The ECB faces problems from the Euro area banks as well as fiscal policy

This morning has brought us up to date on the state of play at the European Central Bank. Vice President De Guindos opened his speech in Frankfurt telling us this about the expected situation.

The pandemic crisis has put great pressure on economic activity, with euro area growth expected to fall by 8% in 2020. ……The tighter containment measures recently adopted across Europe are weighing on current growth. With the future path of the pandemic highly unclear, risks are clearly tilted to the downside.

So he has set out his stall as vaccine hopes get a relatively minor mention. Thus he looks set to vote for more easing at the December meeting. Also he rather curiously confessed that after 20 years or so the convergence promises for the Euro area economy still have a lot of ground to cover.

The severity of the pandemic shock has varied greatly across euro area countries and sectors, which is leading to uneven economic developments and recovery speeds……..And growth forecasts for 2020 also point towards increasing divergence within the euro area.

Looking ahead that is juts about to be fixed, although a solution to it has been just around the corner for a decade or so now.

The recent European initiatives, such as the Next Generation EU package, should help ensure a more broad-based economic recovery across various jurisdictions and avoid the kind of economic and financial fragmentation that we observed during the euro area sovereign debt crisis.

He also points out there has been sectoral fragmentation although he rather skirts around the issue that this has been a policy choice. Not by the ECB but bu governments.

 Consumers have adopted more cautious behaviour, and the recent tightening of restrictions has notably targeted the services sector, including hotels and restaurants, arts and entertainment, and tourism and travel.

Well Done the ECB!

As ever in a central banking speech there is praise for the central bank itself.

Fiscal support has played a key role in mitigating the impact of the pandemic on the economy and preserving productive capacity. This is very welcome, notwithstanding the sizeable budget deficits anticipated for 2020 and 2021 and the rising levels of sovereign debt.

This theme is added to by this from @Schuldensuehner

 Jefferies shows that France is biggest beneficiary of ECB’s bond purchases. Country has saved €28.2bn since 2015 through artificial reduction in financing costs driven by ECB. In 2nd place among ECB profiteers is Italy w/savings of €26.8bn, Germany 3rd w/€23.7bn.

Care is needed as QE has not been the only game in town especially for Greece which is on the list as saving 2,2 billion Euros a year from a QE plan it was not in! It only was included this year. But the large purchases have clearly reduced costs for government and no doubt makes the ECB popular amongst the politicians it regularly claims to be independent from. But there is more.

While policy support will eventually need to be withdrawn, abrupt and premature termination of the ongoing schemes could give rise to cliff-edge effects and cool the already tepid economic recovery.

It is a bit socco voce but we get a reminder that the ECB is willing to effectively finance a very expansionary fiscal policy. That is why it has two QE programmes running at the same time, but for this purpose the game in town is this.

 The Governing Council will continue its purchases under the pandemic emergency purchase programme (PEPP) with a total envelope of €1,350 billion.

There was a time when that would be an almost unimaginable sum of money but not know as if government’s do as they are told it will be increased.

The purchases will continue to be conducted in a flexible manner over time, across asset classes and among jurisdictions.

Oh and there is a bit of a misprint on the sentence below as they really mean fiscal policy.

This allows the Governing Council to effectively stave off risks to the smooth transmission of monetary policy.

The Banks

These are a running sore with even the ECB Vice President unable to avoid this issue.

The pandemic has also weighed on the long-term profitability outlook for banks in the euro area, depressing their valuations. From around 6% in February of this year, the euro area median banks’ return on equity had declined to slightly above 2% by June.

Tucked away in the explanation is an admittal of the ECB’s role here so I have highlighted it.

The decline in profitability is being driven mainly by higher loan loss provisions and weaker income-generation capacity linked to the ongoing compression of interest margins.

The interest-rate cuts we have seen hurt the banks and this issue was exacerbated by the reductions in the Deposit Rate to -0.5% as the banks have been afraid of passing this onto the ordinary saver and depositor. Thus the Zero Lower Bound ( 0%) did effectively exist for some interest-rates.

This is in spite of the fact that banks have benefited from two main sweeteners. This is the -1% interest-rate of the latest liquidity programmes ( TLTROs) and the QE bond purchases which help inflate the value of the banks bond holdings.

Then we get to the real elephant in the room.

Non-performing loans (NPL) are likely to present a further challenge to bank profitability.

We had got used to being told that a corner had been turned on this issue even in Italy and Greece. Speaking of the latter Piraeus Bank hit trouble last week when it was unable to make a bond payment.

