matisse capital management

Rearranging Creditor Priority for Ireland's Banks

Courtesy of  Ireland's Credit Institutions Bill of 2010.  In an ordinary business failure, the shareholders are unsecured creditors and lose their investment first, followed by subordinated creditors and un-subordinated creditors (in the case of a bank these are typically the bondholders).  The latter are the most likely to be made whole, or partially whole, on their investment.  However, because Ireland's bank bail out involved the government buying large quantities of bank shares before losses were recognized, the Credit Institutions Bill of 2010 may permit the reversal of the normal priority ofcreditors in a bank failure.  This would protect government owned shares in Ireland's banks.  Under the new law, subordinated creditors may now be zeroed out before shareholders, at the election of the Minister of Finance, see the article in the Financial Times.

Spain's Economy Is Key to Eurozone Solvency

It might be too big to bailout.  The PIIGS have faced tough economic times of late and today Ireland announced a €85 billion rescue package.  This will be combined with an austerity plan and an increase in value added tax to 23%.  Like Ireland, Spain is facing rising unemployment and a property bubble, but the assets of the country's banking system are estimated at €3.5 trillion, one third larger than Ireland, Greece and Portugal combined.  As the Wall Street Journal argues Spain may be too big to bail out.  Consider Spain's GDP as a share of euro zone GDP:

 

 

 

 

 

 

 

 

 

Also, per the WSJ: "(consider) Spain’s relatively modest gross government debt, which the IMF figures will come in at 63% of GDP this year, against Portugal’s 83%, Ireland’s 94%, and Greece’s astonishing 130%. Economists reckon once the debt to GDP ratio breaches around 90%, financial crisis and default become exponentially more likely."  The article continues to note Spain's growing financial problems: 

The Partitioning of Anglo Irish Bank

Anglo Irish Bank Now  =  Deposit Savings Bank  + Asset Bank for Troubled Loans

The bank has been dividend into two, given the extent of its troubled loans, which apparently far exceeded the original estimates of the National Asset Management Agency (NAMA).   The deposit savings bank will operate as a retail bank while the “asset recovery bank” will take over €38 billion in loans that are not being transferred to Nama, Ireland's "bad bank."  The retail bank will have €54 billion in deposits while the asset bank will be wound down over 15 years (an estimate).  More details here.

Dallas Fed: The Real Federal Funds Rate Is Negative

-1.59% in August 2010.  In finance, the real interest rate is equal to the nominal interest rate minus inflation.  According to the Dallas Fed, the real federal funds rate has been in negative territory since early 2008, when it was lowered to 2.0%.  Negative real interest rates are bad for savers and a disincentive for investing in financial instruments.  They can also be viewed as an unhealthy subsidy for borrowing and consumption - in essence, the lender is subsidizing consumption, as they are losing ground to inflation on repayment.   This may be necessary in a slow economy, but it is an unsustainable position in the long term.  Chart below:

 

 

Royal Bank of Canada Stumbles in the Third Quarter

Q3 profit was down 18%.  For along time Canada's banks seemed to be the only ones bucking the down-trend, but that may have changed.  Royal Bank (RY) missed analysts earnings expectations by 15%.  Bank of Montreal also missed analyst expectations when it reported earnings on Tuesday.  In the third quarter, RY's results were as follows (disclosure: I am long RY):

• Earnings per share of C$0.84 versus the C$1.02 consensus.
• RBC Capital Markets trading profit was down 64%, due to lower trading revenues.
• The international banking division (which includes US operations) lost C$76 million for the quarter.

Seven EU Banks Fail the Tier 1 Capital 'Stress Test"

Their Tier 1 capital could fall below 6%, if there were another recession.  This would make them vulnerable to further economic declines, per the NYT.  A total of 912 banks were tested. The Tier 1 requirement in the EU is only 4%, however the regulators analyzed the ability of banks to withstand further recessions and still maintain a Tier 1 Ratio above 6%.  The banks that failed were Hypo Real Estate in Germany, Banca Civica in Spain, ATE Bank in Greece, Diada in Spain, Unnim in Spain, Espiga in Spain and CajaSur in Spain, as illustrated below:

NAMA Transfers Second Tranche from Ireland's Banks

At an average discount of 48%. The National Asset Management Agency (NAMA) is Ireland's "bad bank," created in late 2009.  NAMA applies to six major financial institutions covered by the Irish government's deposit guarantee scheme.  The troubled assets of these banks (primarily commercial real estate) will be purchased by using government bonds;the banks will then be able to sell these bonds to raise cash to improve their Tier One ratios.  The troubled assets are transferred to NAMA at "long term economic value," which is higher than their market value, but far below nominal book value.  The discount was originally estimated to be 30%, but is now much higher.  The second tranche of assets transferred is listed below by bank:

 

Failed Banks: May and June Edition

17 failures from May 1 through June 4.  The largest of these were Tier One Bank of Lincoln, Nebraska, and Midwest Bank and Trust Company of Elmwood Park, Illinois.  Tier One had $2.8 billion in assets and was closed June 4.  Great Western Bank, of Sioux Falls, South Dakota will assume its deposits.  Midwest Bank and Trust Company had $3.17 billion in assets and was closed May 14.  FirstMerit Bank, National Association, of Akron, OH will assume its deposits.  You can view a list of all the bank closures since January 2010 here at the FDIC's Failed Bank List.  Below are banks that were closed in May and June, click to enlarge:

 

Countries with the Highest Exposure to Greek Debt

From the Peterson Institute for International Economics, the countries that have the most to lose if the debts of Greece are restructured and the principal cut.  France, Luxembourg and Germany are at the top.  Here's the full list; click to enlarge:

WaMu: Where's the Accountability?

The same could be asked of several mortgage lenders.  From todays NYT: "New documents released by a Senate panel show how entrenched Washington Mutual was in fraudulent and risky lending, and highlighted how its top executives received rewards as their institution was hurtling toward disaster...Loan officers received more money for originating higher-risk loans, and loan processors were rewarded for speed and volume, rather than quality, the Senate panel found. Loan officers and sales associates were paid even more if they overcharged borrowers through points or higher interest rates, or included stiff prepayment penalties in the loans they issued..."