BofA Hires Staff, Leans on Merrill to Expand Overseas

By David Mildenberg

March 31 (Bloomberg) -- Bank of America Corp., the lender that bought stakes in foreign firms to expand overseas, will grow on its own by adding staff and offering services through Merrill Lynch, according to the company’s head of global corporate banking.

“Merrill Lynch had three times as many relationships as we had at Bank of America” in Europe, the Middle East, Africa and Asia, Paul Donofrio said in a March 29 interview. Emerging markets are “where we will find the most immediate opportunities,” he said.

The addition of Merrill Lynch in January 2009 gives Chief Executive Officer Brian Moynihan more resources to draw upon outside the U.S. as he maps a bigger international role for Bank of America. His firm is the largest U.S. lender by assets, with only 17 percent tied to foreign nations. Former CEO Kenneth D. Lewis invested in international banks in Argentina, China and Mexico rather than building internal operations.

Moynihan, 50, who made his first trip to China last week as CEO, has said he wants the Charlotte, North Carolina-based bank to concentrate on internal growth rather than acquisitions.

“For Bank of America Merrill Lynch to reach its full potential, we have to be great outside the U.S.,” said Donofrio, 50, a London-based executive who reports to Tom Montag, president of global banking and markets. Success is most likely to happen in emerging markets, where relationships are less entrenched than in Europe and other more mature markets, according to Donofrio, who has worked at the company’s investment bank since 1999.

Hiring Plans

Montag told colleagues at a March conference in London that most global banking hires this year will be outside the U.S., according to two people with direct knowledge of his remarks. Emerging market nations typically refer to Brazil, Russia, India and China, though Donofrio declined to discuss specific geographic targets.

Bank of America added more than a dozen corporate banking executives in Hong Kong, Singapore, London and New York this year to boost its global expertise, including four managers starting in May, according to a March 29 statement. The lender plans selective hiring rather than adding dozens of new corporate bankers, Donofrio said.

One of the fields he’s targeting is treasury services, used by companies to manage payments to suppliers and vendors, collect receivables and to predict cash positions and then invest and borrow accordingly. Bank of America led in 2009 with a 20 percent market share in the U.S., according to an Ernst & Young survey.

“The treasury management fee pool is many times larger than global investment banking,” Donofrio said.

Foreign Affairs

Bank of America’s foreign units, which exclude Canada, reported a $7.3 billion profit in 2009, including a $4.7 billion gain from the sale of shares in China Construction Bank. In 2008 and 2009, Bank of America reported $10.6 billion in losses in its U.S.-dominated credit-card and home-lending units as the domestic economy suffered its sharpest decline since the 1930s. Counting costs of repaying bailout funds, the company posted a $2.2 billion loss for 2009.

The overseas thrust comes as U.S. banks face a regulatory overhaul proposed by Senate Banking Committee Chairman Christopher Dodd, the Connecticut Democrat, and expected revenue losses tied to new regulations on consumer-banking products including home loans, credit cards and debit cards. Bank of America may lose $3.3 billion in net revenue annually as it halts overdraft fees on debit cards, in addition to the lender’s previous acknowledgement of an $800 million after-tax cost due to new federal restrictions on credit card fees, Sanford C. Bernstein analyst John McDonald said in a March 29 report.

Limits at Home

“Tighter regulation on consumer banking in the U.S. is making it more advantageous to invest overseas,” said Gary Townsend, president of Hill-Townsend Capital LLC, a Chevy Chase, Maryland-based investment firm that owns Bank of America warrants. “Bank of America is less likely to invest and hire in the U.S. given our government’s current policies.”

Concentrating on international growth could cause Bank of America to lose its focus on improving unprofitable U.S. operations, said Greg Donaldson, chairman of Donaldson Capital Management, an Evansville, Indiana-based investment firm that manages more than $300 million. Moynihan “is trying to do a lot of things in a hurry, which often proves to be a mistake,” he said. “I’d rather they fix their problems first.”

About 18 percent of Bank of America’s revenue came from overseas last year compared with 25 percent at JPMorgan Chase & Co., the second largest U.S. bank, and more than 40 percent at Goldman Sachs Group Inc., the New York-based investment bank.

Asian Plans

“Our goal is to create one of the world’s largest universal banks in Asia,” Bank of America’s Asia-Pacific President Brian Brille said at a March 24 press event.

Moynihan hasn’t given a timetable on the bank’s plan to incorporate a Bank of America business within China, the world’s most populous nation. The lender is the second-largest shareholder of China Construction Bank.

“We do better when we play to our strengths, and our strengths are in the U.S.,” Lewis said in a June 2007 interview. He cited research by the bank and McKinsey & Co. that showed the U.S. offers the greatest potential for new fees over the next decade.

Fifteen months later, in September 2008, Lewis cited Merrill Lynch’s international scope as a key benefit when announcing the bank’s acquisition of the world’s largest securities brokerage. About a third of New York-based Merrill Lynch revenue typically came from overseas.

China Property Bust May Prove Temporary, BOJ, UBS Analysts Say

By Mayumi Otsuma

March 31 (Bloomberg) -- China’s stage of economic development means any property-market bust following the current boom may prove temporary, according to economists at the Bank of Japan and UBS AG.

China today shares characteristics of Japan’s real-estate boom of the 1970s, when the nation quickly recovered from a slump, according to a Bank of Japan research paper. The Chinese economy will be able to keep expanding even in the event of a property contraction, said UBS’s Beijing-based Wang Tao.

The view contrasts with that of Kenneth Rogoff, the Harvard University professor who said last month China may see growth plunge to as low as 2 percent in the aftermath of the collapse of a “debt-fuelled bubble” within 10 years. Premier Wen Jiabao is trying to rein in property speculation after prices rose the most in almost two years.

“People tend to compare China with Japan in the late 1980s but the two situations are very different,” Wang, the head of China economic research for UBS, said in an interview last week. “The biggest difference is of course that China is still at a low stage of development, so if there is a big correction it still has the potential to grow out of it.”

Economic growth of almost 10 percent, surging incomes and a rapid flow of people into cities spurred “real demand” for housing and boosted property prices in Japan in the 1970s, similar to China today, according to the paper co-written by four BOJ economists.

Parallels With Japan

The parallels also include a low ratio of debt used to buy homes, the Japan central bank officials said in the paper released yesterday. Wang also said the lack of a mortgage- securities market in China means property buyers aren’t borrowing as much as Americans did during the U.S. housing bubble.

Property prices in Japan rebounded “pretty quickly” after plunging in 1974 amid the global oil shock, because brisk economic growth fueled incomes, the officials said. In contrast, Japan’s asset-price collapse at the start of the 1990s drove the country into prolonged doldrums because urbanization was almost complete and growth slowed.

Japan’s experiences show “the depth of the property-market adjustment would differ depending on the stage of economic development,” the economists said. “Given its high potential growth and low leverage, China won’t likely suffer a severe property-market adjustment, like the one Japan went through in the 1990s.”

Development Stage

Growth in Japan averaged 9.3 percent in the decade through 1973, compared with 9.9 percent in China between 2000 and 2009, according to the paper. About 45 percent of Chinese currently live in urban areas, the same level as Japan in the early 1960s, it said. Per-capita gross domestic product in China, the world’s fastest-growing major economy, is about $3,500, similar to Japan’s $3,800 in 1973.

Wang also said the possibility of a “boom-bust is quite high” and “avoiding a property bubble in China will be very, very difficult.”

Rogoff, the former International Monetary Fund chief economist, said in an interview in Tokyo last month that land is “the best bet” for the cause of a China crisis. A collapse would cause a “very painful” period which would persist for about a year and a half, while falling short of a 1990s Japan-style lost decade, he said.

Local Authorities

Local governments in China are aggressively developing properties to boost revenues and are welcoming market rallies, the BOJ report said. The paper was written by Ichiro Muto, Tomoyuki Fukumoto, Miyuki Matsunaga and Satoko Ueyama, all economists at the bank’s international department.

Capital inflow from overseas is also providing short-term speculative money, the report said.

Bank lending in China also draws parallels with Japan in the 1970s. Loans by Chinese banks equal between 110 percent and 120 percent of nominal gross domestic product, the same level as Japan around 40 years ago, the researchers said. The ratio jumped to around 180 percent in the 1980s in Japan.

“During Japan’s bubble economic boom in the 1980s, real- estate prices rose without real demand for houses related to urbanization,” the BOJ paper said. “That makes a difference from the booms in Japan in the early 1970s and China today.”

Irish Banks Need $43 Billion on ‘Appalling’ Lending

By Dara Doyle and Colm Heatley

March 31 (Bloomberg) -- Ireland’s banks need $43 billion in new capital after “appalling” lending decisions left the country’s financial system on the brink of collapse.

The fund-raising requirement was announced after the National Asset Management Agency said it will apply an average discount of 47 percent on the first block of loans it is buying from lenders as part of a plan to revive the financial system. The central bank set new capital buffers for Allied Irish Banks Plc and Bank of Ireland Plc and gave them 30 days to say how they will raise the funds.

“Our worst fears have been surpassed,” Finance Minister Brian Lenihan said in the parliament in Dublin yesterday. “Irish banking made appalling lending decisions that will cost the taxpayer dearly for years to come.”

The agency aims to cleanse banks of toxic loans, the legacy of plunging real-estate prices and the country’s deepest ever recession. In all, it will buy loans with a book value of 80 billion euros ($107 billion), about half the size of the economy.

“The information that has emerged from the banks in the course of the NAMA process is truly shocking,” Lenihan said.

‘Lot of Work’

Dublin-based Allied Irish needs to raise 7.4 billion euros to meet the capital targets, while cross-town rival Bank of Ireland will need 2.66 billion euros. Anglo Irish Bank Corp., nationalized last year, may need as much 18.3 billion euros. Customer-owned lenders Irish Nationwide and EBS will need 2.6 billion euros and 875 million euros, respectively.

“The regulator is taking the bank system by the scruff of the neck,” said James Forbes, senior equity strategist at Irish Life Investment Managers in Dublin. “Allied Irish has a lot of work to do to avoid majority state ownership, Bank of Ireland less so.”

Allied Irish will sell its stakes in banks in the U.S. and Poland and said this will meet a “substantial part” of its capital needs. It also plans a share sale.

Lenihan told the parliament that Bank of Ireland also expects to raise a “substantial” part of its new capital privately. The bank declined to comment ahead of its full-year results, due at 7:00 a.m. today.

The government announcement was issued after the Irish stock market closed. Late yesterday in New York, Allied Irish’s American depositary receipts were down 8 percent to $3.29. Bank of Ireland jumped as much as 21 percent.

Capital Target

Lenders must have an 8 percent core Tier 1 capital ratio, a key measure of financial strength, by the end of the year, according to the regulator. The equity core Tier 1 capital must increase to 7 percent.

AIB had an equity core tier 1 of 5 percent at the end of 2009. Bank of Ireland had a 6.6 percent ratio on Sept. 30. Those ratios exclude a government investment of 3.5 billion euros in each bank, made at the start of 2009.

“The banks are undergoing major surgery via NAMA,” financial regulator Matthew Elderfield said at a press conference in Dublin. “Even after surgery, they will suffer losses in coming years. They need a transfusion now to speed their recovery and that of the economy.”

If Allied Irish can’t raise enough funds privately, the state will step in with aid, Lenihan said. It is “probable” the government will then end up with a majority stake in what was once Ireland’s largest company by market value, he said.

The banks “are in a better position today, but we also have to be cautious about thinking we are done and dusted here,” Forbes said.

‘Awful Losses’

Ireland may not be able to afford to pump more money into the banks. The budget deficit widened to 11.7 percent of gross domestic product last year, almost four times the European Union limit, and the government spent the past year trying to convince investors the state is in control of its finances.

The premium investors charge to hold Irish 10-year debt over the German equivalent was at 139 basis points yesterday compared with 284 basis points in March 2009, a 16-year high.

Ireland’s debt agency said it doesn’t envisage additional borrowing this year related to the bank recapitalization. It is sticking to its 2010 bond issuance forecast of about 20 billion euros, head of funding Oliver Whelan said in an interview.

“The bank losses, awful as they are, represent a one-off hit. It’s water under the bridge,” said Ciaran O’Hagan, a Paris-based fixed-income strategist at Societe Generale SA. “What’s of more concern for investors in government bonds is the budget deficit. Slashing the chronic overspending and raising taxation by the Irish state is vital.”

China fund looks west for rapid expansion

By Jamil Anderlini in Beijing

Published: March 29 2010 19:32 | Last updated: March 29 2010 19:32

China’s National Social Security Fund plans quickly to expand its investments abroad and is looking at the US and European markets, its head said on Monday.

“There is a lot of room for us to expand our investments abroad and we do intend to do that,” Dai Xianglong, chairman of the Rmb777bn ($114bn) NSSF, told reporters in Beijing.

As well as rapidly expanding the fund’s presence in the US and European Union, Mr Dai said the NSSF was looking to India and other fast-growing economies for opportunities and was particularly interested in direct investments in unlisted companies and global private equity funds.

By the end of last year, the fund had invested about 6.7 per cent, or Rmb52bn, of its total assets abroad but it has a mandate to invest up to 20 per cent of its capital overseas.

The NSSF is also rapidly expanding its contribution base and Mr Dai said he expected the fund to more than double to Rmb2,000bn in the next five years, providing an even bigger pile of funds for offshore investment.

Explaining his bullishness, Mr Dai said he thought the US could meet its target of doubling exports within five years and, although it may take a long time, the US economy would continue along its road to recovery from the financial crisis.

He expressed confidence that European sovereign debt problems will not worsen but he said social welfare systems in the EU were a burden on many countries’ economies and would drag down growth.

The NSSF, a reserve fund that has yet to be used to provide any social services for Chinese workers, said it earned Rmb85bn last year, from a rate of return of 16.1 per cent that was largely due to the rebound in the Chinese stock market.

That compared with the fund’s first loss in 2008, of Rmb39.3bn, which accounted for 6.8 per cent of the fund’s total assets. Mr Dai said the fund had managed to achieve an average annual growth rate of 9.75 per cent since it was established in 2000.

With China’s population expected to peak in size and start rapidly ageing within the next few decades, the NSSF is a fund of last resort that is partly aimed at providing pensions in the future for workers affected by Beijing’s three-decade-old one-child policy.

Mr Dai, a former central bank governor, said he expected the US dollar to remain a global reserve currency and, while the Chinese renminbi would appreciate in the long term, he expected it to remain stable in the short term.

In an echo of recent statements by Wen Jiabao, China’s premier, Mr Dai said the renminbi was not undervalued and China would decide on its own whether or when to let its currency appreciate.

He said fluctuations in the stock market were “normal”, adding that while 2010 would be difficult, he was optimistic about Chinese shares in the “long term”.

“Evidence of QE’s effectiveness remains somewhat elusive”

Posted by Izabella Kaminska on Mar 29 11:15. 16 comments.

That’s the verdict from Richard McGuire, Senior Fixed Income Strategist at RBC Capital Markets on the matter of the Bank of England’s latest lending and money supply figures — specifically its preferred measure of money supply: More…

That’s the verdict from Richard McGuire, Senior Fixed Income Strategist at RBC Capital Markets on the matter of the Bank of England’s latest lending and money supply figures — specifically its preferred measure of money supply: ‘lending excluding intermediate other financial corporations’.

As McGuire noted, the second estimate of the figure slipped back into negative territory in February. It fell 1 per cent, having grown 0.6 per cent on a three-month annualised basis in Jan, a figure which was revised down from 1.9 per cent.

BoE lending data, meanwhile, showed that UK mortgage approvals unexpectedly fell to a nine-month low in February, with lenders granting 47,094 loans to buy homes, compared with 48,099 in January.

Which led IHS Global Insight’s Howard Archer to conclude it might be too early for the Bank to say goodbye to QE for good:

Overall, the February data do little to ease concern over low money supply growth and bank lending to businesses. It is evident that ongoing very weak bank lending to companies continues to reflect both low demand for credit from businesses as well as restricted supply from the banks.

Following on from a still largely downbeat Bank of England’s March Trends in Lending survey, the ongoing weak February data maintains concern that ongoing tight credit conditions remain a serious obstacle to significant, sustainable recovery.

This keeps open the possibility that the Bank of England could revive Quantitative Easing, although we suspect that the MPC would prefer not to go down that route unless the economy shows serious signs of faltering over the next few months.

Related links:
Could UK money supply collapse post-QE?- FT Alphaville
UK hits worst deflation on record – HoweStreet
Allocating, multiplying, QE - FT Alphaville

The equity market rally is nearing its end

Posted by Neil Hume on Mar 29 15:37. 4 comments.

That’s the view of Morgan Stanley’s Teun Draaisma, who reckons the much feared tightening is about to begin in earnest.

The trigger according to the strategist will be a strong US payroll reading on Friday and a change in Federal Reserve language at its meeting later this month. More…

That’s the view of Morgan Stanley’s Teun Draaisma, who reckons the much feared tightening is about to begin in earnest.

The trigger according to the strategist will be a strong US payroll reading on Friday and a change in Federal Reserve language at its meeting later this month.

As stimulus is withdrawn from the system equity markets will struggle just like they did in 1994 and 2004.

The recent rally was larger than we expected, and in our eyes was due to: 1) there have been no positive payrolls or Fed language change yet (we even saw some loosening rather than tightening measures last week, with the Greek bailout, the ECB keeping its wide collateral pool for longer and the Obama plan for troubled mortgage borrowers); and 2) sentiment had turned quite cautious in early February. Nevertheless, we do think the market peak associated with the start of tightening is near, and expect 2010 to show a volatile whipsaw pattern in equities.

Previously, Draaisma’s thinking had been to take advantage of this dip to buy. Now, he is less sure.

The first cyclical bull market within the ongoing secular bear market was 2003-07, the current second cyclical bull market started in March 2009 and should continue until the next earnings recession. Our earnings growth leading indicator (EGLI) points to over 50% earnings growth in the next 12 months, and we expect earnings growth of 35 per cent and 10 per cent in 2010 and 2011 (versus IBES consensus expectations of 33 per cent and 23 per cent, respectively). Equity valuations are reasonable. We prefer equities over fixed income on a 12-18 month view. This does not represent a change of view, but it is a change in our choice of wording.

As for the next earnings recession, Draaisma reckons it is a couple of years away.

We believe the secular bear market is incomplete for a variety of reasons, including that banking crises and bailouts tend to precede debt crises; that the amount of debt has not been reduced yet (it only changed hands to the government); that equity valuations never reached end of bear market levels; and our historical analysis that equities tend to struggle for longer in the aftermath of secular bear markets. When the next earnings recession hits, perhaps in 2012, we expect equities to complete the bear market that started in 2000.

Which all sounds very much like Albert Edwards’ Ice Age thesis – i.e. this bear market will only be over once valuations have reached the levels of previous bear markets.

And in case you are wondering what they might be, the following charts provide a clue.

Related link:
Devaluing the yuan – FT Alphaville

JP Morgan Asset Management sees no bubbles in China

Posted by Stacy-Marie Ishmael on Mar 29 17:25. 1 comment.

It would be difficult to describe the chief investment officer and head of emerging markets equity at JP Morgan Asset Management in London as a China bear.

Nor does Richard Titherington buy into the notion that China is blowing bubbles, More…

It would be difficult to describe the chief investment officer and head of emerging markets equity at JP Morgan Asset Management in London as a China bear.

Nor does Richard Titherington buy into the notion that China is blowing bubbles, according to a piece in AsianInvestor on Monday.

As the magazine reported (links/emphasis ours):

“I don’t think China valuations, either of equity or property, are bubble-like in general,” he says. “There are always individual property projects or stocks that are overvalued of course. It might become a bubble, but is not there yet.”

On average, Chinese price-to-earnings ratios are in the mid-teens, which he does not feel is excessive. Some stocks, such as China Mobile, have a P/E closer to 10x, and China P/Es range from 10x to 40x, he says.

“It’s still a market where stock selection is extremely important,” says Titherington. “When you look at previous bubbles, everything was overvalued, and that’s not the case with China.”

No comment from Titherington on matters of political and legal risk or censorship, however.

Related links:
China fund celebrates at conference – FT
China’s banks, more liquid-hot than ever – FT Alphaville
China vs America: fight of the century – Prospect
China Bans 78 Companies From Investing in Property – WSJ

Devaluing the yuan

Posted by Neil Hume on Mar 25 15:45.

Continuing with Thursday’s China theme, SocGen’s Albert Edwards has been looking at the emergence of a trade deficit in the People’s Republic and the implications.

The backstory here is the recent, surprise announcement from Premier Wen Jiabao and Commerce Minister Chen Deming that China would record a trade deficit in March – the first since April 2004.

The deficit, of course, is one result of the massive Chinese stimulus package focused on infrastructure, which has sucked in massive amounts of commodities.

And obviously Edwards thinks this is going to have serious ramifications.

One of the key changes over the last year is the rate at which Chinese import growth now outstrips export growth (see left hand chart below). It is clear much of this is down to the rapid pace of commodity imports, associated with a step-up in infrastructure projects due to the fiscal stimulus programme, but also with stockbuilding. Hence we see total imports handsomely outstripping imports from countries that are not big commodity producers, such as the US and Europe [see charts below].

Now, Edwards believes the trend toward a sustained trade deficit in China is very real, as much because of infrastructure projects as the stock piling of dollar denominated assets.

Now there are a couple of things I have been mulling over in my mind about these developments. It is well known that China has been buying commodities in excess of its needs for final consumption and stockpiling them. This seems sensible.

If you have a pegged exchange rate and have to buy dollar assets, why just pile up mountains of US Treasuries when you can pile up mountains of copper and iron ore that can be usefully consumed at some point in the future?

This change in policy also has the added advantage of engaging in FX intervention on the trade account rather than the capital account, thereby relieving intensifying political pressure for a yuan revaluation. Indeed I would suggest that the pre-announcement of the March trade deficit is the latest salvo in the ongoing war of words.

China can quite reasonably point at its trade deficit and respond to the US that its criticism that the yuan should be revalued is totally invalid if it is running a trade deficit. Some might argue that instead of ‘manipulating’ its currency, it is trying to head off pressure to revalue by manipulating its trade balance.

All of which means, China will be buying a lot fewer Treasuries. Although that does not necessarily mean higher bond yields, says Edwards.

To the extent that China’s trade surplus is ’shifted’ elsewhere (e.g. Canada), these countries may be larger consumers of US goods and hence the US may see a quicker reduction of its own trade deficit. If that is the case, the US could become more like Japan, funding purchases of Treasuries out of domestic savings. Or to the extent the commodity nations see larger trade surpluses and do not peg their currencies in the same way as China, they will see intensifying upward pressure on their own currencies, helping to clear recent extreme global imbalances which were at the heart of the recent credit crisis.

Ultimately though, Edwards thinks there is a bigger issue than US Treasuries yields. And it is this:

I still make the very simple point I made back in November; a collapse of the current recovery seems extremely plausible in both the US and China in the not too distant future. This will only intensify the mutual belligerence seen in both nations. And despite the recent downturn last year, the yuan has strengthened decisively over the last four years.

I think the emergence of a persistent Chinese trade deficit would fundamentally change the political dynamics between the US and China. If political tensions continue to mount and the US begins to erect trade barriers after naming China as a ‘currency manipulator’, at some point China may indeed do exactly as the US authorities wish and stop ‘manipulating’ its currency. And if it is running large trade deficits, investors should consider the very realistic outcome that China does indeed devalue the yuan.

Yikes.

Related links:
Now, China is bashing the euro – FT Alphaville
Down the drain in China – FT Alphaville
Is China blowing bubbles? – FT Alphaville

Spanish risk: let’s get regional

Posted by Joseph Cotterill on Mar 25 16:05.

Ah, the intricacies of Spanish debt instruments. As fears over Spain’s sovereign risk ebb and flow, BarCap analysts have weighed up the various asset classes on offer in its debt markets. The results should intrigue Spanish risk-watchers.

As the AAA Investor note explains, emphasis ours:

…compared with neighbouring asset classes such as sovereign debt, covered bonds or government-guaranteed debt, papers issued on behalf of Spanish autonomous communities offer a pick-up. At the same time, they enable investors to diversify their country-specific exposure at the expense of the ailing housing market and in favour of the public sector, whose aggregate financing needs are nonetheless set to surpass €27bn in 2010.

This is in the context of what BarCap calls a ‘paradox of choice’ for investors faced with exposure to Spain: lots of classes to choose from, but little diversification among those classes so far.

Which is indeed odd — because Spanish debt types seem to be diversifying markedly.

In terms of risk, it now appears Spain’s regional governments are out in front, stealing the limelight from even ICO — the state-backed development bank and former FT Alphaville risk stalwart.

