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BOHICA [Bend Over, Here It Comes Again], pt. 3: Major Red Ink on European Banks’ Books

Com­ment: More sto­ries high­light just how pre­car­i­ous the euro­zone’s finances are right now.  There are $2.6 tril­lion in loans to Por­tu­gal, Ire­land, Italy, Greece, and Spain (the P.I.I.G.S),  that are held by Europe’s banks. No one knows who is hold­ing how much of those loans.  As a result, ter­ror grows in the Euro­pean finan­cial com­mu­ni­ty about the many hid­den finan­cial time bombs sit­ting on banks’ bal­ance sheets.  This is very rem­i­nis­cent to the lead up to the Lehman/AIG melt­down of 2008.

Euro­pean banks’ overnight deposits with the Euro­pean Cen­tral Bank rose to a record high last week, because they did­n’t want to lend to each oth­er over uncer­tain­ty that their bor­row­er (a fel­low bank) would­n’t be able to pay their overnight loans–that’s a sign of seri­ous wari­ness amongst the big banks.

“Banks’ Overnight Deposits with ECB Increase to Record (Update 1)” by Gabi Thesing; bloomberg.com; 6/3/2010.

Excerpt: Overnight deposits with the Euro­pean Cen­tral Bank rose to a record yes­ter­day as the sov­er­eign debt cri­sis made banks wary of lend­ing to each oth­er.

Banks lodged 320.4 bil­lion euros ($394 bil­lion) in the ECB’s overnight deposit facil­i­ty at 0.25 per­cent, com­pared with 316.4 bil­lion euros the pre­vi­ous day, the Frank­furt-based cen­tral bank said in a mar­ket notice today. That’s the most since the start of the euro cur­ren­cy in 1999. Deposits have exceed­ed 300 bil­lion euros for the past five days.

Banks are park­ing cash with the ECB amid investor con­cern that a 750 bil­lion-euro Euro­pean res­cue pack­age may not be enough to stop the cri­sis from spread­ing and spilling into the bank­ing indus­try. The ECB said on May 31 that banks will have to write off more loans this year than in 2009 and their abil­i­ty to sell bonds may be ham­pered as gov­ern­ments seek to finance fis­cal deficits.

“The bank­ing cri­sis is back,” said Nor­bert Aul, an inter­est-rate strate­gist at Com­merzbank AG in Lon­don. “The news flow over the past few weeks has spooked banks and since nobody knows how exposed indi­vid­ual finan­cial insti­tu­tions are, it’s deemed safer to park cash with the ECB rather than lend it on.” . . .

A New York Times arti­cle notes that the bad debt spook­ing the Euro­pean banks totals a mere $2.6 tril­lion! The arti­cle also talks about Dep­fa, a sub­sidiary of the Ger­man state owned bank Hypo-Real Estate Hold­ing.  Dep­fa was bought by Hypo in 2007, right before the sub­prime crash (The Ger­man state-owned banks are the fall guys in all sorts of finan­cial bub­bles.  Five out of nine of them have required bailouts recent­ly accord­ing to the arti­cle).  Dep­fa is one of the few Euro­pean banks to give detailed infor­ma­tion about its finances. The pic­ture is bleak. Hypo has about 80 bil­lion euros in expo­sure to the P.I.I.G.S.  That’s not chump change.  One might guess that Dep­fa is giv­ing its info because Hypo was nation­al­ized last year as a part of the 2008 bailout relat­ed to its mas­sive loss­es from the sub­prime mort­gage backed secu­ri­ties sec­tor, the melt­down in Ice­land, and oth­er finan­cial “irreg­u­lar­i­ties.”
Like IKB (the sub­sidiary of Ger­man state-owned bank KfW that was involved with the Rhineland Funding/Rhinebridge Cap­i­tal and the scam­ming of US munic­i­pal­i­ties), Hypo-Real Estate was also delv­ing into the US munic­i­pal­i­ties mar­ket.  In addi­tion, 25% of Hypo-Real Estate was also bought by Bil­lion­aire financier J.C. Flow­ers. (J.C. Flow­ers is a bil­lion­aire ex-Gold­man part­ner that has spent the year suc­cess­ful­ly push­ing to change the laws pre­vent­ing pri­vate-equi­ty firms from buy­ing major­i­ty hold­ings in US banks using).  Flow­ers, Hypo, and Nord­stream (anoth­er Ger­man state-owned bank) went on to play a big role in fuel­ing the Ice­landic finan­cial bub­ble.  Hypo and Nord­stream both had to get big bailouts as a result and there was a big fight over the nation­al­iza­tion of Flow­ers’ 25% share of Hypo.

Excerpt: It’s a $2.6 tril­lion mys­tery.

That’s the amount that for­eign banks and oth­er finan­cial com­pa­nies have lent to pub­lic and pri­vate insti­tu­tions in Greece, Spain and Por­tu­gal, three coun­tries so mired in eco­nom­ic trou­bles that ana­lysts and investors assume that a sig­nif­i­cant por­tion of that moun­tain of debt may nev­er be repaid.

The prob­lem is, alas, that no one — not investors, not reg­u­la­tors, not even bankers them­selves — knows exact­ly which banks are sit­ting on the biggest stock­piles of rot­ting loans with­in that pile. And doubt, as it always does dur­ing eco­nom­ic crises, has made Europe’s already vul­ner­a­ble finan­cial sys­tem occa­sion­al­ly appear to seize up. Ear­ly last month, in an indi­ca­tion of just how dan­ger­ous the sit­u­a­tion had become, Euro­pean banks — which appear to hold more than half of that $2.6 tril­lion in debt — near­ly stopped lend­ing mon­ey to one anoth­er.

Now, with gov­ern­ment resources strained and con­fi­dence in Euro­pean economies erod­ing, some ana­lysts say the Continent’s banks have to come clean with a trans­par­ent and rig­or­ous account­ing of their woes. Until then, they say, nobody will be able to wres­tle effec­tive­ly with Europe’s mount­ing prob­lems.

“The mar­ket­place knows very lit­tle about where the real risks are parked,” says Nico­las Véron, an econ­o­mist at Bruegel, a research orga­ni­za­tion in Brus­sels. “That is exact­ly the prob­lem. As long as there is no sem­blance of clar­i­ty, trust will not return to the bank­ing sys­tem.”

Lim­it­ed dis­clo­sure and pos­si­bly spot­ty account­ing have been long-voiced con­cerns of ana­lysts who fol­low Euro­pean banks. Though most large pub­licly list­ed banks have offered infor­ma­tion about their expo­sure — Deutsche Bank in Frank­furt says it holds 500 mil­lion euros in Greek gov­ern­ment bonds and no Span­ish or Por­tuguese sov­er­eign debt — there has been lit­tle dis­clo­sure from the hun­dreds of small­er mort­gage lenders, state-owned banks and thrift insti­tu­tions that dom­i­nate bank­ing in coun­tries like Ger­many and Spain.

Dep­fa, a Ger­man bank that is now based in Dublin, is one of the few sec­ond-tier Euro­pean bank­ing insti­tu­tions that have offered detailed dis­clo­sures about their finan­cial where­with­al, and its stark trou­bles may be emblem­at­ic of those still hid­den on oth­er banks’ books.

Despite boast­ing as recent­ly as two years ago of its “very con­ser­v­a­tive lend­ing prac­tices,” Dep­fa, which caters pri­mar­i­ly to gov­ern­ments, has flirt­ed with dis­as­ter. It nar­row­ly avoid­ed col­laps­ing in late 2008 until the Ger­man gov­ern­ment bailed it out, and today its books are still laden with risk.

DEPFA and its par­ent, Hypo Real Estate Hold­ing, a prop­er­ty lender out­side Munich, have 80.4 bil­lion euros in pub­lic-sec­tor debt from Greece, Spain, Por­tu­gal, Ire­land and Italy. The amount was first dis­closed in March but did not draw much atten­tion out­side Ger­many until last month, when investors decid­ed to final­ly try to tal­ly how much cross-bor­der lend­ing had gone on in Europe.

Before Greece’s prob­lems spilled into the open this year, investors paid lit­tle heed to how much lend­ing Euro­pean banks had done out­side their own coun­tries — so it came as a sur­prise how vul­ner­a­ble they were to economies as weak as those of Greece and Por­tu­gal.

“Every­body knew there was a lot of debt out there,” said Nick Matthews, senior Euro­pean econ­o­mist at Roy­al Bank of Scot­land and one of the authors of the report that tal­lied up Greek, Span­ish and Por­tuguese debt. “But I think the extent of the expo­sure was a lot high­er than most peo­ple had orig­i­nal­ly thought.”

Con­cern has quick­ly spread beyond just the sov­er­eign bonds issued by the three coun­tries as well as by Italy and Ire­land, which are also seri­ous­ly indebt­ed. Pri­vate-sec­tor debt in the trou­bled coun­tries is also becom­ing an issue, because when gov­ern­ments pay more for financ­ing, so do their domes­tic com­pa­nies. Reces­sion, along with high­er inter­est pay­ments, could lead to a surge in cor­po­rate defaults, the Euro­pean Cen­tral Bank warned in a report on May 31.

Hypo Real Estate has hun­dreds of mil­lions in shaky real estate loans on its books, as well as tox­ic assets linked to the sub­prime cri­sis in the Unit­ed States. In the first quar­ter, it set aside an addi­tion­al 260 mil­lion euros to cov­er poten­tial loan loss­es, bring­ing the total to 3.9 bil­lion euros. But that amount is a drop in the buck­et, a mere 1.6 per­cent of Hypo’s total loan port­fo­lio. Hypo has not yet set aside any­thing for mon­ey lent to gov­ern­ments in Greece and oth­er trou­bled coun­tries, argu­ing that the Euro­pean Union res­cue plan makes defaults unlike­ly.

The Euro­pean Cen­tral Bank esti­mates that the Continent’s largest banks will book 123 bil­lion euros ($150 bil­lion) for bad loans this year, and an addi­tion­al 105 bil­lion euros next year, though the sums will be part­ly off­set by gains in oth­er hold­ings.

Ana­lysts at the Roy­al Bank of Scot­land esti­mate that of the 2.2 tril­lion euros that Euro­pean banks and oth­er insti­tu­tions out­side Greece, Spain and Por­tu­gal may have lent to those coun­tries, about 567 bil­lion euros is gov­ern­ment debt, about 534 bil­lion euros are loans to non­bank­ing com­pa­nies in the pri­vate sec­tor, and about 1 tril­lion euros are loans to oth­er banks. While the cri­sis orig­i­nat­ed in Greece, much more was bor­rowed by Spain and its pri­vate sec­tor — 1.5 tril­lion euros, com­pared with Greece’s 338 bil­lion.

Beyond such sweep­ing esti­mates, how­ev­er, lit­tle oth­er detailed infor­ma­tion is pub­licly known about those loans, which are equiv­a­lent to 22 per­cent of Euro­pean G.D.P. And the inscrutabil­i­ty of the prob­lem, as seri­ous as it is, is spawn­ing spoofs, at least out­side the euro zone. A pair of pop­u­lar Aus­tralian come­di­ans, John Clarke and Bryan Dawe, who have cre­at­ed a series of sketch­es about var­i­ous aspects of the finan­cial cri­sis, recent­ly turned their atten­tion to the bad-debt prob­lem in Europe. After grilling Mr. Clarke about the debt cri­sis in a mock quiz show, Mr. Dawe tells Mr. Clarke that his prize is that he has lost a mil­lion dol­lars. “Well done,” says Mr. Dawe. “That’s an extra­or­di­nary per­for­mance.”

On a more seri­ous front, Tim­o­thy F. Gei­th­n­er, the Unit­ed States Trea­sury sec­re­tary, vis­it­ed Europe at the end of May and called on Euro­pean lead­ers to review their banks’ port­fo­lios, as Amer­i­can reg­u­la­tors did last year, to sep­a­rate healthy banks from those that need inten­sive care.

Oth­ers say that if such reviews do not occur, the bank­ing sec­tor in Europe could be crip­pled and the broad­er econ­o­my — depen­dent on loans for busi­ness expan­sions and job growth — could stall. And if that hap­pens, says Edward Yardeni, pres­i­dent of Yardeni Research, the Continent’s banks could find them­selves sink­ing even fur­ther because “Euro­pean gov­ern­ments won’t be in a posi­tion to help them again.”

LENDING prac­tices at Dep­fa may have seemed con­ser­v­a­tive before its 2008 melt­down, but its busi­ness mod­el had always been based on a pre­car­i­ous assump­tion: bor­row­ing at short-term rates to finance long-term lend­ing, often for huge infra­struc­ture projects.

