The problem that Steinhoff poses for both QE and the ECB

Yesterday ECB President Mario Draghi was in bullish mood and in some ways why not as the economy of the Euro area has had a good 2017. He was also able to spread some Christmas cheer by raising the economic growth forecasts.

Draghi: GDP projections: 2.4% in 2017 [2.2% in Sept], 2.3% in 2018 [1.8%], 1.9 in 2019 [1.7%] and 1.7% in 2020

However there was an issue which gave a sour note to proceedings and it came from a topic I looked at on the 7th of this month which is the saga of Steinhoff holdings.

The initial response was one of deflection.

Your second point about the bonds, well, first of all let me say that this programme is one of our policy tools that we consider important – very important – for the attainment of our mandate.

Sadly this remained unchallenged because if you reduce corporate bond yields there is a long and winding road at best to you achieving an inflation target of 2% per annum. This from the ECB August Economic Bulletin is derisory in some respects.

 In pursuing its objective of maintaining price stability, the ECB is mandated to act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources.

How is favouring larger companies by allowing them to fund more cheaply and perhaps for bigger amounts “free competition”? Smaller companies would not consider it to be like that. If you look at the data the issue of an “open market economy” is called into question as well.

CSPP holdings stood at €92 billion as at 7 June 2017, corresponding to around 11% of the CSPP-eligible bond universe.

As the holdings are now 130.2 billion Euros then presumably it owns over 15% now. At what point are markets not open? Also and something that is relevant to the current problem is that the biggest gainers have been companies who are at the riskiest end of the investment grade spectrum. If we allow for an anticipation effect then five-year yields for BBB- companies have fallen from over 3% to more like 1%.  Thus a side -effect is that nearly all the “yield for risk” if I may put it like that has been removed from the “open market” here. Here is a crux of the matter which is that the ECB is subsidising such companies which opens quite a few dangers.

If we return to Mario Draghi we were told this.

 The scope of the programme is not to maximise profits or to avoid losses, so let’s keep this in mind. Having said that, running such big corporate programmes, it’s not unusual that losses may be happening.

Indeed it is going well.

Certainly we have a risk framework which has served us very, very well since the beginning of the existence of the ECB.

Or maybe not.

Certainly if we need to draw lessons we’ll do – we’ll certainly draw lessons from this experience. We are always open to improve, but as I said it’s been very, very good. Also as soon as we got news, we stopped buying.

I should think they did stop buying! “As soon as we got news” is quite a confession if you think about it. Also institutions regularly claim to draw lessons whereas in fact it is a type of kicking it into the long grass tactic as the media hounds move on and the perceived crisis passes.

Next in the deflection playbook is to rubbish existing reports.

Also let me add that the losses that had been reported are by and large exaggerated by a factor of 10 with respect to the actual measure of the losses.

You may note that no actual figure was mentioned in spite of this claim.

 we are different because we are much, much more transparent about our programme.

Anyway the losses are really not very important.

But having said that, having said all this, the losses are there. They are not realised and so the issue is, who’s going to pay for these losses? The answer is that these losses really represent a small digit factor number of our €1.6 billion net interest income we produced last year.

Number Crunching

It looks as though someone has leaked something as the Financial Times is reporting this.

The ECB this year bought parts of a €800m bond issued by Steinhoff and is thought to hold about €130m. The bond is due to mature in early 2025 and has a coupon of 1.875 per cent. The bond was acquired by Finland’s central bank as part of the ECB’s bond-buying programme.

So no Chianti special reserve for the Governor of the Bank of Finland at the ECB Governing Council Christmas party just tap water.

Let me correct a mistake I have made which is that losses and profits in this programme are fully shared by the national central banks as it is part of the 20% below.

The ECB is committed to the principle of risk-sharing, and that’s why 20% of the purchases fall under the regime of full risk-sharing.

Steinhoff

The news here goes from bad to worse.  From the FT.

Steinhoff on Wednesday night announced that the accounting irregularities are not only confined to the most recent fiscal year, which ended on September 30, but reached back into the previous one. “The 2016 consolidated financial statements will need to be restated and can no longer be relied upon,” the company said. On Thursday, Mr Wiese tendered his resignation from the board.

As I type this the share price is 8.4 Rand in Johannesburg a far cry from the 45.65 Rand on the 5th of December and nearly 6% lower today alone.

Ratings Agencies

Who could possibly have expected this?

Bankers said that they were caught off-guard because Steinhoff had enjoyed an investment grade rating from Moody’s. ( FT)

The lesson of the credit crunch era that ratings agencies were if not obsolete holed below the waterline seems to have bypassed not only the ECB but the banks.

Wall Street banks including Bank of America and Citigroup are facing potential losses of more than €1bn on loans made to the billionaire backer of Steinhoff International, the South Africa-based home retailer whose shares collapsed last week after disclosing accounting irregularities.  The banks lent €1.6bn to then Steinhoff chairman Christo Wiese in September 2016, which was secured against €3.2bn worth of Mr Wiese’s shares in the company, according to public documents issued by Steinhoff.

As you can see the highly paid banking analysts have been wrong-footed again, will they bear the sort of responsibility those lower in the pecking order would face? It seems unlikely as after all with a central bank having made a mistake too they may step away from the area. Also banks will make mistakes with their lending but the stand out issue here has been summarised well by a reply to the FT.

Another “wizzkid shop owner” has put all their money in his wife’s name in a unfathomable legal system of a third world country.

There was another warning which is  that my late father regularly used to warn me that whilst some companies genuinely go on buying sprees others do so to cover up existing problems.

Comment

There is a lot to consider here as we mull the official ECB line.

Since the financial crisis of 2008, the ECB has adopted a number of unconventional policies that prompted critics to warn that it was about to incur huge losses. The fact is that, ever since its inception, the ECB has continued to make profits

The problem with that is the fact that it has in general been able to enforce this. For example Greece was forced to repay its bonds at par (100) when some form of default would have been far better for it. So the ECB made profits but Greece got more debt. This got so bad that the ECB in fact returned “profits” to Greece. In terms of other purchases it is still buying so newer buys make sure older buys make paper profits. When it comes to sell these bonds there may be a different story.

A four-stage process may apply.

1. There is nothing to worry about we are making profits.
2. Something may be happening and we will look into it and learn the lessons..
3. Maybe we should do something but that is both difficult and dangerous to financial stability.
4. Perhaps we should have done something but it’s too late now.

Meanwhile there is the issue of subsidising what may be zombie companies and worse. Also markets become ever more controlled and there is a clear bias away from  smaller companies to larger ones ossifying the economic system.

This issue will pop up with other central banks as for example the equity holdings of the Bank of Japan look good partly because it keeps buying. We will learn more when it stops. Also the Bank of England holds bonds on the troubled Maersk which may yet hit trouble although its new “improved” website may hide this.

Update 12.20 pm

Sometimes you really couldn’t make it up.

Can't stop laughing. Today, the #EBA published a full list of 16 572 EU Low Default Risk counterparties. (Yes, I know, why am I even looking at this ?!). Right there in the middle of the list: #Steinhoff. LOL

— JohannesBorgen (@jeuasommenulle) December 14, 2017