The evidence, according to the AAA Investor, can be found all over the issuance data. Spanish government bond issuances remain well out in front, while paper issues by sub-sovereigns have declined. However, there’s a new issuer on the block:

Asset classes that had previously been subject to very moderate issuance volumes, among them debt issued by Spanish autonomous communities, for example, also benefited from the increasingly benign situation on the global financial markets. This, in combination with a surge in the aggregate deficit to €27bn in 2010 from €12bn in 2009, has caused issuance volumes to increase sharply as of late, amounting to nearly €7bn year-to-date.

In light of that, BarCap goes on to compare swap spreads:

Provided the richening of peripheral European sovereign swap spreads continues, swap spreads of Spanish agency and government guaranteed debt will likely tighten further, in our view…

In light of their hitherto relatively modest new issuance volumes, swap spreads of debt issued by Spanish autonomous communities have remained relatively unaffected…

However, taking into consideration their nature as sub-sovereign issuers (which, admittedly, are subject to an explicit no-bail-out clause under the Spanish Constitution), we understand a swap spread difference of roughly 60bp between sovereign (eg, 4.400% SPGB January 2015) and sub-sovereign debt (eg, 3.250% VALMUN July 2015) to be somewhat elevated (Figure 7)[click to enlarge:]

Extending the analysis to a comparison between Cédulas Hipotecarias [mortgage-backed bonds] and debt issued on behalf of Spanish autonomous communities further supports the above results. A 40bp swap spread difference between papers backed by residential mortgage loans on property located in Spain (eg, 3.125% SANTAN Jan 2015) and (public sector) debt issued by Generalidad Valenciana (eg, 3.250% VALMUN Jul 2015) is hardly justifiable in light of the current state of the Spanish housing market.

Problems are certainly mounting up for Spain’s regions and municipalities. Thursday’s FT noted that they have become rather lackadaisical in paying debts owed to Spanish businesses — which is surely something of a vicious circle, given Spain’s problems stem from a large private debt overhang.

And regional problems are mounting up for Spain’s central government, too. As the Journal recently reported, its deficit reduction plan hinges on the regions’ restraining of their public spending. Rather tricky, with all that autonomy.

Related links:
The great European SSA recovery. Save Spain? – FT Alphaville
Spain’s ICO distortion – FT Alphaville
Riding on a sovereign guarantee in Spain – FT Alphaville

Germany’s Bank-Asset-Berg

Posted by Tracy Alloway on Mar 18 08:45.

The ABCP Matterhorn? Der Asset-Alps? Das Bank-Massiv?

Below is the net foreign asset position of banks in Germany, France, Italy and Spain.

The chart uses BIS data and was created by financial consultant Achim Dübel.

Put simply, net asset positions are assets minus liabilities — so you can see that German banks’ accumulation of foreign assets (or decrease in liabilities) has been growing substantially:

Much of that is probably down to developments in Landesbanken — Germany’s public sector banks — in the first half of the last decade. In 2001, the European Commission abolished state guarantees for the Landesbanks, but the institutions were granted a four-year adjustment period.

To counter, or prepare for the loss of the state guarantees, the Landesbanks went on something of a shopping spree — snapping up high-yield assets, the effect of which you can see in the chart.

During the financial crisis, Germany’s mountain of assets seems only to have gotten bigger.

Here’s what Dübel says:

The public Landesbanken must have issued several 100 billions in additional taxpayer debt between 2001-2005 . . . So that added to the ‘natural’ surplus by excess private sector savings an element of publicly sponsored autonomous capital investment . . .

In more detail:

There is ‘endogenous’ capital export stemming from foreign excess demand for German manufacturing goods and our ageing effects leading to higher savings ratios; but there has also been huge ‘autonomous’ capital export, such as the US investments of the Landesbanken with taxpayer money (estimates go to some 400bln . . . but you see the 2001-2005 issuance effect quite clearly in the net position; and there are of course follow-on effects as the ABCP consolidation took place in 2007 and 2008), such as the huge international state and commercial mortgage finance investments of mortgage banks, or ship investments of ship banks, with Pfandbriefe.

Now, autonomous capital exports come back as additional excess demand for German manufacturing goods; however they clearly created a bubble . . . Both Landesbanken and mortgage banks . . . only survive with government guarantees.

This . . . matches the huge German capital account surpluses on record and comes close to the implicit guarantee the German sovereign is shouldering;

Shadow (banking) debt anyone?

For German-speakers, a much longer version of the above here.

Related links:
Green shoots: artificial flowers - FT Alphaville
China and Germany unite to oppose deflation – Martin Wolf, FT
Don’t forget the German banks – FT Alphaville
Denial, coverup, and the blaming of others – International Economy

Debunking subprime contagion

Posted by Tracy Alloway on Mar 26 08:25. 12 comments.

Flashback alert!

Fears raised that subprime crisis could spread – The London Times, April 2007

Sub-prime crisis could spread to other markets, IMF warns – The Independent, April 2007

The credit crisis spreads to Europe – Time Magazine, More…

Flashback alert!

• Fears raised that subprime crisis could spread – The London Times, April 2007

• Sub-prime crisis could spread to other markets, IMF warns - The Independent, April 2007

• The credit crisis spreads to Europe – Time Magazine, August 2008

And so on.

But here’s an interesting idea, contained in a just-published Federal Reserve discussion paper, by Steven B. Kamin and Laurie Pounder DeMarco, and asking: “How Did a Domestic Housing Slump Turn into a Global Financial Crisis?”

In it, the authors assert that the global financial crisis was not caused by direct exposure to the US subprime market. In other words, banks’ CDS spreads and stock prices during the crisis were not correlated with their holdings of US mortgage-backed securities (MBS) or dependence on dollar funding.

Instead, the contagion was caused by something else; namely a general “disillusionment” with bank models around the world, or, a sort of global bank run.

