Landfall of a “Told You So†Moment…
Late last year and early this year, we wrote extensively about the problems we thought were coming down the pike for European banks. Very little attention was paid to the topic at the time, but we felt it was a typical example of a “gray swan†– a problem everybody knows about on some level, but naively thinks won’t erupt if only it is studiously ignored. This actually worked for a while, but as Clouseau would say: “Not anymeure!â€
Italy’s prime minister Matteo Renzi, indicating how much capital is left in Italian banks…
Photo credit: Giacomo Morini / INFOPHOTO
Readers may want to check these previous missives out, which provide a lot of background information and color (in chronological order: “Insolvent Zombiesâ€, “Drowning in Bad Loans†and “The Walking Dead: Something is Rotten in the Banking Systemâ€). What is happening now is therefore a “told you so†moment, because, well…we told you so. 🙂
Following the “Brexit†vote, market participants have begun to focus their attentionon what we thought they would focus it on: namely on the risks posed by continental Europe. Perversely, the mainstream press on the continent is brim-full with lamentations describing in lurid prose what an unmitigated catastrophe leaving the EU will be for the United Kingdom! (as we promised, we will write about this in more detail soon – it is truly funny to watch). In reality, the UK has left what increasingly looks like a sinking ship.
One bank that did get its share of unwelcome media attention was Europe’s biggest zombie, Deutsche Bank. Its share price has continued to tumble relentlessly, for no immediately obvious reasons. In a way this is faintly reminiscent of Creditanstalt in 1931– in the sense that Deutsche’s position in the European banking system of today is of roughly similar importance as Creditanstalt’s was back then. This is mainly due to its extremely large derivatives positions, which make it a lynchpin in a vast web of contractual obligations – it is so to speak the mother of all counterparties.
We would however argue that while this is indeed a bit worrisome, the real danger clearly comes from elsewhere. Deutsche Bank is after all headquartered in Germany, and its domestic market is strong. In fact, the real danger is still right where it always was: in Italy and Spain – and to a slightly lesser extent in Greece as well.
Italian banks are sitting on €360 billion in non-performing loans – including, so we are told, loans of the “extend & pretend†variety. Just one day after the Brexit vote, the ECB’s TLTRO II operation took place. Almost €400 billion were lent to euro area banks at negative interest rates. The banks also paid the bulk of the less generous TLTRO I loans back, leaving net new TLTRO additions at about €31 billion. Most of the new TLTRO II loans were taken up – you guessed it – by Italian and Spanish banks (details at Bloomberg).
(Click on image to enlarge)
TLTRO -II: the ECB is subsidizing European banks by offering them fresh funds at negative interest rates, under the condition that they engage in the very thing that has produced the crisis in the first place: more credit expansion ex nihilo! The biggest borrowers are the very banks that are drowning in bad loans
Add to that approx. €25 billion or so in QE since the Brexit, and a €150 billion liquidity guarantee for Italian banks approved by the EU commission on June 30, and you would think that maybe there would at least be some short-covering in European bank stocks. Not so:
