ECB Trapped: Steinhoff Liquidity Collapses As Lenders Pull Credit Lines

When yesterday we discussed the latest troubles facing embattled retailer Steinhoff, whose bonds are owned by none other than the ECB, we said that while the company"s bonds mature in 2025, its bankruptcy is at most months away. In retrospect, and in light of the latest news, that may have been optimistic, because it now appears that a bankruptcy may be imminent and is at most just weeks away. According to Bloomberg, Steinhoff - which is facing an accounting scandal that led to the recent departure of its CEO and destroyed most of the company"s value - said lenders are starting to cut off support.

The reason why Steinhoff is suddenly facing not only a solvency but liquidity crisis is that the company which owns Conforama in France, Mattress Firm in the U.S. and Poundland in the U.K. isn’t yet able to assess the magnitude of financial irregularities disclosed two weeks ago, it said in a presentation to lenders in London on Tuesday (presentation below). The South African company also said it didn’t know when it would be able to publish audited results for 2017 and 2016, nor whether additional years will need to be restated.

Furthermore, Steinhoff also revealed that it didn’t have “detailed visibility” of the cash flows of individual operating companies. The units rely on the company for working capital and “the forecast position for each operating company is evolving daily,” it said. PricewaterhouseCoopers has been hired to investigate the accounts, while AlixPartners LLP is working on an analysis of the cash flow.

In short, the company is flying blind with no budgeting and no corporate overnight.

The presentation also said that the company is still grappling with the task of getting to the bottom of the crisis, which has led to the resignations of CEO Markus Jooste and billionaire Chairman Christo Wiese. As Bloomberg adds, Steinhoff said earlier Tuesday that Chief Operating Officer Danie van der Merwe, 59, had been made interim CEO to helm the recovery attempt, while Conforama boss Alexandre Nodale will serve as his deputy in a new four-member management board.

Needless to say, the last thing secured creditors want, is not knowing the "revised" value of the collateral that secures their loans, especially in the case of a rollup which "suddenly" turned out to also be fraud. Hence: everyone is rushing to get out the back door. Predictably, Steinhoff"s shares - already decimated - resumed their plunge, and ended their recent dead cat bounce by slumping more than 205% in Frankfurt to the lowest since Dec. 8 before paring losses to trade 12 percent lower.

Finally, Steinhoff revealed that it had outstanding debt of 10.7 billion euros ($12.7 billion) as of Dec. 14, the slide below revealed. Almost 4.8 billion euros of that was in Steinhoff Europe AG, an operation based in Austria. About 690 million euros in notional facilities have been rolled over to date, according to the presentation.

As a reminder, the ECB is a creditor to Steinhoff Europe AG Austria.

Which brings us to the question he brought up yesterday: will, or rather when now that Steinhoff"s bankruptcy now appears imminent, will the ECB sell its Steinhoff bond holdings? As we showed yesterday, Mario Draghi appears to be getting ready to do just that. As BofA pointed out, Draghi seems to be taking a more defensive stance with regards to owning Fallen Angel bonds like Steinhoff"s.

Note that the CSPP Q&A has been updated as of 29th November 2017, and the paragraph on ECB selling now reads as follows:

Q1.5 Will the Eurosystem sell its holdings of bonds if they lose eligibility?

The Eurosystem may choose to, but is not required to sell its holdings in the event of a loss of eligibility, e.g. in case of a downgrade below the credit quality rating requirement.

Previously this phrasing was far more specific, with forced selling (or otherwise) not even presented as an option:

Q8 Will the Eurosystem sell its holdings of bonds if they lose eligibility? For example, if they are downgraded and lose investment grade status?

The Eurosystem is not required to sell its holdings in the event of a downgrade below the credit quality rating requirement for eligibility.

Of course, once the ECB breaks the seal and it become public knowledge that the world"s biggest hedge fund not only buys - as everyone had known - but also sells when it has to, all hell could break loose for those IG bonds on its books which are about to be downgraded to junk by one or more rating agencies, leading to the perilous scenario we described yesterday, in which "fallen angels" become very painful "falling knives."

Until then, we will just keep an eye on Mario Draghi for the answer how long he can continue to burn taxpayer money by holding insolvent bonds and pretending that nothing has changed...

* * *

Steinhoff"s full presentation to (evaporating) investors is below (link)

Uh-Oh...Draghi"s Ammunition To Buy Italian Bonds Before The Election Is Less Than We Thought

Having successfully pulled off the announcement of the ECB’s “dovish taper” – where monthly bond purchases will be halved to Euro 30 billion from January 2018 – last month, a challenge for Mario Draghi in Q1 2018 has appeared on his radar. The ECB’s bond buying ammunition is slightly less than analysts thought and there is the small matter of the looming Italian election. The latter is likely to be held in March 2018, although it could take place as late as May. Veteran strategist, now Bloomberg columnist, Marcus Ashworth explains in "Italy"s Shrinking Safety Net".

One of Mario Draghi"s hands is being tied behind his back just as bond markets may need his help the most. Data released by the European Central Bank this week show the ECB president will have reduced scope to buy Italian bonds if markets start convulsing ahead of the country"s general election in the spring. From January, the ECB"s Quantitative Easing program will pare its monthly bond purchases by 50 percent to 30 billion euros ($35 billion). Draghi has sought to soften this so-called tapering by emphasizing how the ECB can reinvest maturing bonds to pick up the shortfall.

 

There"s a hitch -- the central bank said it intends only to reinvest proceeds from maturing bonds in debt of the same country. That leaves Draghi with only limited flexibility to use his buying power to the benefit of one country over another.

Monday"s release showed that proceeds from these maturing securities, which could then fund new purchases of Italian bonds is both less than expected and likely skewed until after the election. Ashworth provides us with the numbers.

Monday’s release showed that proceeds from these maturing securities which could then fund further purchases of government bonds, will only be about 8.5 billion euros, less than analyst expectations of as much as 12 billion euros. This means the pace of bond purchases under the QE program will fall by about a third from this year"s rate of 60 billion euros a month. The first quarter will be noticeably lighter in monthly redemptions compared with the rest of 2018. The big months for Italian redemptions won"t come until April and October.

This is inconvenient, especially as the ECB had already been “pushing the envelope” in terms of Italian purchases (and French), as Ashworth laments.

The ECB has already spent most of 2017 buying more Italian bonds than the capital key, a formula that determines how much of each nation"s debt the central bank can buy, would suggest. That variation is allowable - but it leaves little extra available slack to cut Italy.

Ashworth notes that the fragmented nature of Italian politics could lead to problems for the Italian bond market in the run up to the election. While the anti-Euro 5-Star is the largest party, its reluctance to form coalitions has significantly reduced its chances of forming the next government. While that’s a positive, Ashworth’s biggest concern is the reaction of the bond market if Silvio Berlusconi returns to, “or even near”, power. As we discussed in “Berlusconi: The Greatest Comeback Since Lazarus?” here, last Sunday’s Sicilian elections were seen as an important barometer for the upcoming national election and Silvio is on the comeback trail.

Nationally, the PD (center-left) is just behind 5-Star, which has 28% support. In the center-right bloc, Forza Italia and the anti-immigrant, Northern League, have 14% each, while the far-right Brothers of Italy have 5%. As media outlets emphasised, much of the Sicilian election campaign focused on the personalities of those involved, rather than the “big issues”, like the economy, jobs and immigration. Ironically, we suspect that Mr Berlusconi will revel in such a situation if it continues in the upcoming national election campaign. Besides cementing the alliance between his Forza Italia, Brothers of Italy and the Northern League, we will be watching as Berlusconi seeks to overturn the ban on his running for public office. Berlusconi, of course, denies any wrongdoing.

Super Mario (Draghi) has enjoyed a charmed existence as President of the ECB. There would be a comic irony if his legacy was tainted by his corrupt, octogenarian countryman so late in his tenure. As Ashworth concludes.

Draghi"s toolbox has been downsized. Investors can"t say they weren"t given fair warning. Their only consolation: his ability to pull a surprise at the very last moment.

The ECB Has Bought €1.9 Trillion In Bonds: Here Is Who Sold And What They Did With The Money

Since the ECB launched its sovereign debt QE, initially known as PSPP, in March 2015 and later expanded to include corporate debt, or CSPP, in June 2016, the world"s biggest hedge fund central bank has created enough money out of thin air to purchase bonds with no consideration for price to grow its balance sheet, i.e. investment portfolio, by €1.89 trillion.

Meanwhile, over the entire QE period, net European bond new issuance has only amounted to €394 billion - only one-fifth of what the ECB has bought - and that only after picking up recently.  In fact, through much of 2016, there was hardly any net issuance at all according to Citi data.

Here, as Citi notes, It’s hardly rocket science that for every bond the ECB has bought there must have been a seller – either a new issuer or an existing holder, which means:

    Net € FI issuance = Domestic net buying of € FI + Foreign net buying of € FI + ECB net buying of € FI

Imbalances between desired issuance and desired holdings at the prevailing market price are what drive valuation changes until equilibrium is found. Put differently, if the ECB bought a bond from an investor who wished to remain in the € fixed income market, then that investor would buy from another investor, who could buy from yet another, but unless there was new issuance to invest in eventually prices would reach levels where someone would take the money out and put it somewhere else.

But who has been selling to the ECB? And where have they been putting their money?

That"s the question Citi"s Hans Lorenzen set out to answer, and since per the math above, net of issuance holdings of private investors must have fallen by more than €1.5 trillion, the answer would be rather material. Put that number into context, the €1.5 trillion in debt that someone sold without replacing, is equivalent to more than 9% of €-denominated bonds outstanding at the start of the program. Those are bonds which used to be held by private investors, who have now been given cash and have to park that cash somewhere else.

As Citi notes, "It truly is crowding out on an unprecedented scale."

Going back to Citi"s question, here is the answer in two parts.

First, the "who" sold this €1.5 trillion in private holdings:

Using ECB data, we know that private banks have beem major sellers, to the tune of €645 billion since the start of QE, making up more than 40% of the decline in private holdings. Here the net selling has mostly been of government bonds (€293bn) other MFIs (€273bn), while corporate and other bonds only amount to €70bn. Aside from banks, Citi calculates that while non-resident European investors have sold €400bn since Q1 2015, with non-bank private Euroarea investors filling the gap of €795bn. This calculation challenges the predominant  assumption that the selling to the ECB has mostly been done by foreigners, as much of the non-bank net selling must have come from other domestic investors. When one adds Eurozone banks, it is clear that the majority of private selling in aggregate has been domestic.

The chart below breaks down the transactions in bonds issued by Euro-area residents by investor type. Aside from banks, the main sellers have been households and other financial institutions.

Second, where did the money go?

While the answer will hardly come as a surprise, there are - intuitively - four destinations where a euro pulled out of € fixed income could move into.

1. stay in fixed income, but move into bonds denominated in other currencies;


2. move out of fixed income and into another asset class (domestic or foreign), like equities;


3. move into money markets;


4. leave the securities market altogether, in which case you"d expect it to show up as a deposit (with a domestic or a foreign bank

While there are some potential complications here, mostly because there is no explicit data revealing the "mirror image" for the private selling of €-denominated bonds, if one lines up the transactions against Citi"s proxy, consisting of net purchases of European equities, money market flows, and non-government deposits, and the directional terms of the resulting asset disposition proceeds emerge, or as Citi summarizes, "When investors
have been selling bonds, investments in our proxy have mostly tended to rise."

Furthermore, as shown in the second chart below, splitting up these “proxy investment outlets” into their constituent parts, it becomes clear that the bulk of the “delta” from before QE in 2014 is in an increase the rate of deposit accumulation and an increase in outflows from Eurozone investments. However, since QE began, the deposit accumulation has continued, but the purchases of equities and especially foreign investments have grown, and have accelerated markedly this year.

In short: the ECB purchased €1.5 trillion in bonds, mostly from European banks and domestic investors, with no regard for prices thereby virtually assuring booked profits for the sellers, who then turned around and purchased domestic equities, foreign investments, or converted the money into deposits and money market instruments.

And so, with the ECB set to taper with trial balloons that the ECB could cut its monthly QE by half or more, what happens next now that this swap is about to be throttled by more than 50%? Will households sell more or less bonds, and what will happen to yields? We will present one answer - an answer which the central banks do not want to hear - shortly.

EURUSD Dumps'n'Pumps After ECB QE Decision Delay, Inflation Cut Leaks Reported

Last week Reuters provided the outlet for leaked comments from The ECB (regarding QE) that sparked chaos in EURUSD. This week it is Bloomber who reports sources suggesting The ECB will cut inflation outlooks (pouring cold water on Draghi"s "reflationary forces" hoopla) and seemingly confirming The ECB will kick the can on the decision to taper QE into 2018.

As Bloomberg reports, ECB Governing Council has been presented with documents outlining multiple scenarios for adjusting quantitative easing, according to euro-area officials familiar with the matter.

• Papers were put together by the ECB’s technical committees for the two-day meeting that starts Wednesday, and include different combinations for the size and duration of asset purchases, the people say


• Documents don’t identify a preferred scenario and aren’t intended as formal policy proposals, people say


• A decision doesn’t currently look likely before the Governing Council’s Oct. 26 meeting, people say


• Governing Council will also look at the parameters of QE, including constraints dictated by European law and the ECB’s self-imposed choice of asset classes, to gauge how much room they have for purchases, people say


• Officials may also talk about altering their forward guidance on interest rates, one person says


• Draft economic projections show 2017 growth forecast revised up, 2018 and 2019 inflation forecasts revised slightly lower, separate euro-area official says, citing document distributed to national central banks


• ECB spokesman declines to comment


• People ask not to be named because the Governing Council’s deliberations, documents are private

The reaction was a swift plunge to the day"s lows followed by a surge to the day"s highs, and then retracement...