Perhaps that’s not a huge shock, but the theory is interesting:

To summarize our key findings, we found scant evidence of a direct channel of contagion spreading the U.S. subprime crisis abroad . . . Moreover, even if holdings of U.S. toxic assets and exposure to dollar funding were more important than we were able to document, we still believe that a number of indirect channels stressed in the growing stock of commentary on this crisis were relevant as well:

(1) a generalized run on global financial institutions, given lack of information as to who actually held toxic assets and how much;

(2) the dependence of many financial systems on short-term funding (both in dollars and in other currencies);

(3) a vicious cycle of mark-to-market losses driving fire sales of ABS, which in turn triggered further losses;

(4) the realization that financial firms around the world were pursuing similar (flawed) business models and were subject to similar risks; and

(5) global swings in risk aversion supported by instantaneous worldwide communications and a shared business culture. At an extreme, the U.S. subprime crisis, rather than being a fundamental driver of the global crisis, may have been more of trigger for a global bank run and for disillusionment with a risky business model that already had spread around the world.

The authors say there’s some uncertainty in the MBS data but, overall, it’s certainly food for thought.

And the standout bit from the paper: according to the authors international losses on US portfolio holdings didn’t even stem from assets related to American mortgages, but from other things:

In fact, it is ironic that, although the global financial crisis appeared to originate in the U.S. sub-prime sector, losses on U.S. ABS accounted for only a small part of the total losses taken by foreigners on their holdings of U.S. assets. As indicated in Table 4, foreigners experienced some $1.3 trillion in losses on their portfolio holdings in the United States, but only $160 billion of those losses were linked to ABS. By far the greatest losses were on their holdings of U.S. common stock.

And the table:

So, not the subprime crisis but your-run-of-the-mill stock crash?

It doesn’t have quite the same ring to it.

Related links:
Germany’s Bank-Asset-Berg - FT Alphaville
The role of subprime mortgages – St Louis Fed
So much for diversification… – FT Alphaville

US debt saturation *alert*

Posted by Izabella Kaminska on Mar 26 11:29. 31 comments.

There was an interesting chart put up the other week on Nathan’s Economic Edge blog (H/T Chris Cook).

We’re not sure how accurate its assertion is. However, if what it implies is true, the consequences are worrying. More…

There was an interesting chart put up the other week on Nathan’s Economic Edge blog (H/T Chris Cook).

We’re not sure how accurate its assertion is. However, if what it implies is true, the consequences are worrying. The chart, as seen below, essentially reflects the productivity gained from the addition of $1 of debt into the US debt-backed money system. It does so, says the blog, by taking the change in GDP and dividing it by the change in debt. The data itself comes from the US Treasury’s latest Z1 release.

And, as can be seen from the chart, the recent trend has seen the productivity plunge through the zero-rate [click to enlarge]:

Nathan’s blog explains:

Back in the early 1960s a dollar of new debt added almost a dollar to the nation’s output of goods and services. As more debt enters the system the productivity gained by new debt diminishes. This produced a path that was following a diminishing line targeting ZERO in the year 2015. This meant that we could expect that each new dollar of debt added in the year 2015 would add NOTHING to our productivity.

Then a funny thing happened along the way. Macroeconomic DEBT SATURATION occurred causing a phase transition with our debt relationship. This is because total income can no longer support total debt. In the third quarter of 2009 each dollar of debt added produced NEGATIVE 15 cents of productivity, and at the end of 2009, each dollar of new debt now SUBTRACTS 45 cents from GDP!

It’s a point which has also been picked up by Paul Kedrosky, over at Infectious Greed.

The author’s feeling, though, is that the data should not be taken out of context, given GDP growth leading up to the crisis was unprecedented. As he explains:

But here is the thing. The growth in debt during the last two decades — both amount and rate — was unprecedented. We should expect a significantly declining marginal contribution to GDP , with no mystery or phase transition required. Matter of fact, in recessions before 1970 we saw GDP/debt declines to zero and below, just like we’re seeing today. Now, that doesn’t make the debt okay, because it isn’t and wasn’t, but it also doesn’t mean that, after delevering and time, debt can never again by deployed for profit in the economy.

Furthermore, it’s not like economists would have expected anything other than diminishing returns, he argues :

There should be no doubt that infinite amounts of consumer debt won’t generate any higher gains for a society than will debt for a company. As a matter of fact, declining returns at the margin are guaranteed, and should come as no surprise. After all, if we could just lever our way to a sustainable GDP of 2x current levels then we should just do it. Why screw around?

Nevertheless, it’s still a scenario that’s unlikely to reassure US debt-watchers.

What’s more, as the WSJ wrote on Friday, it means the US Treasury can hardly afford to let interest rates climb higher as it would, amongst other things, ‘jack up’ the government’s borrowing costs.

Weak Treasury auctions reflect that investors may already be turning their attention away from Europe and over to the US, and its ability to refinance its borrowings.

Demand for a $44bn 2-year note auction on Tuesday, a $42bn sale of 5-year debt on Wednesday and a $32bn 7-year note sale Thursday was all notably weak.

And yet the US has only just begun on its yearly refinancing journey. Diapason Commodities’ Sean Corrigan sums up the situation being faced:

Next quarter, the US Treasury must refinance $1.14 trillion in maturing debt + interest payments and another $630bln during the following three months.

The last couple of Treasury auctions have not been good; the Fed has supposedly finished its QE progr amme; China is being antagonised – not a healthy mix. As the attached shows, we are also fast approaching the neckline of a poten tial significant inverse H&S on T-Bonds, one whose breach should , theoretically, project all the way up to near 7% yields, the bear flattening effectively unwinding the whole rally from the previous cyclical top in early 2000.

This would not be too pretty for equities and could strengthen the USD further, hitting CMD Ts UNLESS the Fed steps back in to try to ease the strain – in w hich case the USD implications look dire. Somethin’s gotta give.

Here, meanwhile, is what that Q1 debt rollover — which seemingly originates from the Northern Rock school of finance –looks like this year:

Related links:
Testing the AAA boundaries – FT Alphaville
That European funding problem, charted - FT Alphaville
New (negative) territory - FT Alphaville
The negative swap time-warp- FT Alphaville

Greece and the markets, post-bailout plan

Posted by Joseph Cotterill on Mar 26 12:30. 11 comments.

It’s not a bailout — honest, according to the European leaders who reached an accord on Thursday over a ‘financing plan’ to help Greece, in case it can’t raise funds through the market in the near future. More…

It’s not a bailout — honest, according to the European leaders who reached an accord on Thursday over a ‘financing plan’ to help Greece, in case it can’t raise funds through the market in the near future.

Well, let’s just see what Friday’s markets thought about that — and what might happen to those Greek refinancing efforts when they begin.