From its base in Dublin, where it moved from Ger­many in 2002 for tax rea­sons, Dep­fa helped raise mon­ey for the Mil­lau Viaduct, the huge bridge in France; for refi­nanc­ing the Euro­tun­nel between France and Britain; and for an expan­sion of the Cap­i­tal Belt­way in sub­ur­ban Vir­ginia. Dep­fa was also a big play­er in the Unit­ed States in oth­er ways, like lend­ing to the Met­ro­pol­i­tan Trans­porta­tion Author­i­ty in New York and to schools in Wis­con­sin.

Before the cur­rent cri­sis, Dep­fa was proud of its engage­ment in Mediter­ranean Europe. In its 2007 annu­al report, the com­pa­ny boast­ed of help­ing to raise 200 mil­lion euros for Portugal’s pub­lic water sup­pli­er and 100 mil­lion euros for pub­lic tran­sit in the city of Por­to. In Spain, it helped cities such as Jerez refi­nance their debt and helped raise mon­ey for pub­lic tele­vi­sion sta­tions in Valen­cia and Cat­alo­nia as well as raise 90 mil­lion euros for a toll road in Gali­cia. And in Greece, Dep­fa raised 265 mil­lion euros for the gov­ern­ment-owned rail­way and in 2007 told share­hold­ers of a new­ly won man­date: pro­vid­ing cred­it advice to the city of Athens.

Dep­fa said it per­formed a rig­or­ous analy­sis of the cred­it­wor­thi­ness of its cus­tomers, includ­ing a 22-grade inter­nal rat­ing sys­tem in addi­tion to out­side rat­ings. More than a third of its buy­ers earned the top AAA rat­ing, the bank said in 2008, while more than 90 per­cent were A or bet­ter.

The pub­lic infra­struc­ture projects in which Dep­fa spe­cial­ized were con­sid­ered low-risk, and typ­i­cal­ly gen­er­at­ed low inter­est pay­ments. Yet because long-term inter­est rates were typ­i­cal­ly high­er than short-term rates, Dep­fa could col­lect the dif­fer­ence, how­ev­er mod­est, in prof­it.

To out­siders, Dep­fa still looked like a growth sto­ry even after the sub­prime cri­sis began in the Unit­ed States. Hypo Real Estate, which focused on real estate lend­ing, acquired Dep­fa in 2007. After the acqui­si­tion, Dep­fa kept its name and its base in Dublin.

But when the Unit­ed States econ­o­my reached the precipice in Sep­tem­ber 2008, banks sud­den­ly refused to make short-term loans to one anoth­er, blow­ing a hole in Depfa’s financ­ing and leav­ing it with a loss for the year of 5.5 bil­lion euros and depen­dent on the Ger­man gov­ern­ment for a bailout.

As Hypo’s 2008 annu­al report said of Dep­fa: “The busi­ness mod­el has proved not to be robust in a cri­sis.”  . . .


One comment for “BOHICA [Bend Over, Here It Comes Again], pt. 3: Major Red Ink on European Banks’ Books”

  1. Ok, so it turns out that more than half of the out­stand­ing mort­gages in Den­mark are the kind where the prin­ci­pal pay­ment could be post­poned up to 10 years. For­tu­nate­ly, with one-year adjustable-rate loans aver­ag­ing only 0.42%, the night­mare sce­nario of high inter­est rates get­ting intro­duced to this envi­ron­ment appears to be a no where in sight. Unfor­tu­nate­ly, fore­clo­sures rates are ris­ing any­ways and banks are still issu­ing more inter­est-only loans than any oth­er type of mort­gage, so this inter­est rate risk is going to remain for quite some time. The Dan­ish Cen­tral bank is urg­ing banks to restrict the issuances of these types of loans but the banks appear to view these are help­ful to the con­sumer. The banks are also in a bit of a bind because, by law, they aren’t allowed to extend under­wa­ter inter­est-only loans with­out a write-down. And Den­mark has the third largest mort­gage bond mar­ket in the world. This is prob­a­bly not going to end well:

    Dan­ish Mort­gage Banks Mull Life­line to Home­own­ers: Nordic Cred­it
    By Frances Schwartzkopff — Jan 10, 2013 1:56 AM CT

    Denmark’s $500 bil­lion mort­gage indus­try is look­ing at how to keep strug­gling home­own­ers afloat as the nation’s push into inter­est-only loans a decade ago now threat­ens a jump in loss­es amid ris­ing unem­ploy­ment.