Once again, it appears The ECB is strawman-ing the market"s response ahead of the statement tomorrow... and for now, EURUSD is entirely unimpressed.

Bill Blain: Here Is Southern Europe's Next Tipping Point

By Bill Blain of Mint Parnters

"The Braavosi have a saying too. The Iron Bank will have its due....”

One of the things that’s been niggling me for years has been the question of just how unfixed the European banking sector is.

This morning I’ve attached a note my associate Ben Stheeman and I have put together on Non-Performing Loans (NPLs) in Second Tier European Banking. It’s a simple look at the publically available numbers.

Nobody will be surprised a North/SouthWest line divides Europe into good banks and less good banks. North of the line there are a few issues. Italy remains the problem - 16 out of 19 Italian banks don’t meet European standards on NPLs! We conclude the Italian second tier banks need to raise some €32 bln of new capital just to cover their existing holes. (€32 bln isn’t a massive number any more, but it’s a very large number for what are essentially very small banks – meaning further calls on Italian tax-payers look likely!) 

In recent weeks we’ve seen a gamma burst of activity across European banking: the resolution and bail-in of Banco Popular, the bailout and transfer of the Veneto banks, and a number of completed NPL sales by Italian banks. However, this morning, the FT highlights how new European Securitisation laws may kill the market for Hedge Funds and PE Funds to buy NPL and fund them via Securitisation.

That sums up much of the confused thinking on European banks.

The Eurocrats have made grand assumptions, plans and visions for European Banking Union, including a single regulator, rules and definitions. But the reality is European banks remain very national in their characteristics and outlook. They have little in common that would define a “European Bank”.  

Readers may recall European banks were barely touched by the initial outbreak of banking uncertainty in 2007 and 2008. I remember being told how stupid the British banks were in comparison to the clever European names that hadn’t got involved in structured and secured debt. And then the Lehman moment changed everything and the Global Financial Crisis went critical. Then we tumbled into the European Sovereign Debt Crisis and European banks became mired in a deepening crisis. A collapse in sovereign confidence triggered worries across weaker European banking names.

Since then we’ve seen multiple rescues, bailouts, handouts, defaults, restructurings, recapitalisations and bail-ins across Europe. Regulators and politicians talk big about banks being fit to fail without recourse to taxpayers – therefore they should have lots and lots of capital.

But, it’s never a lack of capital that kills a bank. Its access to liquidity – which depends on confidence.  Folk will keep depositing in a bank as long as they are confident they will get their money back. When confidence unwinds, the bank will fail. Simples.

Regulators have made the assumption you can solve the confidence problem by putting in enough capital to cover any event. Because of the importance of national banking systems, pre-2008 investors read that as a bail-out charter, correctly anticipating banks would be bailed out.

Now it’s changed – but only slightly. The Veneto and MPS events demonstrated the Italians have little choice but to continue bailing out their banks because there was no large private sector to help out.

Otherwise, the reasons confidence in banks collapses is different every time. It might be because of fears a massive mismatch on the derivative book will trigger overnight crisis (watch this space), or might be something more simple. Some of the triggers are obvious – like how certain Irish banks got sucked into unwise property games because they thought they understood the market and the politics of property better than anyone else. Or it might be German and Austrian banks overwhelmed by toxic investments. Some names were simply swept away in the Netherlands. I watched a sinking property market trigger crisis in Spain. (On the other hand, I’m still struggling to understand how the French banks seemed to skate across the thin ice largely unscathed – a story for another day perhaps..)

What became quickly apparent is that there is no such thing as a European Bank. That was particularly true before the ECB became the regulator across the Eurozone. National self-interest trumped Europe every time – still does in many countries. National Characteristics and Politics still define the way in which banks operate.

Post crisis there has not been a clean banking sweep across Europe. Some countries; notably Spain and Ireland, addressed the crisis and have come out with stronger banks. Selective names were rescued, rebuilt and rebranded. Some names were mercy-killed.

But in most cases the symptoms of chronic unwise lending and resulting undercapitalisation were treated with sugar lumps, lashings of free ECB money and a general hope banks would recover as/when/if the European economy recovered.

In the US, banks were put on diet of forced recapitalisation and clean up – it worked.

There has been much talk about European Banking Union – trying to create common rules and practice to make real the illusion European banks are homogenous group. But they aren’t – and won’t be if the rules only apply to large banks. 

Years of regulation, and selective memory gives us a European Systemically Important Financial Instututions (SIFI) Banking sector of some 30 core banks that could be described as healthy(ish). They all meet the core capital tests. They are recapitalising themselves to the levels determined as appropriate by the regulators.

But, there still isn’t any standard definition of European capital, and there is still no single Pan-European banking champions! The German banks seem to be retreating into their home market. The Dutch are focused on their domestic markets. Only the French show any real ambition – and even they have learnt caution from just how doomed they would have been if Greece, Portugal or Ireland had actually exploded! (Now I wonder how large French exposures to Turkey might play out…)

I could ramble on for paragraphs about how national banks reflect national outlook – The UK banks as mercantile commercial funders and mortgage providers, the German banks as instruments of regional economic policy, French banks as lending conduits for the State’s industrial policy, or Italian banks as SME lenders.. Too simplistic – but bear with.. 

Let’s not worry about the big banks. Sure there is a chance the next European financial crisis might be spawned within one of them.. but, it’s far more likely we’ll continue to see a series of smaller crisis gestate in lower down the European banking food chain. There are simply far too many of them..

We’ve looked at European banks with a balance sheet of €10bln plus. We didn’t worry about subsidiaries. Most of Europe’s second and third tier banks are perfectly fine. But a worrying number aren’t – they have flashing red signal lights screaming Danger, Danger! I suspect many depositors (including investors in their bond issues) to these second tier banks continue to lend because, contrary to the evidence, they think they are safe. Maybe it’s national interest, politics or implied government support – but a significant number of Southern European banks still look in crisis, but still attract deposits.

After looking at capital, management, and focused on NPLs, guess what? The bulk of Europe’s smaller banking problems are bound up in Southern Europe – Italy in particular. Surprised? Thought not.

We’d be interested in any feedback on the attached file.

The ECB's Balance Sheet Is Now The Size Of Japan's GDP

Yesterday was a landmark day for the ECB. First, the central bank disclosed that its CSPP, or corporate bond, holdings rose above €100Bn for the first time. As DB"s Jim Reids notes this morning, to put things in perspective, a similar market cap company would be the 18th largest in the Stoxx 600 and 42nd largest in the S&P 500. It"s also roughly equivalent to the annual national output of Kuwait - the 59th largest economy in the world as of 2016."

Assuming that the previously disclosed percentage of bonds purchased in the primary market, or directly from the company, has not changed since our report a month ago, this means that the price indiscriminate ECB has directly injected approximately $15 billion in various European corporate entities in exchange for bonds, bypassing any middlemen in the process.

As for the ECB"s other notable "achievement" according to the latest update, the ECB"s balance sheet now stands at €4.23 trillion, making it the largest central bank holding in the World. As Deutsche Bank notes, this is the same as the GDP of Japan (€4.3 trillion) - the 3rd biggest economy in the world and a decent distance ahead of Germany (€3.02tn) - the fourth largest.