The non-payment of the CoCos coupon will lead to the complete conversion of the convertible bond, amounting to 2.040 billion euros, into 394.4 million common shares.

It is noted that the conversion will not involve an adjustment of the share price and simply, to the 437 million shares of the Bank will be added another 394.4 million shares at the price of 0.70 euros (closing of the share at last Friday’s meeting). ( Capital Gr).

There is a lot of dilution going on here for private shareholders as we note that this is pretty much a nationalisation.

The conversion has one month after December 2 to take place and the result will be the percentage of the Financial Stability Fund, which currently controls 26.4% of Piraeus Bank, to increase to 61.3%.

Meanwhile in Italy you have probably guessed which bank has returned to the news.

LONDON/MILAN/ROME (Reuters) – Italy’s Treasury has asked financial and legal advisers to pitch for a role in the privatisation of Monte dei Paschi BMPS.MI as it strives to secure a merger deal for the Tuscan lender, two sources familiar with the matter told Reuters on Friday.

The equivalent of a Hammer House of Horror production as we mull how like a financial vampire it keeps needing more.

Italy is seeking ways to address pending legal claims amounting to 10 billion euros (£9 billion) that sources say are the main hurdle to privatising the bank.

Even Colin Jackson would struggle with all the hurdles around Monte dei Paschi. Anyway we can confidently expect a coach and horses to be driven through Euro area banking rules.

If we look at the proposed solution we wonder again about the bailouts.

Although banks have stepped up cost-cutting efforts in the wake of the pandemic, they need to push even harder for greater cost efficiency.

So job losses and it seems that muddying the waters will also be the order of the day.

The planned domestic mergers in some countries are an encouraging sign in this regard.

A merger does reduce two problems to one albeit we are back on the road to Too Big To Fail or TBTF.

There is of course the ECB Holy Grail.

Finally, we also need to make progress on the banking union, which unfortunately remains unfinished. Renewed efforts are urgently required to improve its crisis management framework.

Just as Italy makes up its own rules….

Comment

We are now arriving at Monetary Policy 3.0 after number one ( interest-rates) and number two ( QE) have failed to work. In effect the role of monetary policy is to facilitate fiscal policy. It also involves a challenge to democracy as the technocrats of the ECB are looking to set policy for the elected politicians in the Euro area. However there are problems with this and somewhat ironically these have been highlighted by the Twitter feed of the Financial Times which starts with an apparent triumph.

Italy’s bond rally forces key measure of risk to lowest since 2018

So on a financial measure we have convergence. But if we switch to the real economy we get this.

‘There is no money left’: the pandemic’s economic impact is ‘a catastrophe’ for people in southern Italy who were already in a precarious situation

Switching to the banks we are facing the consequences of the Zombification of the sector as the same old names always seem to need more money. Although there has been more hopeful news for BBVA of Spain today albeit exiting the country where banks seem to be able to make money.

PNC to buy U.S. operations of Spanish bank BBVA for $11.6 billion ( @CNBC )

Although the price will no doubt if the speech above is any guide will be pressure to give a home to a Zombie or two.

Podcast

 

 

 

Hard times for the economy and banks of Spain

We have an opportunity to peer under the economic bonnet of one of the swing states in the Euro area. We have seen Spain lauded as an economic success followed by the bust of the Euro area crisis and then it move forwards again. But 2020 has proven to be another year of economic trouble and that theme has been added to by this morning’s data release.

The monthly variation of the seasonally and calendar adjusted general Retail Trade Index (RTI)
at constant prices between the months of September and August, stood at −0.3%. This rate was 1.7 points lower than the previous month. ( INE)

So we have a fall when if we follow the official view of recoveries from the pandemic we should be seeing the opposite. Then we note that relative to August there has been a much larger decline. The breakdown is below.

By products, Food remained the same (0.0%) and Non-food products declined by 0.6%. If the latter is broken down by type of product, Household equipment decreased the most (−3.7%).

The one category which rose was personal equipment which was up 2.3%.

If we switch to the annual picture we see this.

In September, the General Retail Trade Index, once adjusted for seasonal and calendar effects, registered a variation of −3.3% as compared with the same month of the previous year. This rate was four tenths lower than the one registered in August.

In a by now familiar pattern car fuel sales are down by 9.2% and after them the breakdown is as follows.

If these sales are broken down by type of product, Food
decreased by 2.7%, and Non-food products by 3.1%.

So unlike in the UK the Spanish are not eating more. After the news we have looked it sadly it is no surprise that jobs are declining.

In September, the employment index in the retail trade sector registered a variation of −3.0%
as compared to the same month of 2019. This rate was three tenths above that recorded in August. Employment decreased by −4.9% in Service stations.

If we look at the structure of the sales we see that small chain stores have been hit hard with sales down 14.3% on a year ago meaning they are only 88.3% of what they were in 2015. There has been a switch towards large chain stores who are 2.4% up in September on a year ago and some 17% up on 2015.

Looking at the overall picture the “Euro Boom” has pretty much been erased as we note that retail sales in September are only 2.2% above 2015. These numbers are not seasonally adjusted and may give the best guide because if there has been a year not fitting regular patterns this is it. We get another clue from the numbers from the Canary Islands where volumes are 13.5% below a year ago and the overall index is at 87,5. I am noting that because it gives us a proxy for the tourism effect, or in this instance the lack of tourism effect. Regular readers will recall we feared that this would be in play when the Covid-19 pandemic started and we can see that it has.

Housing Market

The Bank of Spain and the ECB would of course have turned to these figures first.

The number of mortgages constituted on dwellings is 19,825, 3.4% less than in August 2019. The average amount is 134,678 euros, an increase of 4.0%.

They will have been disappointed to see the number of mortgages lower but pleased to see an increase in mortgage size which offers the hope of more business for their main priority which is the banks and may even offer a hint of house price rises.

One factor of note is that if we look at the remortgage figures we see a different pattern in terms of fixed to floating mortgage rates than we have become used to.

After the change of conditions, the percentage of mortgages
fixed interest increases from 19.0% to 31.2%, while that of variable rate mortgages decreases from 80.4% to 59.7%.

As to house prices these are the most recent numbers.

The annual rate of the Housing Price Index (HPI) decreased one percentage point in the
second quarter of 2020, standing at 2.1%.
By housing type, the rate of new housing reached 4.2%, almost two points below that
registered in the previous quarter

So we still have growth and the central bankers will be happy with an index that is at 126.8 when compared with 2015. Their researchers will be busy enhancing their career prospects by finding Wealth Effects from this whilst nobody asks why all the emails from first-time buyers saying they cannot afford anything keep ending up in the spam folder.

Looking Ahead

Last month the Bank of Spain told us this.

Under these considerations, the economy’s output would fall by 10.5% on average in 2020 in scenario 1, and by up to 12.6% in the event that the less favourable epidemiological situation underlying the construction of scenario 2 were to
materialise. That said, the pickup in activity projected for the second half of this year, following the historic collapse recorded in the first half, would have a positive carry-over
effect on the average GDP growth rate in 2021, which would reach 7.3% in scenario 1, while remaining at 4.1% in scenario 2,

With the pandemic storm clouds gathering around Europe we look set for scenario 2 of a larger decline in GDP followed by a weaker recovery. Also if you are in an economic depression then how long it lasts matters as much as how deep the fall is.

In any event, at the end of 2022, GDP would stand some 2 percentage points (pp) below its pre-crisis level in
scenario 1, a gap that would widen to somewhat more than 6 pp in scenario 2.

It is a bit like wars which are always supposed to be over like Christmas and like a banking collapse where we are drip fed bad news. Speaking of the banks there is plenty of bad news around. We can start with the Turkish situation.

Turkish debt held by European banks via BIS – $64 billion in Spanish banks. – $24 billion, in French banks. – $21 billion, in Italian banks. – $9 billion, in German banks. ( DailyFX )

Then there was also this earlier this week. The Spanish consumer association took th banks to court over past mortgage fees.

Those affected do not need to initiate an individual lawsuit, with the costs and time that this entails, but can directly benefit from the success of the Asufin class action lawsuit.

So, as previously indicated, those 15 million mortgages may recover up to an average of 1,500 euros without the need to litigate. ( El Economista)

I doubt that is the end of the story but it is where we presently stand.

Comment

The situation looks somewhat grim right now and it has consequences.If we look at the labour market we have learned that unemployment as a measure is meaningless so here is a better guide.

Total hours worked would fall very sharply on average in 2020: by 11.9% in scenario 1 and 14.1% in scenario 2. Although the rise in this variable, which began
with the easing of lockdown, would continue over the rest of the projection horizon, the total number of hours worked at the end of 2022 would still be 4.5% and 8.3% lower than before the COVID-19 crisis under scenarios 1 and 2, respectively. ( Bank of Spain)

Also the public finances will be doing some heavy lifting.

.As regards public finances, it is estimated that the general government deficit will increase sharply in 2020, to stand at 10.8% and 12.1% of GDP in each of the two scenarios considered…….Public debt, meanwhile, would increase in 2020 by more than 20 pp in scenario 1 and by
some 25 pp in scenario 2, to stand at 116.8% and 120.6% of GDP, respectively.