After all, according to Moody’s on Friday, via Reuters:

10:07 26Mar10 RTRS-MOODY’S SAY MARKET REACTION TO SUPPORT PACKAGE IS KEY TO DETERMINING GREECE CREDIT QUESTION

In which case, let’s look at credit default swaps. Greek 5-year CDS narrowed to 299 bps by 10 am London time on Friday, from 311 bps at New York’s close on Thursday. The spread for Greek/German bond yields tightened to 309 bps on Friday compared to 320 at close. As context, both indicators had breached 400 bps on January 28, as Dow Jones reported at the time.

The head of Greece’s debt management agency has already insisted to BusinessWeek that Thursday’s accord ‘wipes out’ the risk of Greek default. Well, he would say that.

Break out the ouzo, then? Er… well, let’s see what analysts were saying about Greece’s market prospects on Friday.

Goldman’s chief European economist Erik Nielsen, who correctly called Thursday’s accord ahead of time, argued in his note on Friday:

I would expect the Greek government to go a long way to avoid the IMF, and therefore try and raise from the market the necessary EUR10bn or so to get through the April-May hump. This would have to happen during the next couple of weeks. Maybe the news of an IMF program as a back-up would be good enough for them to be able to raise the necessary money? – but remember that EUR22bn is only about half of their needs for long term debt amortizations during the next 18 months, and they’ll also need to borrow for the deficit and for the short term roll-overs – which largely depends on the ECB.

Ah yes, the European Central Bank, which U-turned on revised its minimum collateral threshold on Thursday. This allowed BBB+ assets to remain eligible beyond the end of the year, as well as introducing a more graduated policy on haircuts to manage the risk. The WSJ, for one, thinks this takes some credit risk off Greece in the event of a ratings downgrade. This will only help Greece post-accord, won’t it?

Nielsen doesn’t exactly agree (emphasis ours):

Two quick comments:

(1) If they keep the nuclear option (that a country can lose eligibility all together), even if three notches lower than before, then markets will continue to price some risk that this might happen in the future – and if the agencies downgrade Greece (or others) in coming months, then the anxiety of recent months will return; please don’t take us there! This is an unnecessary risk to run when they are at it anyway.

(2) How do you introduce a sliding scale without raising the haircut on the weakest credit? Well you could lower it on the best credits, but they are very low to begin with – so, Greek haircuts are almost certain to increase. Not good for the Greek sovereign – or their banks – unless you think that this will be more than outweighed by the somewhat lower probability of them losing eligibility all together. I belong to those who never thought it realistic at all that they would lose eligibility all together, so to me, today’s announcement by the ECB is a net negative for Greece.

Hmm. Compare BarCap European Credit Alpha note (which came out just before Thursday’s accord was announced) on what the ECB move means for Greece issuance:

The key implications are that, first, Greek banks, which are large holders of Greek sovereign debt, will continue to pledge these as collateral to the ECB in order to secure funding. Second, demand for any potential future Greek issuance will be much stronger than would otherwise be the case. Greek banks have bought perhaps close to half of the sovereign’s issue so far this year, a substantial portion of which is on repo with the ECB.

Which is just as well for Greece. But, as BarCap went on, the sovereign risk genie has spread well beyond the Aegean:

…the acuteness of Greek liquidity needs has pulled attention away from the fiscal situation of other European countries. The UK, Spain, Portugal, Ireland, and Italy all face a steep process of fiscal adjustment.

…

Unless a systemic solution to Europe-wide sovereign issues is reached — and it is difficult to envision what form such a solution would take — investors will remain concerned about fiscal deficits, debt, and liquidity issues across the continent. In our view, this could limit the potential upside to generic credit valuations once Greece’s liquidity needs are resolved. The sovereign spread floor was raised rapidly in 2010 but it looks likely to recede more slowly.

Don’t trip up on the way down, European sovereigns.

Related links:
The Greek bailout, according to Paris and Berlin [updated] - FT Alphaville
Portugal v Greece on sovereign risk – FT Alphaville
Greece, the IMF, and the ECB – FT Money Supply

Argentina’s sanguine approach to its looming debt swap

Posted by Guest writer on Mar 26 20:36. Comment.

Ahead of a major financial event for Argentina — a $20bn debt swap that would herald a new era in its tangled relationship with the capital markets — FT correspondent Jude Webber offers insight into the mood of the country’s finance secretary. More…

Ahead of a major financial event for Argentina — a $20bn debt swap that would herald a new era in its tangled relationship with the capital markets — FT correspondent Jude Webber offers insight into the mood of the country’s finance secretary.

Hernán Lorenzino, Argentina’s finance secretary, looks remarkably relaxed for a man structuring a complex debt swap that could make or break the country’s ability to return to global capital markets.

He’s even hoping to slip in a family holiday at the beach over Easter before the green light from regulators in Europe means thunderbirds are go.

And he has plenty to smile about – though on paper this offer looks to be at least as tough as the debt restructuring Argentina pushed through in 2005, four years after its default. In fact better market conditions have heightened its appeal, pushing its value into the 50s, not 33 like in 2005.

What Argentina is keen to stress now is that it has gone out of its way to tailor the deal as much as possible to retail investors, especially those in Italy who were and remain sceptical. In that sense, Mr Lorenzino’s smiles look like a more softly-softly approach than the hard-line taken five years ago.

Nonetheless, the ultimate message – accept now, it’s your final chance – remains the same. Mr Lorenzino’s cool must also reflect relief the nail-biting SEC approval stage is over and with market sentiment positive on the offer, Argentina must be feeling it’s in the home straits of a very long and bumpy ride.

Jude Webber is the FT’s correspondent for Argentina, Chile, Uruguay and Paraguay (which she most recently wrote about in a piece for the weekend magazine - ‘Ciudad del Este’s deadly trade route‘)

Related links:
Argentine groups may revisit international bonds – FT
Martin Wolf: Argentina holds a weak hand – FT (2005)
Corporate bond issues go local to deliver capital lift – FT
Would you like some chips with that Argentine exposure? – FT Alphaville (2008)

China warned of growing ‘land loan’ threat

By Geoff Dyer in Chongqing

Published: March 28 2010 18:27 | Last updated: March 28 2010 18:27

The Guanyinxia forest stretches up to the mountains north-west of the big central Chinese city of Chongqing. Most is protected land. “Our purpose is mainly preservation – not to make money,” says Liu Siyang, Communist party secretary of the government bureau that manages the forest.