The news takes place one month after another memorable event for central-planning took place, when both the ECB and BOJ balance sheet surpasses the size of the Federal Reserve"s.

Jim Reid"s conclusion conveys our sentiment too: "It"s staggering to think of it in those terms."

Who Knew? German Central Bank Has Been Selling Gold For More Than A Decade

Authored by Louis Cammarosano via Smaulgld.com,

Deutsche Bundesbank gold reserves shrink 45 tons over the past ten years.

• German Central Bank holdings fall From 3,420.6 tons at the end of Q2 2007 to 3375.6 tons, a drop of 1,446,783 ounces.


• German gold reserves have decreased 1.3% over ten years.

Bring the Gold Home & Sell Some

Deutsche Bundesbank, the central bank of Germany, has gained a high profile for its insistence on repatriating a good portion of its gold from vaults at the New York Fed, the Bank of England of London and the Bank of France in Paris. We have been covering the German gold repatriation story since they made their request in 2013 here, here, here and here.

The German repatriation requests aimed to rebalance the Deutsche Bundesbank’s gold holdings from nearly 70% held abroad to 50% held within Germany’s borders. The German Central Bank announced earlier this year that it has nearly completed its plan to repatriate its gold.

Jens Weidman, President of the Deutsche Bundesbank once famously said:

“Indeed, the fact that central banks can create money out of thin air, so to speak, is something that many observers are likely to find surprising and strange, perhaps mystical and dreamlike, too – or even nightmarish.”

In this video from the Deutsche Bundesbank, German nationals, Deutsche Bundesbank representatives and Herr Weidman explain the importance of gold to Germany.

Given the Deutsche Bundesbank’s statements and the accelerated German gold repatriation schedule, we are surprised to see that the Deutsche Bundesbank has been a steady seller of its gold over the past ten years.

German Gold Reserves 2007 – 2017

The Duetsche Bundesbank gold reserves fell 45 tons from June 30 2007 to May 31, 2017.

The Central Bank of Germany holds the second largest gold reserves of any central bank.

Currently, with the People’s Bank of China halting its gold purchases since October 2016, only the Central Banks of Russia, Kazakhstan and recently Turkey are steady buyers of gold.

Both ECB And BOJ Are Just Months Away From Running Out Of Bonds To Buy

With the Fed contemplating whether to hike again next month and start "normalizing " its balance sheet before the end of 2017, the two other major central banks are facing far bigger problems.

* * *

Two months after the BOJ quietly started tapering its QE program, when it also hinted it may purchase 18% less bonds than planned...

... Governor Haruhiko Kuroda admitted last week that the Bank of Japan’s bond holdings are currently growing at an annualized pace of only ¥60 trillion ($527 billion), 25% below the bottom-end of its policy range, and confirming that without making any formal announcement, the BOJ has quietly followed the ECB in aggressively tapering its bond buying program.

Under questioning from opposition party lawmaker Seiji Maehara, who noted that the pace of bond accumulation by the BOJ had slowed, Kuroda said the trend could continue, without elaborating. He noted that the central bank’s target is to control interest rates rather than the amount of bond purchases. "This development signals to me that they are going with rates without talking about a quantitative target," said Atsushi Takeda, an economist at Itochu Corp. in Tokyo. "That will be better when they think about an exit.”

While the BOJ"s purchase slowdown has been visible for months in data released by the central bank, Kuroda’s confirmation of this reality in parliament last Wednesday marks a stark change. As Bloomberg notes, until now he’d struggled to emphasize that the annual pace could vary from an indicative 80 trillion yen, depending on the state of the economy and financial markets. He now appears to have thrown in the towel.  Meanwhile, investors are watching for any hint of tightening in monetary policy amid speculation that the central bank’s bond purchase regime is unsustainable and as consumer prices in Japan are expected to pick up later this year. The most likely way for the BOJ to begin tightening would be scrapping the 80 trillion yen guideline altogether, especially since the central bank is no longer following it.

"The Bank of Japan appears to be ramping up its efforts to improve communication with the market to lay the groundwork for its next move - tapering," Bloomberg Intelligence economist Yuki Masujima wrote in a report on Kuroda’s remarks.

What was surprising to markets is that Kuroda"s unexpectedly hawkish comments had virtually no impact on the market last week; if anything they led to an even weaker Yen, something which on the surface would seem paradoxical; however it was reassuring for the BOJ and could boost arguments in favor of dropping the 80 trillion yen reference point.

Speaking in an interview with Bloomberg in April, Kuroda said the BOJ would keep as a reference point the aim of increasing its holdings of government bonds at a pace of around 80 trillion yen per year. After four years of aggressive monetary stimulus, and with his term set to end in April 2018, Kuroda is still far from his goals while his Federal Reserve counterpart Janet Yellen is taking rates higher and policy makers in Europe debate tapering. These three central banks have all run up huge balance sheets since the financial crisis after buying bonds and other assets.

In an unexpected admission that even central banks are subject to simple math, Kuroda also revealed some of the BOJ’s modeling on balance sheet risks, indicating that a BOJ simulation found that a 100bps increase in long-term yields could mean a valuation loss of ¥23 trillion on its bond holdings, equivalent to a DV01 of roughly a $2 billion.

* * *

And while the the BOJ is quietly tightening ahead of an inevitable official taper which it will have to commence over the next year as it runs out of monetizable private bonds to purchase, the ECB finds itself in a far worse situation as it may have just 4 months before it runs out of eligible German bonds to purchase. According to analyst calculations based on ECB bond-buying data published at the start of May, the European Central Bank bought roughly 400 million euros fewer bonds in Germany in April than its rules allow.

According to ABN Amro"s Kim Liu, in April the ECB deviated from the capital key in Germany by around 400 million euros when excluding corporate and covered bond purchases and adjusting for Greece.

The shortfall raises questions about how close the ECB is to hitting its bond-buying limits in Germany, the euro zone"s benchmark issuer and (at least until now) the deepest and biggest source of bonds under the ECB"s QE program which is currently scheduled to run until the end of 2017.

"It was by far the largest deviation, at least for Germany, and for me suggests that on top of the political stress and smoothing of purchases, there are scarcity constraints for the Bundesbank," said Pictet Wealth Management senior economist Frederik Ducrozet, quoted by Reuters. "What it means is that the ECB has to be very cautious with its exit and if they don"t taper within less than six months (of ending the programme) something might have to give."

Here"s why:

ECB asset purchases are based on the so-called capital key, meaning the central bank buys a country"s bonds in line with the size of its economy, making Germany the biggest source for the scheme. According to Barclays, if the ECB maintains its buying program as is, it will hit its mandated, 33% ceiling on German Bund holdings as soon as October, or just over 4 months from now.

