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Friday, January 13

13th Jan - Guest Post: Credit by Macronomics

Guest post by Martin from Macronomics:

Markets update - Credit - Bayesian thoughts

"In the Bayesian (or epistemological) interpretation, probability measures a degree of belief. Bayes' theorem then links the degree of belief in a proposition before and after accounting for evidence. For example, suppose somebody proposes that a biased coin is twice as likely to land heads than tails. Degree of belief in this might initially be 50%. The coin is then flipped a number of times to collect evidence. Belief may rise to 70% if the evidence supports the proposition." - source Wikipedia

Today's analogy refers to our rising degree of belief courtesy of Bayesian statistics but also to the well-studied "optimism bias" which most of us are affected by:
"The ability to anticipate is a hallmark of cognition. Inferences about what will occur in the future are critical to decision making, enabling us to prepare our actions so as to avoid harm and gain reward. Given the importance of these future projections, one might expect the brain to possess accurate, unbiased foresight. Humans, however, exhibit a pervasive and surprising bias: when it comes to predicting what will happen to us tomorrow, next week, or fifty years from now, we overestimate the likelihood of positive events, and underestimate the likelihood of negative events. For example, we underrate our chances of getting divorced, being in a car accident, or suffering from cancer. We also expect to live longer than objective measures would warrant, overestimate our success in the job market, and believe that our children will be especially talented. This phenomenon is known as the optimism bias, and it is one of the most consistent, prevalent, and robust biases documented in psychology and behavioral economics."
Talit Sharot - The optimism bias - Current Biology, Volume 21, issues 23, R941-R945, 6th of December 2011.

But, here we go again, lost in our thought process once more. It is time for a credit market overview, the improved tone in the credit space and following up on our previous Hungarian story with an interesting goodwill write down, courtesy of BayernLB, what a surprise...

The liquidity picture in four charts. ECB Overnight Facility, Euro 3 months Libor OIS spread, Itraxx Financial Senior 5 year index, Euro-USD basis swaps level - source Bloomberg:
While banks are still so far hoarding cash at the ECB's overnight facility earning 0.25% in the process (new reserve period starts on the 18th of January), liquidity picture is improving at least on the Libor OIS spread level, indicating clearly the 30th of November Central banks operation has had its effect on dollar funding issues.

The Credit Indices Itraxx overview, overall a better tone - Source Bloomberg:
Itraxx Financial Subordinate 5 year CDS index falling below the 500 bps level and closing around 480 bps, overall a better tone in the Credit space with a flurry of corporate bonds issuance, Spanish bond auctions, ECB keeping rates at 1% and more. Since the beginning of the year we have seen quite a few issues of Senior Financial Unsecured bonds issuance from core European banks:
Nordea Bank 2.24% 2014 (1 billion euros, quarterly floating) on the 4th of January,
Abn Amro Bank 4.75% 2019 (1 billion euros) on the 4th of January
ING 4.25% 2017 (1 billion euros) on the 6th of January,
UBS 3.125% 2019 (1.5 billion euros) on the 11th of January,
Rabobank 4% 2022 (1.75 billion euros) on the 11th of January,
Standard Chartered 4.125% 2019 (1 billion euros) on the 11th of January.

Itraxx Crossover 5 year index (High Yield gauge) evolution - Source Bloomberg:
The Itraxx Crossover represents 50 companies with mostly high-yield credit ratings. The index decreased by around 21 basis points today to 713 bps.

The most important news reported was by Handelsblatt about the European Banking Authority being likely to postpone the annual stress test for banks initially set up for June and published in 2012. Could it be in order to avoid spoiling the celebration of the London Olympics? It might be more realistically to do with the recent concerns of raising much needed capital in 2012 following the dreadful right issues results of Unicredit which we discussed previously and avoid a dreadful credit crunch for 2012 in the process. Deleveraging bank balance sheets in conjunction with reaching a core tier one capital level of 9% was indeed a recipe for disaster looking at 2012 wall of refinancing (somewhat alleviated by the 36 months LTRO operation conducted on the 21st of December by the ECB).

There is again an interesting disconnect between the move in the 10 year German Bund and the Eurostoxx, a point we touched in our post "Mind the Gap..." - source Bloomberg:
Volatility falling still in the process as shown in the bottom level of the graph displaying 6 month implied volatility and V2X index.

Could the disconnect be different this time?