Of course debt affordability fears are much reduced when some of your bonds can be issued at negative yields and even the ten-year is a mere 0.17%.

As to the banks the eyes of BBVA and Banco Santander will be on developments in Turkey right now.

Me on The Investing Channel

The banks of Italy face another crisis

2020 has been quite a year and something of an annus horribilis.What such events reveal if we borrow the words of Warren Buffet is those who have been swimming with swimming trunks. If there is a group anywhere in the world that has been doing this it has been the Italian banks who had enough problems before the Covid-19 pandemic started. So much so that at least in one case I am reminded of the famous words of Paul Simon.

Hello darkness, my old friend
I’ve come to talk with you again

Monte dei Paschi di Siena

If there is a bank that deserves that lyric it is Monte Paschi which has had bailout after bailout but still rather resembles the walking dead in banking terms.

MILAN (Reuters) – Italy’s clean-up scheme for Monte dei Paschi di Siena BMPS.MI is set to be approved by shareholders of the state-owned bank on Sunday after two years’ in the planning, but it is unlikely to be enough to attract a buyer.

The last bit raises a grim smile after all nobody wanted Monte Paschi even in what were considered to be the good times of the “Euro boom” so who would want it now? Along the way the Italian taxpayer has taken quite a hammering.

The government rescued Monte dei Paschi (MPS) in 2017, paying 5.4 billion euros ($6.3 billion) for a 68% stake now worth 1 billion euros, which it must sell next year under the terms of the 8.2 billion euro bailout.

I think that rescued is the wrong word as it implies a sort of permanence, whereas the reality has been that Monte Paschi rather like Oliver! is always asking for more. Indeed one route involves the Italian taxpayer taking another hit.

To boost the appeal of the world’s oldest bank still in business, Italy has been working on a scheme to cut MPS’ problem loan ratio below the industry average, offloading 8 billion euros in soured debts to state-owned bad loan manager AMCO.

The repeating problem for Monte Pasch is that it needs more money but getting it from shareholders is shall we say problematic when you have a track record like this.

MPS has been laid low by years of mismanagement, an ill-advised acquisition and risky derivatives deals.

It faces 10 billion euros in legal claims, mostly from disgruntled investors who lost money in a string of cash calls worth 18.5 billion euros in the past decade.

Now if we do some back of the envelope maths we have at least 23 billion Euros lost in the deals above to which is added risk on another 8 billion. Against that we have a bank valued at 1 billion Euros. It was only a few years ago that the then Italian Prime Minister Matteo Renzo told us MPS was a good investment. Surely that must come under the Italian version of the trade descriptions act?

We can also note something of an Alice In Wonderland world.

To authorise the clean-up, which shaves 1.1 billion euros off MPS’ capital and must be completed by Dec. 1, the European Central Bank has demanded MPS raises fresh capital via costly issues of Tier 1 and Tier 2 debt.

MPS paid 8.5% for the Tier 2 issue, and analysts say Additional Tier1 (AT1) debt is a non-starter for a bank that expects to remain loss-making through 2022 and would not be allowed, as such, to pay a coupon on it.

Paying 8.5% for your debt hardly helps your profitability and wait for the original estimates of what it would have to pay on riskier debt.

The ECB has asked the bank to prove that private investors would be ready to buy 30% of a potential Tier1 issue but broker Equita estimated such debt could cost Monte dei Paschi as much as 15% a year, further weakening its finances.

The only way I can see this circle being squared is a new ECB asset purchase programme which will allow investors to buy such debt and then pass it on.

Merger Mania

This is another way of kicking the can if you have a problem. My late father used to argue that many mergers were driven by the reality that such an event makes the accounts pretty opaque for a couple of years. Thus something like this was little surprise.

Intesa Sanpaolo’s public tender offer for UBI Banca shares, launched on February 17, 2020, ended on 30 July, with acceptance by 90.2% of UBI’s shareholders.

Following a five-month process, Intesa Sanpaolo successfully surpassed the two-thirds acceptance by UBI Banca shareholders needed to ensure the merger of UBI into Intesa Sanpaolo.

That really defines bad timing doesn’t it? Whilst it is hard to think of a good time to buy an Italian bank buying this year is bad even on that perspective. But according to Intesa it is something of a triumph.

In a statement following the announcement of the provisional results, Intesa Sanpaolo CEO Carlo Messina said that a new European banking leader had been created.