Furthermore, according to calculations shown previously, based on ECB data in just six months the average maturity of monthly German debt purchases by the ECB has dropped to under five years from more than 10. That suggests that a shortage of longer-dated eligible debt is forcing the Bundesbank, which buys securities on behalf of the ECB, to take advantage of recent rule tweaks to buy more shorter-dated bonds. Reuters adds that while that shift was expected after last December"s change allowing the ECB to buy bonds yielding less than the -0.40% depo rate, "the speed at which the Bundesbank put that to use has taken markets by surprise."

According to ABN"s Liu, "this means that the average maturity of monthly German purchases remains much lower than those of other countries and that the Bundesbank continuously is forced to buy short-dated bonds with yields that are below the ECB"s deposit rate."

Germany is not the first country whose bonds are becoming scarce: the ECB has already deviated from the capital key in Ireland and Portugal, where it is running out of bonds to buy. However, the latter two countries are tiny in terms of supply compared to the budgeted monthly purchases from Germany. The German bond scarcity shows that the ECB would struggle to extend the scheme without further changes to its own bond-buying rules, and one option is simply to raise the 33% self-imposed ceiling, although that would likely require a substantial political intervention, and it would also make the European bond market even more illiquid as the ECB ends up owning half of German bonds.

* * *

For now, the ECB has been lucky: the economic situation in Europe has been improving, with inflation posting a modest pick up, and all signs suggesting that Mario Draghi will be able to taper - not because he wants to but because he has to. Last Monday, ECB board member Yves Mersch said the ECB was close to replacing its negative view on whether the euro zone economy would reach growth targets with a neutral one, providing yet another justification to reducing its unsustainable bond purchases.

As a reminder, in December the ECB already tapered its monthly purchases by €20 billion to €60 billion in April, while money markets price in roughly a 70 percent chance of a rate hike in early 2018.

"The ECB can always get around its rules, it has the flexibility on whether to buy central government or local government or agency debt to fulfill its quotas," said Marchel Alexandrovich, senior European economist at Jefferies. "But the longer QE goes on, the more the ECB will have to think about changing the rules again ... And the issue now is the willingness to carry on with QE."

Indeed, and as for European false dawns, just ask Jean-Claude Trichet and the infamous rate hike of 2011 which launched the most serious leg of the European sovereign debt crisis. Should Europe"s economy turn south again and the central bank be forced to keep or even boost its QE, Mario Draghi bank may suddenly find itself in very big trouble. That, or simply do what the BOJ has been doing for years, and start buying ETFs and single stocks.

One final point: even if all goes according to plan, recall that the only reason stocks are at all time highs, is due to the $250 bilion per month, or $1+ trillion YTD - an all time high - in central bank purchases; purchases which are only thanks to the ECB and BOJ. With both banks now having no choice but to trim their asset monetizations, the outlook for risk assets is anything but good.

"Audit The ECB"? - German Officials Call For Greater Oversight Of Central Bank

With the omnipotence of the world"s central banks suddenly all too evidently exposed as nothing more than "Oz"-like smoke-and-mirrors, it is not just US politicians that are losing faith and calling for more oversight of the most-powerful unelected officials in the world. Handelsblatt reports today that Germany"s federal auditor says The ECB lacks accountability in banking sector oversight and government will work to close that oversight gap.

Handelsblatt reports, citing a parliamentary report it obtained, that the European Court of Auditors is unable to perform an "extensive review" of the bank supervisory functions at ECB. Furthermore, the German Federal Court of Auditors says in a report submitted to the German parliament’s budget committee
Germany should explore all options for closing the oversight gap.

In its report, the federal auditor says bank oversight is an important public function that does not fall under the rubric of central bank independence, noting that national banking regulators like Germany’s used to be fully audited before the ECB took over the responsibility in 2015.

“The federal government should explore all options for closing this oversight gap,” the report said.

The ECB has argued that the European Court of Auditors only has the authority to review the central bank’s efficiency in terms of personnel and budgeting, not its decisions as Europe’s top banking supervisor. The European Court of Auditors has complained in the past that the ECB has used this argument to justify its refusal to turn over some documents for review.

That, according to the German agency, has left a gap in oversight that didn’t exist before 2015, since national regulators in the euro zone tended to be separate from their country’s central banks.

In a statement, the ECB said that it works closely with the European Court of Auditors and has made “a considerable number of documents and explanations available.”

While we fully understand the concerns at the lack of transparency and oversight of Europe"s most powerful entity, it is comewhat ironic that it is the Germans complaining when they just used the "well, it"s not us messing with the currency, the ECB is independent" argument to eschew Trump"s currency war tweets.

We are sure Dragh is not too worried for now, but if this escalates, this is what we would expect him to look like...

EU Taxpayers Brace As Deepening Banking Crisis Means Euro-TARP Looms

Authored by Don Quijones via WolfStreet.com, 

If the ECB scales back stimulus, banks face even greater risk of collapse. But now there’s a new solution

Events are moving so fast in Europe these days, it’s almost impossible to keep up. While much of the attention is being hogged by political developments, including the election in the Netherlands, Reuters published a report warning that the European banking sector may face even higher bad loan risks if the ECB begins to scale back its monetary stimulus programs, something it has already begun, albeit extremely tentatively.

The total stock of non-performing loans (NPL) in the EU is estimated at over €1 trillion, or 5.4% of total loans, a ratio three times higher than in other major regions of the world.

On a country-by-country basis, things look even scarier. Currently 10 (out of 28) EU countries have an NPL ratio above 10% (orders of magnitude higher than what is generally considered safe). And among Eurozone countries, where the ECB’s monetary policies have direct impact, there are these NPL stalwarts:

• Ireland: 15.8%


• Italy: 16.6%


• Portugal: 19.2%


• Slovenia: 19.7%


• Greece: 46.6%


• Cyprus: 49%

That bears repeating: in Greece and Cyprus, two of the Eurozone’s most bailed out economies, virtually half of all the bank loans are toxic.

Then there’s Italy, whose €350 billion of NPLs account for roughly a third of Europe’s entire bad debt stock. Italy’s government and financial sector have spent the last year and a half failing spectacularly to come up with a solution to the problem. The two “bad bank” funds they created to help clean up the banks’ toxic balance sheets, Atlante I and Atlante II, are the financial equivalent of bringing a butter knife to a machete fight. So underfunded are they, they even strugggled to hold aloft smaller, regional Italian banks like Veneto Banca and Popolare di Vicenza, which are now pleading for a bailout from Rome, which in turn is pleading for clemency from Brussels.

What little funds Atlante I and Atlante II have left are hemorrhaging value as the “assets” they’ve been used to buy up, invariably at prices that were way too high (often at over 40 cents on the euro), continue to deteriorate. The recent decision of Italy’s two biggest banks, Unicredit and Intesa Sao Paolo, to significantly write down their investment in Atlante is almost certain to discourage the private sector from pumping fresh funds into bailing out weaker banks.

Which means someone else must step in, and soon. And that someone is almost certain to be the European taxpayer.

