Friday, 27 August 2010 01:09

I Suggest Those That Dislike Hearing "I Told You So" Divest from Western and Southern European Debt, It'll Get Worse Before It Get's Better!

So, S&P finally gets around to Cutting Ireland's Rating on the Cost of Bank Support, as reported by CNBC:

Ireland's financial headache worsened on Wednesday after Standard & Poor's cut its credit rating in a move criticized by the country's debt management agency.

...

The premium investors demand to hold Ireland's 10-year bonds over German bunds has been steadily widening in the past few weeks and remained elevated at 327 basis points on Wednesday.

The spread finished at 330 bps on Tuesday, its highest level since the Greek financial crisis broke in May.

Brenda Kelly, an analyst at CMC Markets, said she expected Irish borrowing costs to climb on the back of S&P's move.

"I think we are going to have to an awful lot more in interest payments," she said.

Although Ireland has raised virtually all of the 20 billion euros of long-term debt targeted for 2010, S&P's move may make it more difficult for the country's banks to extend the maturity of their funding later this year and eventually wean themselves off a state guarantee on their debt.

...

S&P cut Ireland's long-term rating by one notch to 'AA-', the fourth highest investment grade, and assigned the country a negative outlook late on Tuesday saying the cost to the government of supporting the financial sector had increased significantly.

Rating agencies have been steadily hacking away at Ireland's credit rating and S&P's is now on a par with Fitch and one notch below Moody's, which cut its rating to Aa2 last month.

S&P said it expects Ireland will need to spend 90 billion euros to support its banking system, up from its prior estimate of 80 billion euros including capital used to improve the solvency of financial institutions and losses taken from loans the government acquired from banks.

Ireland's budget deficit ballooned to 14 percent of gross domestic product, the highest in Europe, last year due to the cost of propping up nationalized lender Anglo Irish ANGIB.UL and it could climb higher if Dublin injects an additional 10.05 billion euros into the bank...

I'm not going to say I told you so, but I did throw some pretty strong hints...

On April 29th, I was quite blatant in stating , urging my susbscribers to review the File Icon Irish Bank Strategy Note and the File Icon Ireland public finances projections that I made available earlier that month. You see, unlike many of the pundits in Europe who state that Ireland has moved beyond the worst of its problems and is an example of how austerity should work, I believe that Ireland is in very, very big trouble and I outlined the reasoning behind such in my very first posts on the Pan-European Sovereign Debt Crisis.

image009.png

At the very beginning of the year, I visually illustrated how bad off Ireland was, with considerably more that 6% of its GDP being mired in bank NPAs (non-performing assets). This number is quite conservative, for my research team only canvassed the larger banks in Ireland - you can rest assured that the smaller ones contain a similar (if not greater) proportion of NPAs to total assets. Add to this the fact that these banks are probably overstating assets and understating liabilities and you can probably throw another 150 basis points on top of the figures above and still be a tad bit conservative.

As a matter of fact, I went further into the topic in mid-April with Many Institutions Believe Ireland To Be A Model of Austerity Implementation But the Facts Beg to Differ! where I showed that Ireland is heavily leveraged into the problems of the PIIGS group faced. A picture (and/or graph is worth a thousand words! From the afore-linked post...

For the most part, Ireland has considerable embedded risk through both foreign claims on troubled countries (ex. PIIGS) and significant bank NPAs as a percent of its GDP.

ireland_claims_against_piigs.jpg

Below is an excerpt from our recent forensic Ireland analysis. Subsccribers, please download the most recent report here:File Icon Ireland public finances projections_040710:

A deteriorating external environment and a correction in the domestic housing market made 2009 a difficult year for the Irish economy. Ireland’s GDP growth registered a fall of 7.5% (the highest rate of decline since the country’s records have been compiled) with a fiscal deficit of 11.7% of the GDP for 2009.

I then followed up with a recap of my findings along with a snapshot of the social unrest that economic turmoil is bound to bring about in BoomBustBlog Irish Research Becomes Reality...

Banks protesters storm Irish parliament

Wednesday, 12 May 2010

Gardai Clash with protestors marching against government cutbacks outside the Gates of Leinster House in Dublin tonight

Gardai Clash with protestors marching against government cutbacks outside the Gates of Leinster House in Dublin tonight

Have they read my report?

Read more: http://www.belfasttelegraph.co.uk/breaking-news/uk-ireland/banks-protesters-storm-parliament-14804947.html#ixzz0nh5g9M7M

The title of my research really says it all (Many Institutions Believe Ireland To Be A Model of Austerity Implementation But the Facts Beg to Differ!), yet the pictures really do drive the point home.

