis. Of course, by now I'm not the only one to sound the alarm that an interest rate storm is about to erupt and it will travel the world.

From CNBC: Euro Zone Considers Greek Restructuring: Report

Some euro zone governments are concerned highly indebted Greece will not be able to refinance itself and may have to restructure its debt, the Financial Times Deutschland reported on Wednesday. The newspaper said representatives of several euro zone governments told the paper that a restructuring could no longer be ruled out. ..."An extention and top-up of the aid package would not be politically possible. Then, consequences would have to be drawn," the paper quoted a source in the finance ministry of a large euro zone country as saying.

It also quoted an advisor to the leader of an EU state as saying: "We must have a plan B ready" for the possibility Greece requires more financial assistance. Greek and European officials have long insisted that Greece can recover without restructuring its debt, and that even discussing a restructuring now would be counter-productive by damaging banks across Europe and causing panic in markets. On Saturday, the International Monetary Fund denied a report in German magazine Der Spiegel that it was privately pressing Greece to restructure its debt.

From JP Morgan, via the FT.com:

Irish banks have recently issued €18bn of notes backed by government guarantees with the aim of replacing expensive ELA funding from the Irish Central Bank (at the ECB’s marginal lending facility of 1.75% plus a penalty) with ECB funding at 1%. This replacement is likely to be reflected in the end- February financial statement of the Irish central bank. As of the end of January, Irish banks borrowed €126bn from the ECB (down €6bn from December) and €51bn from the national central bank’s ELA (unchanged from December).

The issuance of state guaranteed notes not only allows Irish banks to unwind their ELA dependence and reduces the cost of borrowing from central banks, but it also protects them against rating downgrades. Rating downgrades of non-guaranteed bonds raises the haircut applied by the ECB or in extreme cases can make these non-guaranteed bonds ineligible with the ECB.

This has been a problem for Greek banks, which, at the end of last year rushed to issue €25bn of government guaranteed bonds to meet new, more punitive collateral requirements by the ECB. The Greek government has just extended state-guarantees to Greek banks by another €30bn, on top of €55bn of outstanding state-guaranteed bank bonds. It appears that one Greek bank has already made use of the new €30bn liquidity package, issuing €1bn of government- guaranteed paper this week.

To the extent that this extra €30bn is being used by Greek banks, it will mean that from the €140-150bn of collateral that Greek banks have posted with the ECB so far, almost all of it will be government-related collateral (€85bn of stateguaranteed bank paper, €45bn of Greek government bonds owned by Greek banks and €8bn of zero-coupon bonds which the Greek government had lent to Greek banks in 2008). The huge exposure to government-related collateral puts the ECB at a huge disadvantage in the event of government restructurings/defaults.

If you remember, I warned of this months ago! This literally getting uglier by the second. Reference:

• “The ECB Loads Up On Increasingly Devalued Portuguese Bonds, Ensuring That They Will Get Hit Hard When Portugal Defaults

• ECB Swallows Massive Portuguese Bond Losses As It Is Clear That The Third State Will Soon Join The Bailout Brigade – Haircuts, Here We Come!!!

• and The Truth Behind Portugal’s Inevitable Default – Arithmetic Evidence Available Only Through BoomBustBlog followed by The Anatomy of a Portugal Default: A Graphical Step by Step Guide to the Beginning of the Largest String of Sovereign Defaults in Recent History (December 6th & 7th, 2010).

The UK is showing signs of very real stagflation. For those who haven't already, browse through my recent posts on how many are confusing inflation with the more damaging stagflation:Inflation Misconceptions Hide A Downright U-G-L-Y Real Estate Landscape! – Part 1 andInflation Is When The Price of The Most Valuable Things (Such As Your House or Small Business) Drop Precipitously During High Unemployment, Right???!!! And back to the UK...Industrial production and economic activity is dropping, via AP (h/t ZeroHedge): UK industrial production in surprise drop in Feb

LONDON (AP) — British industrial production fell 1.2 percent in February from January, an official report said Wednesday, marking the largest monthly fall since August 2009 and far worse than analyst expectations for an increase of 0.2 percent. The Office for National Statistics said a 7.8 percent drop in oil and gas extraction was the main reason for the fall, while the manufacturing sector was flat. For the December-February period, overall industrial production was up 0.8 percent

But, inflation is rising...

The US Is Losing The Race To Insolvency, But Not For Lack Of Trying!

Of course, the US is close to insolvent (not there yet though, but we’re working on it). Our housing problem is worse than it ever was in the market crash of 2008 - see In Case You Didn’t Get The Memo, The US Is In a Real Estate Depression That Is About To Get Much Worse

and Further Proof Of The Worsening Of The Real Estate Depression. As a matter of fact, it's what caused the global crash to begin with. Despite that, the banks that hold the loans to these underwater loans have increased 300% in price, doled out record bonuses, and are reinstating dividends while the country that bailed them out and transferred private debt onto the tax paying public needs to raise the debt ceiling yet again.

Japan may be approaching 250 - 300% debt to GDP, the highest of any developed nation.

See Can Contagion Be Avoided Considering The Magnitude Of Japan’s Woes? Most already know Japan’s issues, which started when they were at a 200% debt to GDP ratio. Some say it will take $350 billion to dig them out of the hole which will make them the most indebted developed country in the world with a good portion of their infrastructure damaged.

How Did We Get Into Such A Global Mess??? Thank our central bankers, who won't prick a blowing bubble, but will pull their ass hairs out to try to reinflate a popped one!!!

And this is the cause of all of this mess...

Do Black Swans Really Matter? Not As Much as the Circle of Life, The Circle Purposely Disrupted By Multiple Central Banks Worldwide!!! or put a little more poetically, Did Bernanke Permanently Cripple the Butterfly That Is US Housing? Interested readers can follow me on twitter and review our latest European opinion and analysis. I will be lecturing on this "realistic" style of analysis as the special guest speaker and keynote at the ING Real Estate Valuation seminar in Amsterdam. I will also introduce the structured products that we have been working as a solution to this mess that we see ourselves in. See www.seminar.ingref.com. The event is sold out with a waiting list, but I hear there were a few last minute cancellations.