In February ECB Vice President Vitor Constancio called for the creation of a whole new class of government-backed “bad banks” to help buy some of the €1 trillion of bad loans putrefying on bank balance sheets. Constancio’s idea bore a striking resemblance to a formal proposal put forward by the European Banking Authority (EBA) for the creation of a massive EU-wide bad bank that, in the words of EBA president Andrea Enria, would “make it much easier to achieve critical mass and to create a well functioning market for (impaired) assets.”

Here’s how it would work, according to Enria (emphasis added):

The banks would sell their non-performing loans to the asset management company at a price reflecting the real economic value of the loans, which is likely to be below the book value, but above the market price currently prevailing in illiquid markets. So the banks will likely have to take additional losses.

The asset manager would then have three years to sell those assets to private investors. There would be a guarantee from the member state of each bank transferring assets to the asset management company, underpinned by warrants on each bank’s equity. This would protect the asset management company from future losses if the final sale price is below the initial transfer price.

One of the biggest advantages of launching an EU-wide bad bank is that it would avoid the sort of public “resistance” that would occur if it was done at a national level, says Enria. Italian lenders would presumably be able to continuing pricing bad loans at or around 40 cents on the euro on average, even though their real value — i.e. the current value priced by the market — is often much lower. The difference between the market price, if any, and the price the banks end up receiving for their bad debt will be covered by Europe’s taxpayers.

If given the green light, the scheme would pave the way to the biggest one-off bail out of European banks in history. It would be Euro-TARP on angel dust, with even fewer checks and balances and much less likelihood of ever recovering taxpayer funds. According to a banker source cited by Reuters, while Germany has not yet endorsed the EBA plan, the EU documents describe the development of a secondary market for NPLs as a priority. According to Enria, the EBA hopes to finalize matters “at the European level” in the Spring.

The documents also include proposals for a wider “restructuring of banking sectors” as states address the NPLs problem. This “could lead to mergers among EU banks after they offload their bad loans,” a banking industry official said.

In other words, EU taxpayers would have to spend potentially hundreds of billions of euros saving yet more banks from the consequences of their own acts and bail out their bondholders and potentially their stockholders too, with funds desperately needed in other areas. Those banks, once saved and their balance sheets cleansed, would then be handed on a platter to much bigger banks. In return, taxpayers would end up with an even more concentrated, consolidated, interconnected financial system that is even more prone to abuse, corruption, and excess.

The ECB’s policy isn’t about creating inflation but about keeping a financial system and a currency union from collapsing upon each other. Read…  ECB Trapped in its Own “Doom Loop” as Inflation Surges

Euro Surges, Bunds Tumble On Report Draghi Considering Rate Hikes Prior To QE End

Update: Reuters chimes in with its own headline, saying the discussion was brief, without broad support.

•  SOME ECB RATE SETTERS RAISED POSSIBILITY OF RATE HIKES BEFORE END QE, DISCUSSION WAS BRIEF, WITHOUT BROAD SUPPORT - SOURCES

* * *

The EURUSD spiked, European stocks faded gains, and German Bund futures tumbled to session lows following B loomberg report that the ECB has discussed whether the central bank can hike rates before the end of QE.

As Bloomberg further adds, ECB policy makers considered the question of whether interest rates could rise before their bond-buying program comes to an end, and notes that the central bank"s Governing Council on March 9 "exchanged views on ways of communicating and sequencing an exit from unconventional stimulus."

That said, Bloomberg"s sources notes that the council didn’t discuss any specific scenario or timeline and hasn’t made any formal decisions on a strategy. An ECB spokesman declines to comment on the rumor. Bloomberg further adds that the ECB Governing Council currently “expects the key ECB interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases.”

While the report may be merely the latest trial balloon to gauge the market"s response, for the now the market is not taking chances, and has aggressively sold off the German bunds, while paring gains on the Stoxx 600 to only 0.2% on the day: Bund futures tumbled to session low of 159.10 on the news, sending the Bund yield to 0.48%, while Schatz futures likewise drop sharply and the Euribor strip steepens in expectation of future ECB rate hikes.

As to the mechanics of just how the ECB hikes rates while continuing to buy bonds, we eagerly look forward to the details.

BIS Admits TARGET2 Is A Stealth Bailout Of Europe's Periphery

While debates over the significance of the Eurosystem"s TARGET2 imbalances may have faded into the background now that sovereign yields in the Eurozone remains broadly backstopped by the ECB"s debt monetization generosity, and fears about an imminent European breakdown fall along the lines of populist votes more than concerns about lack of funding, the BIS has finally chimed in with the truth about what the TARGET2 number really showed.

As a reminder, in mid 2012, financial pundits "discovered" the gaping imbalances building up within the Eurozone, as a result of a huge increase in TARGET2 claims at the Bundesbank, offset by a matched surge in liabilities across the European periphery, most notably Italy and Spain.

At the time, most conventional economists and analysts, especially those based in Europe, and certainly the ECB, said to ignore the divergence as it was irrelevant. Others, such as Hans Werner Sinn, and this site, warned that TARGET2 is a "less than thinly veiled bailout for Europe"s periphery" as the stealth fund flow amounted to a financing of peripheral obligations, illegal under European rules.

Then, at the end of January, it was none other than Mario Draghi who, almost 5 years later, made the first tacit admission that the skeptics were right when he explained to Italian lawmakers that a country could leave the euro zone but only first it would need to settle its debts with the bloc"s TARGET2 (T2) payments system. 

"If a country were to leave the Eurosystem, its national central bank"s claims on or liabilities to the ECB would need to be settled in full," Draghi said in the letter. He did not specify in what currency the "settlement" would have to take place.  Draghi then suggested that Italeave is possible, but only if the peripheral European state were to first pay down its roughly €357billion in obligations.

In other words, the ECB for the first time admitted what we had said earlier, namely that TARGET2 liabilities, far from some synthetic construct as T2"s advocates suggested, were indeed a fungible means to fund the outflows at various peripheral European nations, i.e., a bailout mechanism which however needs to be repaid if a given country had decided that it would no longer need a bailout, tacit or otherwise in the future.

Now, in its latest quarterly report, the BIS analysts Raphael Auer and Bilyana Bogdanova confirm precisely what we speculated, and what Draghi implicitly confirmed in January: that TARGET2 was merely the latest covert means in Europe"s disposal to fund sovereigns without breaching the Eurozone"s anti-state funding clause, to wit:

In the period leading up to mid-2012, T2 balances grew strongly (Graph A, left-hand panel) due to intra-euro area capital flight. At the time, sovereign market strains spiked and redenomination risk came to the fore in parts of the euro area. Private capital fled from Ireland, Italy, Greece, Portugal and Spain into markets perceived to be safer, such as Germany, Luxembourg and the Netherlands.

 

Indeed, during that period, the rise in T2 balances seemed related to concerns about sovereign risk. The blue dots in the centre panel of Graph A show the close relationship between the sovereign credit default swap (CDS) spreads of Italy, Portugal and Spain and the evolution of their combined T2 balance from January 2008 to September 2014. Whenever the CDS spreads of those economies rose, the associated private capital outflows increased their T2 deficit. When the CDS spreads decreased after confidence in the euro area was restored in mid-2012, the capital outflows partly reversed, and T2 deficits dwindled.

