Waiting for Godot or Does Anyone Really Know What Is Going on with Eurozone Banks?

Yves here. Another sighting on the sorry state of Eurozone banks. Keep in mind that the Eurozone banking system is a prescription for bank runs, although they have mainly been the slow motion kind. First, the deposit guarantee schemes are national, not Eurozone-wide, and are typically very much underfunded. Second, even before the January 2016 effective date of the Bank Recovery and Resolution Directive, the Eurozone had made clear its fondness for bail-ins via the ones it forces on the two biggest banks in Cyprus in 2013, as well as encouraging banks to issue “co-co” bonds, as in bonds that were convertible into equity in a crisis. Their performance when Deutsche Bank looked wobbly in late 2016 confirmed what a bad idea they were.

Moreover, the predilection of bank regulators in Europe is to keep visibly sick banks functioning, which also encourages deposit flight. The extreme example was Greek banks, which were clearly bust but the ECB continued to deem solvent so as to provide support under Target2. That meant the authorities could put the banks under at any time by yanking the drip feed. Not a place anyone who feels exposed and has options would like to be in.

By Michael J. Schussele, a Registered Investment Advisor, MA, and CPA whose website is mjscpaplan.com. Originally published at his website, The Pursuit of Financial Happiness

I have been researching Eurozone banks’ excess reserves and repo availability for a few weeks trying to work my way through muddled commentary and sort the reality from the assumptions and found myself questioning what I know.  In doing so, I have misstated to others what I am thinking and even the data, facts, and issues about which I am concerned.  Sometimes it is best to just stand back and look for the string that pulls the material together.

I have yet to write that article which will address whether Eurozone banking rules to promote solvency of banks is creating a liquidity problem, because  the Eurozone banking resolution authorities seem to have so badly mismanaged the Banco Popular resolution to the point of intensifying a bank run despite monitoring bank liquidity on a daily and hourly basis.

Banco Popular was Spain’s 6th largest bank having been in existence since the early 20thCentury and one of the more profitable banks until about 2016.  In February 2017, it announced it had a €3 billion loss on asset writedowns and Non Performing Loan sales while maintaining it still had more than sufficient quality assets on its balance sheet.

By the end of May and first days of June reports were circulating that Banco Popular had received only €3.5 billion  on €40 billion collateral rather than the €9.5 billion  it had expected one month previously and had applied to the Bank of Spain for liquidity support receiving only 10% of the collateral it pledged drawing €2 billion and €1.6 billion which it managed to burn through in just a few days.  Banco Popular had been down rated by all foud major credit rating agencies between April and the 19th of May causing institutional clients with minimum credit requirements for banking to start withdrawing deposits during as period when the bank was trying to receive bids to privately resolve though a sale of the bank.  But on May31st, an anonymous EU official leaked to Reuters that an “early warning” had been issued.  This was followed by an immediate denial by the Single Resolution Board, which would have been the entity issuing such an early warning.  As a consequence, it experienced 20% daily drops in stock value on June1, 5, and 6 and by 6th June had supposedly endured (never publicly verified yet) €18 billion  deposit outflows.  While this may have been, according to EuroIntelligence, someone going to the press because the Single Resolution Board had communicated to the Single Supervisory Authority it was going to initiate early intervention measures, the communication to Reuters was the early warning had been issued, although, according to FROB (Spain’s resolution authority), the Single Resolution Board had notified them on June 3 of their intention to act.

This had caused some people to postulate that the Eurozone bank resolution mechanism actually encourages bank runs.

Additionally, the valuation of Banco Popular subsequently commissioned by the Single Resolution Board found a negative €2 billion  to a negative €8 billion in a stressed scenario.  Banco Popular was considered solvent immediately prior to this meeting its minimum regulatory capital requirements and a positive value of €11 billion, which would a €20 billion  difference in value. This has caused many people, including Bank of Spain supervisors, to question and demand to know how those figures with such a huge range were determined adding to the controversy over whether this was an actual solvency crisis or rather a liquidity crisis caused by the valuation of its collateral by the bank of Spain and the ECB and the refusal of the Spanish government to defy Eurozone authorities and aid a private resolution.

Banco Popular was sold for €1  to Santander further consolidating banking in the Eurozone, which raises the issue of the Eurozone bank resolution process creating large, systemically dangerous banks in the Eurozone.