Messina also underlined that Intesa Sanpaolo has become the first bank in Europe to launch a new consolidation phase that will strengthen the Continent’s banking sector.

Considering the record this looks like very faint praise.

UBI is the best run medium-sized bank in Italy

Putting it another way the Intesa share price went above 2.6 Euros when the deal was announced and is 1.58 Euros now.

Unicredit

This is desperately trying to avoid being a white knight for Monte Paschi. It has enough of its own problems with a share price of 7 Euros which is half that of what it was as recently as February.

Comment

This has been something of a slow motion car crash. I am not surprised that we see legal claims being enacted because whilst the Covid-19 pandemic came out of the blue, it is also true that money has been raised whilst the truth has not been told. The official view of the Bank of Italy from April reflected this.

Italian banks are facing the new risks from a
stronger position than at the start of the global
financial crisis. Between 2007 and 2019, the
ratio of the highest loss-absorbing capital to
risk-weighted assets almost doubled, loans are
now funded entirely by deposits, and there are no
signs of a weakening of depositor confidence in
banks.

There are certainly plenty of signs of weakening shareholder confidence in banks. This comes in spite of the fact that they have been handed another freebie.

#Italy‘s 10-year bond #yield down to new record-low of just 0.79%… ( @jsblokland )

For newer readers Italian banks hold a lot of government bonds ( around 400 billion Euros) so the rise in price driven by ECB buying allows them to sell at a high price or at least to put such prices in their accounts. Although of course they did have a scare earlier in the year after the “bond spreads” statement made by ECB President Christine Lagarde.

We have seen various fund emerge to take on the bad debts and regular readers will recall the private-sector Atlante and Atlante II. The latter got renamed as the Italian Recovery Fund which I think speaks for itself. These days there is a state backed vehicle described by Fitch in May like this.

AMCO is a debt purchaser and servicer with nearly EUR25 billion of assets under management and a leading position in the unlikely-to-pay (UTP) loans sector. While operating at market conditions the government’s backing makes AMCO the reference company for direct or indirect state-led bail-outs of distressed banks.

So with “unlikely-to-pay” we have yet another new phrase and change of language.

What we have seen is in fact the consequence of kicking the can into the future and discovering that the future is worse than the present. We look back on a pile of losses for shareholders and taxpayers for what exactly? At the same time a bus has been driven through Euro area rules.

Another hint of negative interest-rates from the Bank of England

The weekend just gone has provided another step or two in the dance being played out by the Bank of England on negative interest-rates. It was provided by external member Silvana Tenreyro in an interview published by The Telegraph on Saturday night. Perhaps she was unaware she was giving an interview to a media organisation with a paywall but this continued a poor recent trend of Bank of England policymakers making some more equal than others. As a recipient of a public salary interviews like this should be available to all and not some but it is not on the Bank of England website.

As to her views they were really rather extraordinary so let us investigate.

LONDON (Reuters) – The Bank of England’s investigation into whether negative rates might help the British economy through its current downturn has found “encouraging” evidence, policymaker Silvana Tenreyro said in an interview published late on Saturday.

It is not the fact that she may well vote for negative interest-rates that is a surprise as after all she told us this back on the 15th of July.

In June I therefore voted with the majority of the MPC to increase our stock of asset purchases. Lower gilt
yields and higher asset prices induced by QE will lead to some aggregate demand stimulus, although the low
prevailing level of the yield curve may reduce the impact somewhat, relative to some of the MPC’s previous
asset purchase announcements. As with the rest of the committee, I remain ready to vote for further action
as necessary to support the economy and ensure inflation returns to target.

So she voted for more QE ( Quantitative Easing ) bond purchases in spite of the fact that she felt the extra £100 billion would have a weaker impact than previous tranches. This means that with UK bond or Gilt yields continuing to be low and in some cases negative ( out to around 6/7 years in terms of maturity) then in any downturn that only really leaves lower interest-rates. As they are already a mere 0.1% that means a standard move of 0.25% would leave us at -0.15%

Something Extraordinary

I am pocking this out as even from a central bank Ivory Tower it is quite something.

Tenreyro said evidence from the euro zone and Japan showed that cutting interest rates below zero had succeeded in reducing companies’ borrowing costs and did not make it unprofitable for banks to lend.

Let me start with the latter point which is about it being profitable for banks to lend in a time of negative interest-rates. This is news to ECB Vice-President De Guindos who told us this last November.

Let me start with euro area banks, which have been reporting persistently low profitability in recent years. The aggregate return on equity of the sector slightly declined to less than 6% in the 12 months to June 2019. This weak performance is broad-based, with around 75% of significant banks generating returns below the 8% benchmark return demanded by investors for holding bank equity.