This is the BIS" effective admission that absent the T2 system, which provided back door funding as "private capital fled" through the front door, the Eurozone would have collapsed, leading to the end of the Euro, the ECB and imminent currency redenomination or as we explained in 2012, a bailout - whether temporary or not - from Germany - which has the most to lose from a Eurozone failure, in the form of a loan, which as Draghi has since explained, must be repaid should a member state contemplate exiting the common currency.

However, where things get amusing is that while the BIS admits that in 2012 T2 balances were effectively stealth loans, this time around, record imbalances are something far more "benign" according to the Basel-based organization:

TARGET2 (T2) balances are again on the rise. Since early 2015, the T2 balances of euro area national central banks (NCBs) have risen steadily, in some cases exceeding the levels seen during the sovereign debt crisis (Graph A, left-hand panel). However, unlike then, record T2 balances should be viewed as a benign by-product of the decentralised implementation of the asset purchase programme (APP) rather than as a sign of renewed capital flight.

Oh ok, so unlike last time around, the massive IOU funded by Germany - again - is nothing to be worried about because it is simply a byproduct of the ECB"s QE, which of course, is another stealth way of preventing the Eurozone from imploding by keeping interest rates artificially low. At least back in 2012, Europe did not have Mario Draghi suppressing rates by purchasing €80/60billion or so per month, with the ECB"s balance sheet now holding 11% of all corporate bonds in the Euro area. The result was at least a somewhat accurate representation of sovereign risks through record high bond yields. Alas, since then the European bond market has lost all informational relevance as the only trade is whether or not to frontrun the ECB.

The BIS then adds that "the current rise seems unrelated to concerns about the sustainability of public debt in the euro area. The red dots in the centre panel of Graph A show that, between October 2014 and December 2016, there was no relationship between the sovereign CDS spreads of Italy, Portugal and Spain and the evolution of their combined T2 balance."

As the European interbank market is still fragmented, the liquidity does not circulate in the euro area and T2 imbalances grow as the total holdings under the APP accumulate. Indeed, the overall increase in T2 imbalances can be linked closely to the total purchases under the APP (Graph A, right-hand panel). A recent study, which takes into account the precise geography of the correspondent banks of each and every APP security purchase, shows that APP transactions can almost fully account for the re-emergence of T2 imbalances

Well, actually, they are related to concerns of sustainability, however as a result of massive ECB-driven distortions, neither bonds nor CDS are an accurate indicator of sovereign risk. As to whether Europe"s fragmented liquidity system and monetary piping - the reason why according to the BIS T2 balances are currently building up - are sufficient to deem the latest build up as benign...

... we will reserve judgment until the ECB is forced to halt its asset purchase program and perhaps raise rates, leading to the same surge in sovereign bonds yields, not to mention CDS surge, that was the hallmark of the summer of 2012 when T2 imbalances hit their previous all time high. After all, what is the ECB"s QE other than merely the latest means to keep the Eurozone together by keeping rates of peripheral bonds ridiculously low.

We look forward to a similar report by BIS in the year 2022 when it will, once again, admit that conventional wisdom on Target2 was once again wrong.

Germans: 'Yes, Gold IS Money'

Whereas a few years ago countries repatriating their gold seemed to be ‘the hype of the month’, once the dust started to settle, we didn’t hear much about gold repatriations anymore.

At least, until last week, when Germany announced it has been able to accelerate the gold repatriations. Indeed, the country has now repatriated all the gold it wanted to get back from New York and now has to bring just 91 additional tonnes ‘back home’ from Paris.

Source: Bundesbank.de

Once those final 91 tonnes will be back in  Frankfurt, Germany will cut all ties with the custodian in Paris and its gold will remain in the Frankfurt, London and New York vaults, and approximately 50% of the entire inventory of the country will be held inside the country.

What’s really interesting is how hard Germany wanted to emphasize it has received ‘real’ gold and it looks like the Bundesbank wanted to nip some comments in the bud. In fact, the German Central Bank has now promised to release a list of gold bars on Thursday to confirm which bars have been ‘sent home’ by the New York Fed, where the US-based bars were held.

You’d almost start to think the Bundesbank is trying ‘too hard’ to convince the population it really received the yellow metal from New York. If this would indeed be a normal transaction (after all, it should be. ‘You have our gold, please give it back to us!’), why would the Bundesbank be so dramatic about receiving it. The president effectively showcased bars of gold, and showed pictures of the German vault in New York, as you can see on the next image.

Source: Reuters

You’d almost start to think they were surprised to be effectively able to get the gold back! And you’d almost start to think gold is valuable, contrary to the ‘gold isn’t money’ rhetoric after the global financial crisis.

If gold had no monetary value – which is what the central banks really wanted you to believe – why are the Germans making such a fuss about it?

Perhaps because gold IS money, and perhaps because gold remains an insurance policy not only against inflation, as we argued in the past few weeks, but also against political uncertainty. And whilst the appointment of Donald Trump as president of the United States was initially seen as a great decision for the American economy, a lot of the plans the president wanted to execute remain uncertain, and more importantly, unclear.

One of the proposals was to allow companies to repatriate the cash they are holding in overseas subsidiaries back to the USA. The tax income associated with such a repatriation would bolster the US government income, but it would also ‘incentivize’ American companies to invest (a large part of) it in the domestic economy.

That’s a great plan and will undoubtedly have a positive impact on the employment rate and the domestic growth numbers, but investors were probably kinda hoping to see a real ‘plan’ by now.

Source: CME Group

As the Federal Reserve seems to be planning to hike the interest rate again in March (as you can see on the previous chart, the market is pricing in a very small chance to see another rate hike), it’s really interesting to see the market doesn’t believe a single word of this. With a probability of less than 18% to see a rate hike happen, investors seem to be pretty certain it will take a while before we will effectively see a rate hike.

Source: CME Group

Indeed, even for the May meeting date, the market is still estimating a 56% chance the Federal Reserve won’t hike the interest rate, and it’s only after July 2017 the market gives a rate hike a 75% probability to happen.

These are for sure very interesting times, and gold seems to be very strong these days as the tension in world politics remain at an elevated level. And during distressing times, people always fall back on gold as a safe heaven. And so does the Bundesbank.

>>> Read our Guide to Gold and find out how you could use gold as an insurance policy

Secular Investor offers a fresh look at investing. We analyze long lasting cycles, coupled with a collection of strategic investments and concrete tips for different types of assets. The methods and strategies are transformed into the Gold & Silver Report and the Commodity Report.

Follow us on Facebook @SecularInvestor [NEW] and Twitter @SecularInvest

World's Largest Actively Managed-Bond Fund Dumps "Excessively Risky" Eurozone Bank Debt

Back in September, Tad Rivelle, Chief Investment Officer for fixed income at LA-based TCW, said in a note that "the time has come to leave the dance floor", noting that "corporate leverage, which has exceeded levels reached before the 2008 financial crisis, is a sign that investors should start preparing for the end of the credit cycle." Ominously, he added that “we’ve lived this story before.” Five months later, the FT reports that TCW, which is also the US asset manager that runs the world’s largest actively managed bond fund, has put its money where its bearish mouth is, and has eliminated its exposure to eurozone bank debt over fears these lenders are "excessively risky."