So if Ireland is really that bad off, what's up with that tall stalk next to it in the bank NPA chart at the beginining of the post? Oh, those are the guys (and gals) who lent Ireland all of that money, and Ireland's issues are probably a significant portion of those NPAs you see towering over that of Ireland. Here's a look at their public finances (for subscribers onlyFile Icon UK Public Finances March 2010). I am not picking on Ireland and the UK, for much of Europe suffers from similar anathema, reference Ovebanked, Underfunded, and Overly Optimistic: The New Face of Sovereign Europe, wherein I delve into this topic in detail.

It is not as if no one could see the Euro-bank issues coming. In January of 2009, I explained to readers that the real estate bust in Spain could not be avoided by the banks and there will be a time when the piper comes a callin' (see The Spanish Inquisition is About to Begin…, and then Spanish Banking Macro Discussion Note Spanish Banking Macro Discussion Note 2010-02-09 02:48:06 519.40 Kb).). This, of course, will be subsidized by the Spanish state, as subscribers can reference out study of the Spanish Government's Public Finances. This didn't just start with Greece, although I Think It’s Confirmed, Greece Will Be the First Domino to Fall.

So what does it all mean?

Well, from my point of view, things rarely happen in a vacuum. Many European nations are over leveraged, overbanked, highly indebted, social powder kegs literally and economically sitting right next to each other. Lord forbid someone inadvertantly lights a match! Whether that match be of financial or economic origin (see Financial Contagion vs. Economic Contagion: Does the Market Underestimate the Effects of the Latter?) a very unpleasant domino effect will ensure. On that note, we revisit a BoomBustBlog proprietary stratagem... Introducing The BoomBustBlog Sovereign Contagion Model: Thus far, it has been right on the money for 5 months straight!

The BoomBustBlog Sovereign Contagion Model

Nearly every MSM analysts roundup attempts to speculate on who may be next in the contagion. We believe we can provide the road map, and to date we have been quite accurate. Most analysis looks at gross claims between countries, which of course can be very illuminating, but also tends to leave out many salient points and important risks/exposures.

foreign claims of PIIGS

In order to derive more meaningful conclusions about the risk emanating from the cross border exposures, it is essential to closely scrutinize the geographical break down of the total exposure as well as the level of risk surrounding each component. We have therefore developed a Sovereign Contagion model which aims to quantify the amount of risk weighted foreign claims and contingent exposure for major developed countries including major European countries, the US, Japan and Asia major.

I.          Summary of the methodology

  • We have followed a bottom-up approach wherein we have first identified the countries/regions with high financial risk either owing to rising sovereign risk (ballooning government debt and fiscal deficit) or structural issues including remnants from the asset bubble collapse, declining GDP, rising unemployment, current account deficits, etc. For the purpose of our analysis, we have selected PIIGS, CEE, Middle East (UAE and Kuwait), China and closely related countries (Korea and Malaysia), the US and UK as the trigger points of the financial risk dissemination across the analysed developed countries.
  • In order to quantify the financial risk emanating in the selected regions (trigger points), we looked into the probability of the risk event happening due to three factors – a) government default b) private sector default c) social unrest. The probabilities for each factor were arrived on the basis of a number of variables determining the relative weakness of the country. The aggregate risk event probability for each country (trigger point) is the average of the risk event probability due to the three factors.
  • Foreign claims of the developed countries against the trigger point countries were taken as the relevant exposure. The exposures of each developed country were expressed as % of its respective GDP in order to build a relative scale for inter-country comparison.
  • The risk event probability of the trigger point countries was multiplied by the respective exposure of the developed countries to arrive at the total risk weighted exposure of each developed country.

My next post on the Pan-European Sovereign Debt Crisis will outlined the likely haircuts many investors will take on their European debt, using our proprietary in-house models. Interested parties can click here to subscribe to our research materials.

Last modified on Thursday, 14 July 2011 06:27

3 comments

  • Comment Link Elvis from Norway Tuesday, 31 August 2010 03:01 posted by Elvis from Norway

    The Norwegian oil fund has invested a lot of money in PIIGS bonds. They might get burned.

    Report
  • Comment Link Reggie Middleton Friday, 27 August 2010 14:05 posted by Reggie Middleton

    Central and northern Europe is there as well. If a major default occurs, it will be difficult for anyone to "dodge the bullet".

    Report
  • Comment Link Blaag Vanderbilt Friday, 27 August 2010 14:02 posted by Blaag Vanderbilt

    Did Norway pop up in your research as well or did they dodge the bullet so to speak?

    Report
Login to post comments