Flight to quality mode is so far is still on, with Germany 10 year Government bond trending back towards record lows - Source Bloomberg:

One of the indicators we have been following in our various credit conversations has been the spread between 10 year Swedish government yields and German 10 year government yields. It looks like this relationship is coming back following the scary German auction of the 23rd of November (see our post "The song of Roland") - source Bloomberg:

The current European bond picture with some respite for Italy and Spain - source Bloomberg:

Even our CPDO/EFSF is looking healthier in yields term back to the 3% levels - source Bloomberg:

But what made our credit friend and us really chuckle today, following up on our "Hungarian dances" post, was the news regarding BayernLB (Bayerische Landesbank, the second-biggest German state-owned lender) which as reported today by Stefan Wagstyl in his column "beyondbrics" in the Financial Times has effectively been "bloodied in Budapest":

"Germany’s BayernLB said it would report a net loss for 2011 because it was writing down the value of its Hungarian subsidiary, MKB Bank."

Reminding us exactly of what discussed last time around:

"Tracking goodwill impairments will indeed be a necessary exercise in 2012 as they can take a real chunk out of bank earnings in the process."

BayernLB anticipates net loss for 2011 under German accounting standards (HGB) due to Hungarian government actions - press release:
"12 January 2012
Munich - Due to the need to write down the book value of its holding in its Hungarian subsidiary MKB Bank, BayernLB currently anticipates that it will report a net loss for 2011 in its separate accounts under German accounting standards (HGB).

BayernLB is compelled to take this measure because actions by the Hungarian government, to include the extremely high bank levy and recently passed Foreign Currency Conversion Act, have substantially impaired MKB Bank's earnings prospects.

The writedown on the book value of its holding in MKB Bank will have a significant impact on BayernLB's net income under German accounting standards and thus overshadows the positive performance of its operating business with customers.

As a result of the expected loss in the HGB financial statements, BayernLB does not expect to service its equity capital instruments (profit participation certificates, silent partner contributions and BayernLB Capital Trust 1 securities) for financial year 2011.

As things currently stand, it will not be possible for the profit participation certificates and silent partner contributions to avoid sharing the loss. A definitive statement on the amount of the loss participation is not expected to be possible until the financial accounts have been approved at the end of April 2012."

Consequence: Bayern LB Capital Trust (Tier 1 ) Perp call 2017 – 6.2032% - $ 850 million – Isin XS0290135358. Price: 32/34 Down 7 points...

We have to say it again, like we did in our previous conversation and as well in November in our Goodwill conversation:

"Tip for “banks’ friends”: First came dividends cuts, then bonds haircuts. Next, we will see some massive write-off (Goodwill ?). UniCredit started, others will follow. The path will be very painful for both shareholders and bondholders."

So effectively, BayernLB equity capital instruments holders can kiss their coupon goodbye...

And my good credit friend to comment:

"And this kind of event will affect much more banks than expected by the market. I expect Austrian banks to make similar announcements very soon, with potential worse consequences considering their position in Central Europe."

EUR/HUF currency levels - source Bloomberg:
We were in agreement with Deutsche Bank in our last conversation:

"As a conclusion, we expect events to unfold rather quickly in Hungary. It may come down to a choice between a partial loss of sovereignty in economic management or of a debt restructuring, to be made at the highest political level."

In fact according to Bloomberg, the likely choice seems so far towards partial loss of sovereignty, indeed we argued last time around, we have seen this movie before...

According to Bloomberg:

"London, January 12 (MTI) - There is a "good probability" that the Hungarian government will sign a Stand-by Arrangement with the IMF as early as the first quarter of this year, London-based emerging markets economists said on Thursday.
In its comprehensive 2012 outlook for the CEEMEA region released to investors in London, Morgan Stanley said a two-year programme of 15-20 billion euros would be sufficient to reassure markets about Hungary's funding needs."

But given our current "Bayesian thoughts", and as indicated by Morgan Stanley in the same article:

"We think that the next few months should see Hungary's refinancing risks
fall significantly thanks to assistance provided by the IMF/EU". That said, "we think that even though there are good chances of a deal in the near term, the relationship with the IMF is likely to be rocky to say the least, as long as the current administration is in place... Therefore, the risk of some rift between Hungary and the EU/IMF a few months down the line remains intact", Morgan Stanley said."

So, all in all, we would have to agree with Dr. Constantin Gurdgiev, from his latest post entitle "Great Moderation or Great Delusion":

"when investors "infer the persistence of low volatility from empirical evidence" (in other words when knowledge is imperfect and there is a probabilistic scenario under which the moderation can be permanent, then "Bayesian learning can deliver a strong rise in asset prices by up to 80%. Moreover, the end of the low volatility period leads to a strong and sudden crash in prices."

And to use a baseball analogy from our Americans friends, don't try stealing third base in this market environment!

"Information: the negative reciprocal value of probability."
Claude Shannon

Stay tuned!