For several years I have communicated privately that I believe any Euro crisis will start in Spain and spread to Italy, which would be the keystone.  I have come to believe it will not happen quickly but accumulate momentum over time.  The ECB worked very hard a few years ago to strengthen the asset quality of Spanish banks and stabilize the Spanish banking system, while Italy had reorganized its small state banks prior to the Great Financial Crisis (Spain had not).

Consequently, let us look at Italy and the problems with Banco Popolare di Vicenza and Veneto Banca — as the problems with Monte dei Paschi di Siena (the oldest bank in Europe) are well known.

The Italian government has been actively seeking to resolve the two banks through a precautionary recapitalization based on the December 2016 legislative decree used to enable a precautionary recapitalization and liquidity support to Monte dei Paschi.and official statements.  The Italian authorities have talked with several large Italian banks, although it appears to be devolving down to Intesa  Sanpaolo.  Veneto Banca will have a €85 million  payment on a subordinated bond due on 21 June 2017 delayed until mid-September as a result of the legislative decree, because both banks need a total of  €6.4 billion in capital while they try to sale bad debts and because the Italian government and the European Commission have been been debating for months  the European Commission’s demand that private investors put €1.25 billion  in both banks before any taxpayer money can be used.  This European Commission demand has held the precautionary recapitalization from proceeding.  It appears that a consortium of banks and private investors have rejected the European Commission demand and the Italian government is no looking for a good bank.bad bank split and sale of the good bank for €1 as no willing buyer wants to take on the non performing loans.

Under Eurozone bank resolution you have the choices of private recapitalization, private sale resolution, good bank/bad bank, or liquidation.  If the European Commission is going to continue to insist on the €1.25 billion  private investment in the two banks to permit Italy to use taxpayer money, the possibility of creating a bad bank becomes much more difficult.  The only way I see it happening is if the Italian authorities either arrange the private investment to happen or if the Italian authorities defy the European Commission and act consistent with the 23 December legislative decree.

If this fails, it will only feed the anti-eEuro political climate in Italy, which is already looking at elections next year and the possibility of a more right wing government coalition of Berlusconi and Renzi.  Then what happens in the Eurozone?  And with Eurozone banks?

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  1. visitor

    Meanwhile, a whole series of medium-sized German banks deeply involved in the shipping industry, already in poor shape after the 2008 crisis, have been hammered by the recent turmoil in shipyards and shipping lines and are thrashing about trying to shore up their capital.

    The consequences are not nice, as exemplified by the fate of HSH Nordbank. That Landesbank has been in the red for years, nearly failed ECB stress tests, had to be reorganized under a “good bank/bad bank” scheme, and got substantial financial guarantees from the Länder of Hamburg and Schleswig-Holstein. It must be privatized in 2018, but nobody wants to buy. No wonder: non-performing loans (mainly linked to the shipbuilding and transport sectors) keep accumulating; the regional state guarantees are used up; and the bank only managed to get its first quarter 2017 positive by denying further credits to shipping lines (causing the bankruptcy of Rickmers) and by plunging into… real estate. Other smaller banks face similar difficulties, but, apart from Deutsche Bank (which is also desperately trying to divest its portfolio of loans to the shipping industry), no systemic institution is critically involved in that sector.

    In Germany, it looks like a series of small dykes showing signs of crumbling as the flow of bad loans keeps slowly rising, with regional and federal states as well as the ECB patching up leaks here and there and piling sacks of sand in the hope nothing will break, while trying to figure out how to attend the much bigger troubles in the country (Deutsche Bank) and outside (Spain, Italy…)

    1. Colonel Smithers

      Thank you, Visitor.

      I was at HSBC from 1999 – 2006 and recall from 2003 onwards how German and Austrian banks, especially the state and cooperative banks, were giving money away, as if lending was going out of fashion and in markets that they had no expertise in, and would even troll us about our lack of risk appetite. Some loans were so ridiculously priced that the income would not even pay our team PA’s annual salary (about £20k at the time). The London Branch of one state bank, now bust, tried to recruit me twice in 2006, even showing me the pipeline of loans that they had or planned to make for their Dublin securitisation vehicles. The desperation was apparent then. Goodness knows what BaFin was playing at, but nothing has changed at BaFin.

      You may remember WestLB’s Robin Saunders cutting a dash, not just in the City, but across the more glamorous parts west, too.