    Loan write­downs for mort­gage banks in Den­mark jumped 51 per­cent in the first half of last year, accord­ing to a report released last month from the finan­cial reg­u­la­tor. Loss­es rose 17 per­cent in 2011, com­pared with a 25 per­cent drop in pro­vi­sions at 35 of Germany’s largest cred­it banks and a 55 per­cent drop in net loan loss­es at Sweden’s mort­gage lenders.

    Loans that allow prin­ci­pal pay­ments to be post­poned by as many as 10 years now com­prise more than half of out­stand­ing mort­gages after being intro­duced in 2003. Denmark’s two mort­gage bank­ing groups, whose mem­bers include Nykred­it A/S, Europe’s biggest issuer of home-loan backed bonds, are in talks with reg­u­la­tors on how to help home­own­ers unable to meet prin­ci­pal pay­ments or refi­nance into sim­i­lar loans.


    Esca­lat­ing loans loss­es, cou­pled with signs inter­est rates are on the rise, could stall efforts in Den­mark, home to the world’s third-largest mort­gage bond mar­ket, to emerge from a four-year slump in its hous­ing mar­ket. Home fore­clo­sures jumped to the high­est in two decades last year as the econ­o­my con­tract­ed, even amid record-low inter­est rates and signs the hous­ing mar­ket sta­bi­lized.

    The yield on Denmark’s gov­ern­ment bond matur­ing 2023 has jumped 25 basis points since a low in the first week of Decem­ber to about 1.55 per­cent. Danes’ finances got a boost last year from investor demand for their AAA rat­ed mort­gage bonds amid a flight from the strug­gling euro area. The yield on one-year adjustable-rate loans aver­aged 0.42 per­cent in recent auc­tions, the mort­gage asso­ci­a­tion said Dec. 17. The Nykred­it index of the market’s largest, most trad­ed mort­gage bond series, hit a record 404.72 last month.


    Forced Write­downs

    More fore­clo­sures could trig­ger anoth­er down­ward spi­ral in the hous­ing mar­ket. House­holds have too much debt and the cost of that debt is like­ly to wors­en as rates go up, weigh­ing on the mar­ket, said Andreas Hakans­son, an ana­lyst at Exane BNP Paribas.

    “This prob­lem will only become big­ger over time as more house­holds lose their inter­est-only sta­tus at the same time,” Hakans­son said in an e‑mail response to ques­tions.

    Mort­gage banks by law can lend 80 per­cent of a property’s val­ue. Home­own­ers whose prop­er­ty val­ues have dropped, push­ing loan-to-val­ue ratios above 80 per­cent, can refi­nance though gen­er­al­ly only to mort­gages that require prin­ci­pal. Lenders that extend the inter­est-only peri­od must write down the loans.

    “That’s not a very good solu­tion for the mort­gage banks,” Karsten Beltoft, direc­tor of the Mort­gage Bankers’ Fed­er­a­tion, said in an inter­view. “Banks will have to write down cus­tomers and they don’t want to do that.”


    Inter­est-only loans made up 56 per­cent of out­stand­ing mort­gage bank debt after climb­ing 4.7 per­cent in the third quar­ter from the same peri­od a year ear­li­er, the Copen­hagen- based mort­gage asso­ci­a­tion said in Octo­ber. That com­pares with 55 per­cent a year ear­li­er.


    Dan­ish cen­tral bank Gov­er­nor Nils Bern­stein has urged banks to restrict use of inter­est-only loans. While the bank found in a Decem­ber report most house­hold bud­gets are “robust” and can sur­vive a longer peri­od of job­less­ness or ris­ing rates, it con­clud­ed the loans intro­duce imbal­ances in house­holds and the mort­gage indus­try and inflate house prices.

    The indus­try has defend­ed the loans, say­ing the prod­ucts and adjustable-rate mort­gages have helped soft­en the effect of the eco­nom­ic con­trac­tion and helped keep peo­ple in their homes. Fore­clo­sures fell in Decem­ber to 363 from 451 a month ear­li­er, the Copen­hagen-based sta­tis­tics agency said.

    “We don’t think these are a mis­take,” Knoes­gaard said. “It’s not black and white only.”


    Posted by Pterrafractyl | January 10, 2013, 8:34 am

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