In an interview with the FT, Rivelle said the company began to reduce its exposure to debt issued by eurozone lenders following the UK’s vote to leave the EU last June. In the first half of last year TCW, which oversees $160bn in fixed income strategies, had around $2bn invested in European bank debt. This has fallen to less than $500m since the Brexit vote, most of it in UK banks.

Rivelle, who previously was a bond fund manager at PIMCO, said his biggest concern was the number of toxic loans held by eurozone lenders, which amount to more than €1 trilion. Last month Andrea Enria, chairman of the European Banking Authority, said the scale of the region’s bad-debt problem had become “urgent and actionable”, and called for the creation of a “bad bank” to help lenders deal with the issue. Rivelle said: “The [eurozone] banking system [has] a bad combination of negative rates, slow growth and lots of problem non-performing loans. It is inherently prone to a potential crisis should global economic conditions, or European economic conditions, worsen. [These are] the preconditions of a potential banking crisis.”

Continuing his bearish bent, Rivelle added that there is a 50% likelihood of another global recession within the next two years, removing any incentive to invest in the eurozone banking sector within that timeframe. The forthcoming French presidential elections in April, which could see Eurosceptic candidate Marine Le Pen come to power, and the problems facing the Italian banking system, are additional risks for eurozone banks this year.

“[The likelihood of another recession] is an unbearable level of risk for European banks, given they were not recapitalised [following the last financial crisis]. They are over-levered, and you are not well paid to underwrite the risks. We view continental European banks as being excessively risky.”

As the FT adds, other asset managers have acknowledged that political risks in Europe this year, including the French elections and German elections in September, could intensify pressure on eurozone banks. PIMCO owner Allianz has conveniently created the following graphic summarizing just that.

Some other opinions:

Iain Stealey, fixed income portfolio manager at JPMorgan Asset Management, the US investment house that oversees $1.8 trillion in assets, said: “The main [concern] in the eurozone is political risk. We’ve got the French elections in April and May, and the German elections [in September]. At the moment, the market is a little bit risky. [The French elections] could be a risk to eurozone bank debt.”

Amundi, Europe’s largest listed fund house, is considering reducing its exposure to French banks ahead of the presidential election, according to Hervé Boiral, head of European credit at the asset manager.

However, several asset managers highlighted reasons for optimism about Europe’s banking sector, including the likelihood that the European Central Bank will begin to scale back its bond-buying programme at the end of 2017, and potentially raise interest rates next year. The central bank’s record-low interest rate policy has hurt banks’ profitability as they have earned less money against customers’ deposits.

Mr Stealey, whose $2.7bn global bond fund has 5 per cent of its assets invested in European financials, said: “We have been in and out [of eurozone bank debt] over the past year, but at the moment we are looking at it as an opportunity. Overall the European economy is picking up.”

While concern about European exposure ahead of a flurry of political event risks is understandable, it is not quite clear where the capital will be allocated to instead, especially now that Trump"s honeymoon with capital markets is souring (see Dalio, Goldman), and it is possible that the US will become the next source of capital flight at least until such time as much more clarity on Trump"s policy implmentation is available.

Mario Draghi is Mistaken - European Debt is Unsustainable (Video)

By EconMatters

We discuss the European Debt Sustainability issue in this video, and why we believe the European Union breaks up within 5 years. The main tools governments have been incorporating is Relative Currency Devaluation along with Relative Money Printing, all of which are hard to pull off with a Standardized Centralized Approach which is the European Union. We believe all European Banks are Insolvent Right Now, They Just Don`t Know It!

When you factor in what these banks hold on their balance sheets, versus what the correct Mark to Market prices for these assets will be over the next five years; there isn`t enough money to bail these banks out in the European Union. Major haircuts are coming for European Assets, and in Fact lots of Assets across the developed Financial Landscape.

When Markets are in Bubbles, they usually are there through artificial means, just like the credit bubble of 2007, things looking real good should scare the hell out of investors. Ask yourself why things are looking so good? And at what costs to financial stability? In fact six months before the entire Global Financial Market crash in the second half of 2007, markets were at all-time highs, and everything looked rosy. Financial Markets couldn`t have been more mispriced, and wrong about correctly pricing in the appropriate risk. I can tell you that nothing that is going on right now is "Sustainable"!

© EconMatters All Rights Reserved | Facebook | Twitter | YouTube | Email Digest | Kindle    

ECB Lowers Deutsche Bank's Capital Requirements, Allowing It To Pay Bonuses

While Deutsche Bank has had a generally terrible year, with its stock price plunging to all time lows on capitalization (and, at times, liquidity) concerns following the now concluded episode of its RMBS fine which the bank settled last week for roughly $7 billion of which just over $3 billion in actual cash payments, well below Wall Street"s worst case scenario, another far more important open item was whether DB executives and staffers would receive a bonus in a year in which markets seriously wondered if the biggest European bank would get a government bailout.

Here, the the rumormill was in overdrive: in October speculation was rampant was that DB would skip cash bonuses, making payments in shares of non-core units of the bank; other rumors tied bonus payments to the company"s share price, while in yet more rumors, some suggested that DB would cancel or even clawback bonuses for/from former executives.  In any case, had DB not succeeded in settling its RMBS litigation, it was assured that the German lender would not pay any bonuses to anyone.

So now that that particular episode in the bank"s history has been concluded, and the management team got an implicit greenlight to make bonus payments... a new problem emerged: Deutsche would be in further breach of its capital requirement had it made billions in bonus payments.

Fast forward to this morning when the ECB once again rode to the rescue, if not so much of Deutsche Bank the company, then certainly the employees of the German bank, and as Reuters reported overnight, Mario Draghi agreed to lower the minimum capital requirements for Deutsche Bank on Tuesday, "giving the lender more leeway to structure bonus payments and dividends."

Deutsche Bank said the ECB requires it to maintain a phase-in common equity tier 1 (CET 1) ratio of at least 9.51% on a consolidated basis, starting January 2017. This is below Deutsche Bank"s current requirement of 10.76 percent, a threshold the bank cannot fall below this year without having to limit dividends, variable remuneration and coupon payments to holders of Additional Tier 1 instruments, the bank said.

The drop in requirements for 2017 comes after a change in the rules. The ECB now expresses parts of its capital demands as voluntary guidance.

The ECB demanded that, on average, banks hold Core Equity Tier 1 capital, a key measure of their own funds, equal to 8.3% of their risky assets if they are to pay out to staff and investors. Once capital guidance is factored in, the ECB"s demands were stable year on year at 10.1%.

However, as it turns out, when that particular number makes the payment of bonuses impossible, "further revisions" are to be implemented with the blessing of the European Central Bank.