      Some of my colleagues had joined Midland Bank, taken over by HSBC in the early 1990s, in the late 1950s and late 1960s. I learnt a lot from them. They said that the period felt like the run-up to the Latin American crisis of the 1980s, Tequila of 1994 and Russia et al of 1998. Credit was being commoditised, “cheap as chips”, and often in and by the wrong hands. HSBC was getting competition from unlikely quarters. They felt that the whole thing would end in tears, but not until the next decade, by which time they would have retired, as there was enough juice left in the system. 2007 – 8 was expected, but not until the turn of the decade or soon after. The drying up of liquidity, what had seemed a mile wide, but was only an inch deep, and the pace of the drought did surprise them.

      HSBC’s own problems were building up at the time, especially from John Bond’s acquisition spree, but that is for another occasion.

  2. PlutoniumKun

    Irish banks aren’t out of trouble yet either. The Irish government is pressing ahead under pressure from the ECB with its stupid plan to sell AIB shares, despite it having 11 billion euros in impaired loans (this, despite a boom in the Irish property market). This is likely to lay bare the reality, which is that many rescued banks are still in very deep trouble.

    1. Eustache de Saint Pierre

      According to your recommended Dr. Doom a large amount of SME’s are up to their eyeballs in Ireland & Draghi was planning to reel these in as an experiment, using the Republic as a guinea pig.

      1. PlutoniumKun

        Yes, he’s been quiet for a while – he made that prediction a few years ago, I haven’t seen much from him since (he’s known to be someone who doesn’t like the limelight). He is almost certainly right that cheap credit from the ECB is largely responsible for the Irish recovery – its certainly the only reason Irish banks can still lend money, as they are as close to insolvent as you can be and still legally exist – which is why I think selling them off is crazy. But I do think the Irish recovery now is more self-sustaining, not least as there seems to be significant inflows of money from investors. The property market is nearly ‘normal’ now, which has dragged a lot of people who were underwater on mortgages back into the black, and the economy is close to full employment.

        The SME situation is more interesting and I don’t really know the precise situation they are in now. Many healthy businesses were nearly destroyed from dabbling in property in the boom years, and many have been living for years on life support. Its not really clear as to whether these debts are being cleared out over the years or whether they are crippled forever, always lurking at the back of bank balance sheets. As Kelly suggests, I suspect we’d only find out of the ECB cut off the supply of money or interest rates started to climb.

        1. Eustache de Saint Pierre

          I spent five years in Ireland working for a manufacturing company that employed around a hundred people. The owner / manager became a classic case of what was described by the power = brain damage article. Eventually he got the staff down to around twenty by outsourcing to China. I was invited to house parties given by the management in which I could barely stay awake as the only talk was about property, but after overdoing the drinkies one night, which lead me to informing them that I had been to better funerals I was fortunately no longer invited – I got away with much more than the other staff as he knew I would just go work for one of his competitors.

          I got on with the accountant very well who in confidence told me that he felt that the company could be in trouble in the event of a crash due to investment in property, which included the bosses buying of a Neo- Classical fifteen bedroom Anglo- Irish mansion which had a beautiful garden . I heard that he spent over a million renovating the former & sadly he basically destroyed the latter, by among other things, chopping down some rare mature trees. I actually came across the negatives a couple of years ago from the before pics he asked me to take.

          He was quite likeable when I first knew him, but soon went rotten, I have no idea whether his business is in the same state.

          1. PlutoniumKun

            Sounds a familiar story, numerous small businesses were caught up in the property boom, using the inflated value of their premises to invest or join syndicates. Hence many perfectly good businesses went bust – or would have if the loans had been called in, which in many cases they were not as it wasn’t in the banks interest.

            I suspect a lot of people hid the money outside the country, and are now reinvesting – a surprising number of properties are being bought these days in cash, and unlike in the UK, Ireland, Canada, etc., it seems these cash buyers are locals, not foreign investors.

            And some of the craziness is coming back – one former Celtic Tiger developer just bid an astonishing 107 million euro for a site in dublin with room for about 500 apartments. You can just do the maths to see how much they will have to sell for to get that money back.

            1. Eustache de Saint Pierre

              I heard that those guys were bailed out by NAMA……moral hazard ?

              BTW, besides those awful soirees, I had probably the best times of my life in Ireland, which included some of those who had no choice to sit through those events, but mainly with the lads off the shop floor.