Yet the same forest has a double life in the commercial world. It has been used as collateral by a company controlled by the local government forestry bureau to help secure a Rmb300m loan it took out last year from a state-owned bank, which was then spent on infrastructure projects in Chongqing.

Deals such as this are leading analysts to look more closely at local government finances in China. Some are beginning to warn that not only is China’s debt position much worse than advertised but that the banking system could also be heading for a big problem if many of these loans turn sour.

“This will eventually require a massive bail-out from the budget and the foreign exchange reserves,” says Victor Shih, an academic at Northwestern University in the US.

Over the past year China has pulled off a feat that seems remarkable in an era of commonplace double-digit budget deficits. The economy grew 8.7 per cent after the government launched a huge stimulus programme, yet the debt-to-gross domestic product ratio has barely budged from its modest level of about 20 per cent.

The catch is that most of China’s stimulus came not from conventional fiscal spending but from bank loans issued by state-owned financial institutions. New loans last year more than doubled to Rmb9,600bn, equivalent to nearly a third of GDP.

Local governments have only limited opportunities to borrow money, but they can set up special investment companies, such as the one operated by the Chongqing Forestry Bureau, which can use public land as collateral to raise loans. Officials have privately admitted that a significant chunk of last year’s bank loans went to these investment companies.

Such companies were pioneered in the early part of the last decade in Shanghai and Chongqing but there are now more than 8,000 across the country.

While the banking regulator puts local government debt at Rmb6,000bn ($878bn €655bn £590bn), Mr Shih estimates it is nearer to Rmb11,400bn, with another Rmb12,700bn of loans committed over the next few years. If these loans are included, he estimates, China’s debt-to-GDP ratio was 71 per cent at the end of 2009 and will be 96 per cent by 2011.

“The notion that there is not any leverage in the Chinese real estate market is false,” he says. “That might be the case for people buying houses, but local governments are leveraged in a big way.”

How much of these debts will go bad is guesswork. Mr Shih reckons the companies owned by big cities such as Beijing and Shanghai will be fine, but smaller towns and rural districts could struggle and that non-performing loans might reach Rmb3,000bn.

Huang Qifan, mayor of Chongqing, has also raised concerns. “For the Chongqing municipal government, there is no debt problem at all,” he said last week. “But we should pay more attention to some district governments.”

There are reasons not to fear the worst. A large part of the potential bad debts are from commitments to lend over the next two years. A portion of those loans cannot be halted without leaving half-built bridges, but the government is already taking some pre-emptive steps, warning banks to reduce lending to local governments and pledging to slow new infrastructure projects.

In the medium term, Beijing is discussing two reforms that could help. Ha Jiming, an economist at China International Capital Corporation, says the auth­orities could significantly expand the municipal bond market, providing a more stable financing channel. Officials are also examining a property tax to boost local government revenues .

Finally, the local governments can make up for losses at their investment companies by selling land.

Yet, as the Guanyinxia forest indicates, not all of the land used as collateral is commercially viable. And the volumes could become huge. Stephen Green, an eco­nomist at Standard Chartered in Shanghai, estimates that the collateral used to back loans issued to these investment companies is equivalent to three times all the land sold over the past five years.

“It is hard to see how this game can continue without an unhappy ending,” says Mr Green.

“If land values fall or the market stagnates . . . this game can never be brought to a successful close.”

EU leadership puts IMF on standby for Greek bailout

European leaders have put the International Monetary Fund on standby to help aid debt-stricken Greece, shrugging off the European Central Bank's plea that Europe solve the crisis on its own.

Leaders of the 16-nation eurozone endorsed a Franco-German proposal for a mix of IMF and bilateral loans at market interest rates, while voicing confidence that Greece would not need outside help to cut Europe's biggest budget deficit.

"It's an extremely clear political message," European Union president Herman Van Rompuy told reporters after the leaders met in Brussels early yesterday morning. "It's a mixed mechanism but with Europe playing the dominant role. It will be triggered as a last resort."

European leaders sought to bury concerns that divisions over aiding Greece would escalate the debt crisis and further undermine the euro after it sank to a 10-month low against the US dollar.

After objecting to a possible IMF intrusion on the US$12 trillion eurozone economy, the ECB endorsed the package, with president Jean-Claude Trichet saying European governments will remain in control of the process.

Trichet described surrendering control to the IMF as "very, very bad", before backtracking and revising his comments.

The euro rallied after Trichet came out in favour of the package.

Under the accord brokered by German Chancellor Angela Merkel and French President Nicolas Sarkozy, each eurozone country would provide non-subsidised loans to Greece based on its stake in the ECB, a statement said. Europe would provide more than half the loans and the IMF the rest, which would only be triggered if Greece runs out of fund-raising options.

Asserting her clout as head of the EU's largest economy, Merkel pushed for the IMF to be brought in amid mounting opposition in Germany to putting taxpayers' funds at risk. Counterparts, including Sarkozy, said Europe should show its credibility by fixing the crisis on its own with loans to Greece.

The contingency plan is "very satisfying", Greek Prime Minister George Papandreou said. "Europe, and Greece with it, emerge stronger from this crisis."

The Greek government is counting on wage cuts and tax increases to shave the deficit to 8.7 per cent of gross domestic product this year from 12.7 per cent last year, the highest in the euro's 11-year history.

"It's a stopgap plan," said Klaus Baader, co-chief eurozone economist at Societe Generale. "It really only meets Greek expectations half way. It'll help get bond yields down, but won't be enough to satisfy the markets."

Greece needs to sell about €10 billion (HK$103 billion) of bonds in coming weeks. About €8.2 billion of debt matures on April 20 and €8.5 billion on May 19, with about €3.9 billion of bills maturing next month.

The budget deficits of all 16 euro nations are forecast to exceed the EU's limit of 3 per cent of gross domestic product this year after the worst recession since at least the second world war. While the euro's German-designed "stability pact" foresees financial penalties for countries that go over the limits, no country has been punished.

Merkel has left open the possibility of pushing wayward countries out of the euro and sought a rewrite of European treaties to impose more fiscal rectitude. All 27 EU countries would have to back such an overhaul. The EU's latest treaty, in force since December, took eight years to negotiate and ratify.