He went further that day and the emphasis is mine

The recent softening of the macroeconomic growth outlook and the associated low-for-longer interest rate environment are likely to weigh further on their profitability prospects. Many market analysts are concerned about the drag on bank profitability that could result from the negative impact of monetary policy accommodation on net interest margins. And net interest margins are indeed under pressure.

If we fast forward to last week there is this from Peter Bookvar on Twitter.

A chart of the Euro STOXX bank stock index. Record low. Please stop calling central bank policy ‘stimulus.’ It is ‘restrictive’ if it kills off profitability of banks.

Or there was this.

PARIS (Reuters) – Societe Generale (PA:SOGN) is considering merging its two French retail networks in an attempt to boost profitability, after two consecutive quarterly losses due to poor trading results.

We do not often look at the French banks who have mostly moved under the radar but there is “trouble,trouble,trouble” ( h/t Taylor Swift) here too.

Shares in SocGen were up 1.2% to 11.9 euros at 0843 GMT, just above their lowest level in 27 years of 11.3 euros, after it said the review would be completed by the end of November.

So profitability is fine but share prices have collapsed? I guess Silvana must have an equity portfolio full of banks waiting for her triumph. Remember the ECB is presently throwing money at the banks by offering them money at -1% in an attempt to offset the problems created by negative interest-rates.

Another way of looking at bank stress was the surge in access to the US Federal Reserve Dollar liquidity swaps post March 19th. We saw the ECB and Bank of Japan leading the charge on behalf of banks in their jurisdictions. Intermediaries were unwilling to lend US Dollars to them as they feared they were in trouble which again contradicts our Silvana.

As to companies borrowing costs they have fallen although there have been other factors at play. For example the bond purchases of the ECB will have implictly helped bu lowering yields and making corporate bonds more attractive. Also it has bought 233 billion Euros of corporate bonds which in itself suggests more was felt to be needed. Actually some 289 billion Euros of bank covered bonds have been bought which returns us to The Precious! The Precious!

Tractor Production is rising

Apparently all of that means this.

“The evidence has been encouraging,” she said, adding that cuts in interest rates below zero had been almost fully reflected in reductions in interest rates charged to borrowers.

“Banks adapted well – their profitability increased with negative rates largely because impairments and loss provisions have decreased with the boost to activity and the increase in asset prices,” she said.

This really is the banking equivalent of Comical Ali or in football terms like saying Chelsea have a secure defence.

Comment

The picture here is getting ever more fuzzy. I have no issue with policymakers having different views and in fact welcome it. But I do have an issue with claims that are simply rubbish like the Silvana Tenreyro one that bank profitability has not been affected by negative interest-rates. Even one of her colleagues is correcting what is simply a matter of fact.

BOE’S RAMSDEN: ENGAGEMENT WITH BANKS ON NEGATIVE RATES WILL TAKE TIME……….BOE’S RAMSDEN: RATES ON RETAIL DEPOSITS TEND NOT TO FALL BELOW ZERO WHICH IS RELEVANT IN UK CONTEXT AFTER RING-FENCING…….BOE’S RAMSDEN: I SEE THE EFFECTIVE LOWER BOUND STILL AT 0.1%. ( @FinancialJuice)

However as is often the way with central banks he seems to be clinging to a theory that died over a decade ago.

BOE’S RAMSDEN: I STILL THINK THERE IS LIFE IN THE PHILLIPS CURVE, THE SLOPE MAY HAVE FLATTENED.

Later we will hear from Governor Bailey who only last week was trying to end the negative interest-rate rumours that he had begun. Oh Well!

Still there is one thing we can all agree on.

BOE’S RAMSDEN: THE BURDEN OF PROOF FOR ANY FUTURE RISE IN INTEREST RATES WILL BE HIGH.

Too high…..

Continuing a theme of agreement let me support one part of the Tenreyro interview.

“Flare-ups like we’re seeing may potentially lead to more localised lockdowns and will keep interrupting that V(-shaped recovery).”

Meanwhile these  days the main player are  bond yields making the official rate ever less important. Why? The vast majority of new mortgages are at fixed interest-rates and with fiscal policy being deployed on such a scale they matter directly.

Podcast

The banks are in trouble yet again

This week has opened with what has become a familiar drum beat and bass line. The banks are in trouble again. Or rather what has now been over a decade of trouble has just got worse.

HONG KONG (Reuters) – HSBC HSBA.L and Standard Chartered STAN.L Hong Kong shares dropped on Monday after media reports that they and other banks moved large sums of allegedly illicit funds over nearly two decades despite red flags about the origins of the money.

