Tuesday, 21 June 2011 08:42

LGD 100+: What's the Possibility of Certain European Banks Having a Loss Given Default Approaching 100%? Featured

We are in the process of updating the very revealing work we performed last year, identifying which banks were most likely to do the "Lehman Brothers" thing. I believe we were the only media source to predict the collapse of Lehman Brothers, CountryWide, WaMu, Bear Stearns, etc. months in advance - with each of these calls being precedent setting calls from both a profit and strategic preparation perspective. The thought process that went into the research and taking speculative positions behind said research against the crowd, resulted in an interesting experience -to say the least. Reference  the introductory paragraph from Is this the Breaking of the Bear? from January 27, 2008, two months before this banks collapse (I gave a similar diatribe for Lehman, several months before their collapse or even mere negative presence in the media as well):

Anybody who follows my blog knows that I am extremely bearish on the global macro environment, particularly risky and financial assets. As I see it, the Doctor(s) FrankenFinance are constantly percolating econo-alchemical brews such as that of the ongoing “Great Macro Experiment,” eliciting undulating waves of joy and elation from amateur speculators such as myself while simultaneously creating risk/reward traps that many a financial and real asset concern may never escape from. While discussing with my team how best to move forward to find a target of our “Macro Experiment” victim analysis in the financial sector, I was queried as to what to look for in creating the short list. Evaluating investment banks, like evaluating the monolines, is not necessarily a straightforward endeavor. No matter how you do it, someone is going to disagree. This is what makes what I do so appealing. All I have to answer to is performance. I just need a profitable result in order to be successful. No corporate politics or conflicts of interests to get in my way. In the end, absolute return is the ultimate criteria, and not whether it is accepted by the ivy league or academia, industry practitioners, sponsors, clients or whether or not XZY bank has been doing it differently for the last 25 years. Investing for your own account enforces a certain code of realism that, at times, may not be shared by others. So, I used that realism as my strength and my focal point to guide the creation of a short list, the ultimate target, and the valuation/risk analysis methodology. I simply said, in the REAL world where I would have to make some money from some REAL assets,throwing off REAL cash flows and REAL market transactions? Using this “Reggie REALity Engine” (so to speak) to power the analysis proved very enlightening. We found banks that counted spread guesstimates as assets. We found banks that could not afford to keep their best employees. We found too many banks that faced insolvency in the very near future. We found a lot. To keep this story short, let’s just say we used the engine to find that truth that nobody really wants to hear. That truth as marked to reality. This resulted in a short list of 2 firms. The first one is Bear Stearns, which we will delve into here. The second one is what I call, “The Riskiest Bank on the Street”, and the blog post and analysis will be out in a few days. Using a Sherlock Holmes style of forensic analysis, we have tried very hard not to leave anything out of our scope of analysis. In the case of Bear Stearns, it was not easy since very little info was available outside of the plain vanilla 10Q, 10K, etc. They also volunteered very little information. Much of this is investigative analysis and it would be much more detailed if we had access to the Bear Stearns inventory. We wrote to Bear Stearns’ investor relations department asking for more information on the company’s exposure to risky assets and their breakup. So far, no word back. No need to be concerned for my health, I’m not holding our breath…

Alas, as I stated earlier, it is that truth that no one wants to hear. So if you are one of those "no ones" that don't want to hear the truth, cover your ears, cause here we go...

Well, here we go again, but this time on a much, much larger level. In addition, the investment portion of the game has become much more complicated for now you don't just have to know what the disease is and who has it, but you have to be able to navigate the fact that our dear Fed Chairman has eliminated all inoculations against said disease (or put more aptly, poked holes in all of our condoms) by artificially suppressing volatility and rates and distorting normal price discovery through market mechanisms, see Did Bernanke Permanently Cripple the Butterfly That Is US Housing? The Answer Is More Obvious Than Many Want To Believe and as excerpted: 

... Do Black Swans Really Matter? Not As Much as the Circle of Life, The Circle Purposely Disrupted By Multiple Central Banks Worldwide!!!, Bernanke et. al. have snipped the chrysalis of the US markets and economy one too many times. He has interrupted the circle of life...

I have always been of the contention that the 2008 market crash was cut short by the global machinations of a cadre of central bankers intent on somehow rewriting the rules of economics, investment physics and global finance. They became the buyers of last resort, then consequently the buyers of only resort while at the same time flooding the world with liquidity and guarantees. These central bankers and the countries they allegedly strive to serve took on the debt and nigh worthless assets of the private sector who threw prudence through the window during the “Peak” phase of the circle of economic life, and engaged in rampant speculation. Click to enlarge to print quality…


The result of this “Great Global Macro Experiment” is a market crash that never completed. BoomBustBlog subscribers should reference File Icon The Inevitability of Another Bank Crisis while non-subscribers should see Is Another Banking Crisis Inevitable? as well as The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance. All four corners of the globe are currently “hobbling along on one leg”, under the pretense of a “global recovery”.

