This topic is and yet isn’t a bit afield from the normal beat of this blog.
A reader sent links to some recent posts at Bronte Capital, a blog by John Hempton, which is reportedly read by top financial executives in Sweden and has a following among some of the more savvy analysts in London.
He makes a bold call:
But otherwise enjoy a post that breaks all the rules. I am loudly calling the likely collapse of a politically sensitive country. Its one of those circumstances when shouting fire can cause the tragedy. To some extent I take comfort in my low readers…
Hempton then goes through what he calls the “fixed currency model of bank collapse” which on a quick reading seems sound (and note Hempton has made quite a study of this area and has several posts on banking crises, per here and here, so he does have a basis for his views).
Back to the post:
Past currency crises have been associated with bank collapses. In Thailand (which was precisely to this model) the finance companies actually collapsed and the banks almost collapsed. In Korea both the banks and currency collapsed.
But you need to be really careful of countries with fixed exchange rates and huge, unsustainable current account deficits.
Never much fun shorting the banks in such countries
If you had picked the collapse of the Thai Banks you might have cleverly shorted the stocks. It would not have helped much. Suppose you shorted $100 worth of a Thai bank. It collapsed down 95%. So you had $95 in profit. The only problem is that you have the profit in the pre-crisis exchange rate. The currency also dropped almost 90%. So you were left with about $10 profit. That is fine-and-dandy but it is not much reward for effort of picking a system that is about to collapse.
You would of course be much better just shorting the currency – or shorting the ADRs of the target stock (the ADRs being priced in a hard currency).
The real exception is that if you find a bank in a hard currency that is totally exposed to the debacle country you can make a fortune. You can guess now that Swedbank is my bank. It is not the only one – but is very spectacular.
Hampton then goes into a lengthy discussion of the very vulnerable Eastern European currencies, in particular Latvia, Estonia, and Lithuania, to which good old Swedbank is heavily exposed. We get to a bottom line:
Swedbank funds the Latvian current account deficit. It funds it in Euro.
So what happens next?
Well if the Lati devalues (as would seem inevitable) then Hansa Bank has to pay Euro to Swedbank – and as its assets are in Lati it would be insolvent.
If the Lati doesn’t devalue its only because people (ie Swedbank) are prepared to continue to fund it. This is not pretty at all. All in Hansa owes Swedbank over 30 billion Swedish Kroner – all denominated in Euro and which can’t be paid. The equity capital of Hansa (roughly 7 billion Swedish Kroner) is also going to default.
This is a very big problem for Swedbank. Swedbank’s equity is 68 billion SEK – but 20 billion is intangibles. Swedbank is probably solvent at the end of this – but only just. Swedbank will (at best) lose its independence. Swedbank is in turn wholesale funded – and the chance of it becoming Swedish Government property is not low.
Having lent that much to a country with a phoney fixed exchange rate in a currency they can’t print – Swedbank management deserve it. Bad things happen to bad banks and this is a bad bank.
I wrote this post before SwedBank’s great looking 2Q results. They made it all work – by lending even more to the Baltics. Latvian deposits are actually falling despite high inflation and rapid (but declining) loan growth.
I used to think Swedbank would probably survive. I now think it probably goes to zero.
Now this appears to be a judgement call as to how bad things will get for Swedbank, but the point it is that it is plausible that they could get sufficiently bad that the bank is nationalized.
I may not be as plugged in as I sometimes like to fancy myself (we Americans can be pretty insular), but I suspect very few people here or in the UK expect a financial crisis to erupt in Sweden and the Baltics. How destabilizing could that be? Swedbank has roughly $280 billion in assets, so it isn’t a small fry. The bigger cause for pause might be political instability in the Baltics, which is something I am in no position to assess, or the impact of a flight to quality in currencies.
I’d be curious to get readers’ take on this one, both the bank’s vulnerability and the larger consequences if the situation devolves as Hempton suggests.