So this started before the wave of post credit crunch bank bailouts although those two banks were only implicitly rather then explicitly supported. The driver here is explained by Reuters below.

BuzzFeed and other media articles were based on leaked suspicious activity reports (SARs) filed by banks and other financial firms with the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCen).

The revelations underscore challenges for regulatory and financial institutions trying to stop the flow of dirty money despite billions of dollars of investments and penalties imposed on banks in the past decade.

There are all sorts of issues here as we note that the supposedly reformed system has failed again.The reason for the article relating to Hong Kong is that is where the financial week has mainly started with Japan being closed for Respect the Elders day.

The share price impact is as follows.

HSBC shares in Hong Kong fell as much as 4.4% to HK$29.60 on Monday, their lowest level since May 1995. The stock has now nearly halved since the start of the year.

StanChart dropped as much as 3.8% to HK$35.80, the lowest since May 25 this year. The Hang Seng Index .HSI was down nearly 1%.

The two banks noted here have followed a typical path for banks as it was only a few short years ago that there emphasis on China and the Far East was presented as a triumph. Now HSBC has a share price at its lowest for 25 years.

Who are the main players?

According to the ICJJ report it is again a familiar list.

The records show that five global banks — JPMorgan, HSBC, Standard Chartered Bank, Deutsche Bank and Bank of New York Mellon — kept profiting from powerful and dangerous players even after U.S. authorities fined these financial institutions for earlier failures to stem flows of dirty money.

Of these one is picked out.

JPMorgan, the largest bank based in the United States, moved money for people and companies tied to the massive looting of public funds in Malaysia, Venezuela and Ukraine, the leaked documents reveal.

However in terms of scale we have a case of hello darkness my old friend.

In all, an ICIJ analysis found, the documents identify more than $2 trillion in transactions between 1999 and 2017 that were flagged by financial institutions’ internal compliance officers as possible money laundering or other criminal activity — including $514 billion at JPMorgan and $1.3 trillion at Deutsche Bank.

Market Impact

You may not be surprised to learn that my old employer DB is down 6% this morning at 7.19 Euros. This compares to over 16 Euros at various points in the “Euro Boom” of 2017. It also rallied to above 9 Euros in early June presumably buoyed by the subsidy provided by the even better than free money provided by the ECB, For newer readers banks can go to it and borrow money at -1%. This is presently the lowest official interest-rate in the world.

If we switch to the Italian banks there are not many to look at as the falls have been so large that prices now mean little. If we go back to 2015 there were more than a few presenting Unicredit as a triumph of what was then being called Renzinomics. Anyway like so often happens with an Italian bank the around 30 Euros of late 2015 has been replaced by 7.23 Euros now sown 4% or so today.

If we switch to my home country the UK I noted this from @RonnieChopra1

UK economic bellwether, Lloyds Bank shares at 24p – lowest level since 2009.

I am not so sure they are a bell weather anymore but none the less. Barclays are down 6% at 91.5 pence as is Nat West.So the pain is widespread.

Bank of England

The official view is below.

Banks’ capital and liquidity positions have remained resilient through the shock so far.

It is based on this.

The global banking system entered into this shock in a much stronger position than the global financial crisis. Major UK banks and building societies (‘banks’), in aggregate had over three times their pre-crisis common equity Tier 1 (CET1) capital ratios at end-2019.

That is good except as we have been noting from the share prices it is not enough and the ever lower share prices limit the ability of the banks to raise new equity capital. Or of you prefer it becomes ever more expensive for existing shareholders in terms of dilution or weakening of their position.

Also whoever was responsible for this last week is probably hiding down in the darkest recesses of the Bank of England cellar where even the tea trolley fears to go.

Subsequently, the MPC had been briefed on the Bank of England’s plans to explore how a negative
Bank Rate could be implemented effectively,

As it put the UK banks on the back foot before the weekend just in time for the ICIJ news to break.

Neel Kashkari

The President of the Minneapolis Federal Reserve made an interesting speech on this subject last week. He thinks they need more capital.

This analysis shows clearly that large banks should fund themselves with equity of at least 24 percent of risk-weighted assets—up from around 13 percent today. That would maximize the benefit to society and protect taxpayers because, at those levels, banks could cover their own losses.

Also he points out that the US banking sector has grown.

 But the 10 largest bank holding companies in America are around 45 percent larger than they were going into 2008, having grown from roughly $9 trillion to nearly $13 trillion in assets.2

But there has been something very worrying going on.