              1. PlutoniumKun

                They were constantly whinging that they were being ripped off by Nama – lots had their portfolios taken in their entirety and there are some endless court cases going on. But Nama is so opaque I doubt if anyone apart from a few insiders really knows who has won and who has lost.

                In reality, is was the relatively ‘straight’ developers who lost out. The sensible ones had money boltholes – there were stories of big SUV’s stuffed with jewellery and art going on the ferry to France in 2008 to be stored in lock-ups, out of the range of creditors. Much of this money is now seeping back in to reinvest.

  3. Eustache de Saint Pierre

    Just a question – according to Wolf Richter bondholders were wiped out during the Banco Popular bail-in. Are these bondholders stuck by being unable to remove their assets & therefore ripe for the picking ? I imagine that if this is not the case then there would be a likelihood of them getting out while the going is good.

  4. Colonel Smithers

    Thank you, Yves.

    I caught up with half a dozen former colleagues in the City yesterday evening. One, a benchmarks expert, has been approached by the French markets regulator (AMF) to help with supervision. He is thinking of leaving his US consultancy and setting up his own. He has worked around the world.

    Another, working for a trade association, reported that BaFin and the ECB are, in reality, soft pedalling or encouraging soft pedalling on repatriation from the City as they don’t have the expertise yet to be able to supervise what is coming home or to the EU27 from third country branches – or would rather keep that (London) stuff out of sight and out of mind.

    The benchmarks expert is applying for an Irish passport for his family. About half of the dozen former comrades out last night are also applying for Irish passports for their families. They said that it was not just Brexit, but they don’t see a future for their (young) children in the UK (especially in terms of higher education, housing and careers). Most voted out in the referendum, but as a means of giving the Cameroons a kicking, and also for Labour in the general election. None was surprised about Labour doing well / better, especially in middle class / professional and rural / commuter areas. The social collapse, evidenced by the homeless getting ready to bed down as we headed home about 9:30, is just getting too much to ignore / pass by.

    A hard Brexit is still expected by those working on Brexit as they thought the government is not prepared, can’t be bothered to prepare and / or plans to storm out of the negotiations and blame dastardly Johnny Foreigner.

    They were scathing about May and laughed about the Tory interest in fox hunting. None could recall a Tory party / cabinet as weak as this one. This said, none blamed May for what is going on. The rot had been building for decades. She is just holding the parcel as it blows up.

    1. vlade

      Hah (on ECB/BaFin). Can’t say about ECB, but the local regulators in the EU (ex FCA) are pretty much clueless when they have to face big boys.

      That said, I’m sick of the people like you describe – who voted out, and are now planning to leave. Because the poor sods you’re leaving behind don’t have the option – and you contributed to their misery. Thinking like that is what landed us here in the first place TBH. You eat your dogfood.

      And I do blame May, because she’s clearly clueless. She wanted the job, she should take the responsibility for it. By applying and taking the job at the time she did, she ensured she WILL go down into history. It was up to her how, and she f*cked it up.

      In fact, it looks to me like Tories from 2015 onwards (visibly, less visibly even before) made sure that the UK is as f*cked as it can possibly be. It’s almost like they would WANT to foster a revolution (be careful what you wish for…)

      1. vlade

        Just to clarify – by using “you” in the second para, I wasn’t referring to you Colonel.. (I have no idea how you voted and neither I know whether you planning to skip the boat :) ) .

      1. Colonel Smithers

        Thank you, Moneta.

        Osborne had been courting foreigners for the Old Lady for a while. Gordon Brown did, too, vide Donald Kohn and (the admirable) Bob Jenkins. Australia’s Glenn Stevens, New Zealand’s Alan Bollard and Zambia’s Stan Fischer were also in contention. Getting Carney / a foreigner was one way of stalling reformers like Andy Haldane. Minouche Shafik’s appointment was identity politics on steroids.

        Mrs Carney’s sister is married to Cayzer shipping heir Lord Rotherwick. Lord Rotherwick has an estate in Cornbury, Oxfordshire, and near Chipping Norton. They are part of the “Chipping Norton set” that ran the UK under Cameron. The initial approach to Carney was at some country gathering in Oxfordshire. Negotiations progressed at the G20 events in Mexico.