This brings us back full circle to today, where (despite the protestations of many in the sell side such as "Buy the Euro Banks Goldman" and those in the mainstream media who proclaim that risks are beimgn overblown, Europe's banking system is sitting on the nuclear version of a veritable powder keg that could very well make the Bear Stearns/Lehman days look like a veritable bull market. I plan on delivering an update to our European bank exposure analysis for subscribers:

Take note that this update will include several American banks and the risks they face from writing nearly all of the richly priced CDS purchased by said European banks. This is an interesting and complicated story because all of those IMF/EU bailouts, besides adding more debt to already debt laden countries, have considerably subordinated the claims of the stakeholders involved. The following was written over a year ago, and has proven to be quite prescient:

The year 2013, with a IMF-proclaimed debt ratio of a tad under 150%, is the time when Greece will have to refinance the debt to pay the IMF. However, since the current debt raised by Greece is at fairly high rates, new debt will only be available at much higher rates (as markets should price-in the risk of high debt rollover) unless there is some saving grace of a drastic plunge in world wide interest rates and a concomitant plunge in the risk profile of Greece. At a 150% debt ratio, historically low artificially suppressed global interest rates that have nowhere to go but higher and prospective junk ratings from the US rating agencies, we don’ t see this happening. Thus, the cost of borrowing for in 2013 is likely to be much higher in the market than the nearly five percent for the existing debt. Greece will either be unable to fund itself in the markets at all, and will have to convince the Euro Members and the IMF to extend the three-year lending facility just announced (reference What We Know About the Pan European Bailout Thus Far) or, it will get the debt refinanced at very high rates. In both cases the total debt as a percentage of GDP will continue to rise, and this is not a sustainable scenario over the longer-term. In addition, if it accept the EU/IMF package and there is an event of default or restructuring, the IMF will force a haircut upon the private and public debtors beyond what would have normally been the case. This essentially devalues the debt upon the involvement of the IMF, a scenario that we believe many sovereign bondholders (particularly Greek, Spanish and Irish) may not have taken into consideration. This also leaves the possibility of a significant need for many banks to revalue their sovereign debt – particularly Greek sovereign debt – holdings.

As illustrated above, there is a higher probability for a Greek sovereign debt restructuring in 2013, which will definitely not hurt IMF (since it has a preferred right) but the Euro Members and other investors who will be holding the Greek debt.


LGD: Loss Given Default... ~100%???

We're talking damn near complete wipeouts boys and girls. There are practicaly no entities holding this debt at par that are leveraged under 30x. The starting point in case of default for Greece is between roughly 48% to 52% of par. You've seen the math on BoomBustBlog many a time - Over A Year After Being Dismissed As Sensationalist For Questioning the ECB's Continued Solvency After Sovereign Debt Buying Binge, Guess What!


Add forced subordination due to IMF and US imperialitic dictate, and discussion of recoveries may very well be moot. On that oh so cheery note, let's move on to the basis of the refresh of our European bank exposure note for subscribers, who have voted overwhelmingly to have us pursue this venue...
I woild like to take this time to warn those who may have a waning interest in real estate due to the fundamentals defying act of REITs over the two years, that party is likely quite over if and once the Europeans blow up. The real long term risks still sitting on US, Asian and European bank balance sheet are still real asset based, and because it is so labor intensive to hide tons of bricks, dirt and mortar under pulp based ledger sheets using creative yet relatively meek accountants, these chickens are coming back home to roost to.

I will end this post with some graphs that show the bubblistic mentality of the German and French banks as they gorged on soon to be 2 for 1 sale sovereign debt at the height of the US induced credit and real asset bubble. You see, many outside of the Americas blame the US for instigating the last world wide crash (and admittedely rightfully so), but this time around the crash will be much bigger, and we all know whose fault it will be (hint: it doesn't rhyme with jaflerican). Remember, these supposedly risk free assets are being accumulated with somewhere between 30x to 72x leverage.

In preparation for what will probably be a very, very valuable subscriber update, I will start off my next post on this topic with a public display of what we published this time last year regarding French and German banks. In passing, remember: 
  1. The US still has the right to singularly vote down a supermajority in the IMF, and it is the only single state to be able to do that.
  2. We see how well the EU has agreed on things in the past when time was of the essence.
  3. The EU voluntarily took subordinate positions to existing claimholders, that was the purpose of the bailout. The IMF has never inferred such.
  4. The Fed has opened up the swap lines in the past, and didn't do so for charitable reasons. Read my post on FICC risk and bank implosions on my blog. The Fed can't afford for Euro banks to start calling on those faux hedges. That's why the lines are open.
  5. Any haircut you get before adding on a trillion dollars of debt and the IMF standing in front of you for $120 billion is going to be less then the one you get afterwards

As always, may the BoomBust be wth you! Interested parties may feel free to follow me on twitter, email me directly, or register for/subscribe to BoomBustBlog.

Last modified on Monday, 11 July 2011 10:16

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