        1. vlade

          Incidentally, Haldane (who was super-dovish) contradicted Carney today morning on rates, revealing he almost voted for an increase, which would bring the vote to 4-4. Carney’s vote breaks any ties, so the rates would stay, but this changes the future arithmetics quite a bit.

          1. templar555510

            Funny I was just thinking about Haldane this morning ; super bright guy , but not part of the in-crowd . Carney – Goldman alumni – just perfect for Osborne / Cameron ; gave them confidence in the old Tory power of patronage malarkey now being played out by the head girl in the kitten heels. This party’s almost over thank God.

      2. Mickey Hickey

        Foreigner? Mark Carney’s parents were born British Subjects in Ireland, he was born in a British Commonwealth country Canada in 1965. In addition on graduating from Harvard he got a masters and doctorate at Oxford University. His wife Diana Fox is a British Subject who graduated from Oxford University with a degree in economics. From a British perspective how foreign is that. From an Irish perspective he is Irish and entitled to an Irish passport, from a Canadian perspective he will be their next Prime Minister. Talent is always in demand and is border free.

        1. Moneta

          Explain that to the birthers. Population 65M in the UK and no talent for a central banker… LOL!

    2. Eustache de Saint Pierre

      I am currently half way through the excellent four hour Adam Curtis documentary ” The Mayfair Set ” from 1999 which highlights the rot you refer to, & of course it hasn’t improved since.

      1. Colonel Smithers

        Thank you, Eustache.

        Adam Curtis makes good documentaries. Have a look at the one on fear / scare mongering.

        About thirty years ago, there was a documentary about “big house” unionists in Northern Ireland, including footage of them hunting foxes. The contrast with the squalor and violence in Belfast and Stroke City was breath taking. The documentary was banned.

  5. Chauncey Gardiner

    Whether the underlying causes were policy decisions to force open the private sector credit spigots for short-term economic growth; systemically poor and perhaps even fraudulent bank underwriting decisions for private financial gain; centrally imposed and ideologically driven fiscal austerity policies that have lead to economic stagnation, contraction, curtailment of public services and privatization of publicly owned assets; derivatives speculations; inadequate bank capitalization and liquidity structures; Germany’s desire for ongoing current account surpluses; or other as yet unrecognized factors; it is clear the EU banking system is facing severe institutional and systemic difficulties.

    In response to the question in the title to this post, it is unclear what is specifically going on with the opaque EZ banks. But far from waiting for Godot, the ECB injected 292.5 billion euros ($US 325 billion) into the monetary system in the month of March alone, and 757.5 billion euros over the past 8 months. Further, this total does not consider any additional amounts that may been allocated under the European Financial Stability Facility or other sources. In addition to the expropriation of bank depositors’ money in Cyprus through the artfully crafted term “bail-ins” mentioned by the author, the imposition of negative real interest rates by the ECB and Northern European central banks is also effectively a hidden tax on bank deposits. Which raises a question about why senior bondholders are treated as a protected class in most instances?

    1. OpenThePodBayDoorsHAL

      The ECB runs out of bunds to purchase next year, and they are already dipping into the primary market on Eurozone corporates (15% of their recent purchases). It’s one thing for them to buy in the secondary market, where supposedly a banker and a credit committee have underwritten the risk (LOL) but even that fig leaf is now gone.

      The debt-based fractional reserve snake has a firm bite on its own tail, it’s just a matter of time. The IMF will step in with SDRs, which will work for a while, but that’s just a parlour trick too (“the individual sovereigns are bankrupt, so let’s lump them together into one basket and give it a different name”).Janet and Mario and Kuroda and Zhou are at the party, it’s 3 AM and everybody’s absolutely hammered, and the best thing they can think to do in their infinite wisdom is to pour a gallon of 101-proof Wild Turkey into the punchbowl. What they should do, of course, is raise rates, smack down the speculator pigs a notch or two (they would still be waaay ahead of the game), the risk-free rate hurdle would go up so stupid companies would not get funded, a brush fire would clear out alot of dead wood, and (oh perish the thought) people and pension funds would earn some interest on their deposit accounts.

  6. Otra explicacion

    “The ECB worked very hard a few years ago to strengthen the asset quality of Spanish banks and stabilize the Spanish banking system”
    What did the ECB do?

    Thanks from Spain.


  7. RBHoughton

    Delighted to read this article and Colonel Smithers’ contributions above. We members of the human race are starting to recognize where our self-interest is, which imo is in more transparency and debate.

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