 In fact, combined, the eight largest global banks headquartered in the United States bought back more than $110 billion of stock in 2019 alone.

ECB

It is hinting at this today.

They said important questions for the review would be to consider how long the Pandemic Emergency Purchase Programme should continue and whether some of its extra flexibility should be transferred to the ECB’s longer running asset-purchase schemes.

More support for the banks?

Comment

If we step back and consider the situation we are facing what looks ever more a fatal mistake bu the establishment. What was supposed to rescue the banks has ended up crippling their ability to make any money. As @Goldmarketgirl put it earlier.

Banks are screaming they need higher rates on longer term loans. Their business models are based on difference between long and short term debt.

For a while this was hidden by the capital gains on their bond portfolio’s especially in Italy where the banks hold a lot of sovereign. The issue that they could never get out in that size has been ended by the purchases of the ECB. But these are one-off and once you have taken them you are back with a struggling business model. That is why the share prices are so poor.

We were promised that in return for the bailouts and all the various subsidies the banks would recover and support the economy. Does anybody still believe that?

As to money laundering this is an ongoing issue that never goes away. There was a large swerve here though because the authorities put the burden of proof on the banks partly because it shifted it from them and partly because bodies such as the Serious Fraud Office are so useless. Perhaps they need the sort of emergency pack suggested by my local council over the weekend.

Podcast

 

Australia sees a GDP plunge whilst it prepares for a trade war

This morning has brought us much more up to date on the state of economic play in a land down under. Even what we have come to call the South China Territories could not keep up its record of economic expansion this year.

Gross Domestic Product (GDP) fell a historic 7.0% this quarter, as the COVID-19 pandemic and the corresponding movement restrictions continued to impact economic activity. The June quarter release records the first annual estimate of GDP for 2019/20, which fell 0.2%,ending Australia’s longest streak of continuous growth, 28 years. ( Australia Statistics)

We find ourselves in curious times as we note two things. Firstly that this is a depression which will only end when output regains the lost ground. Also that a quarterly fall of 7% is a relatively good performance which does question some of the things we keep being told as locked down Australia has done better than the more laissez faire Sweden. Curiously the media seem to be concentrating on this being a recession ( GDP fell by 0.3% in the first quarter) which seems to be quite an under playing of it.

The Detail

We see a familiar pattern of a sharp decline in private demand.

Private demand detracted 7.9 percentage points from GDP, with household final consumption expenditure driving the fall. Public demand partly offset the fall, contributing 0.6 percentage points, as government increased spending in response to COVID-19.

Indeed so much of what has happened was a consumption plunge.

Household final consumption expenditure fell a record 12.1%, detracting 6.7 percentage points from GDP. Household expenditure fell 2.6% for the 2019/20 financial year, the first annual fall in recorded history.

The next bit is intriguing as we have seen elsewhere rises in purchases of food as a type of stockpiling.

Spending on services fell 17.6% reflecting temporary shutdown of businesses and movement restrictions. Spending on goods fell 2.8% driven by record falls in operation of vehicles and clothing and footwear, while spending on food recorded the biggest decline since June 1983.

There was something of a space oddity in the trade data however. One might reasonably think that as China was something of an epicentre for the pandemic then supplying it with resources was not going to be a winner. But net trade provided a boost.

The record fall in imports (-12.9%) was greater than the fall in exports (-6.7%). Imports of goods fell 2.4%, reflecting reduced imports of consumption and capital goods. Imports of services fell 50.5% with travel services falling 98.7% in response to travel bans. Exports of goods fell 3.5%, driven by falls in non-rural and rural goods due to a fall in global demand. Exports of services fell 18.4%, reflecting the travel bans.

Whilst no-one will be surprised at the travel data we know that national accounts struggle to measure services trade with any degree of accuracy. It seems more than a little curious that in a pandemic physical trade was barely affected whereas services and especially imports of services were hammered. If we put the number below back we get close to what Sweden did.

Net exports contributed 1.0 percentage point to GDP

There was another curiosity in the shop.

Health care and social assistance value added experienced its greatest fall since September 1997, down 7.9% in June quarter. The fall was driven by a decline in both private and public health services with reduced demand for medical aids, hospital services and allied health services as face to face visits to practitioners were limited.

The last bit is really rather Orwellian as a reduction in supply is reported as a reduction in demand! This issue of course goes way beyond Australia as whilst some health care areas were flat out others pretty much shut down. It looks quite a mess frankly.

Savings and Wages

There are two separate trends here as some did well.

The household saving to income ratio rose to 19.8%, the highest rate since June 1974. This was driven by the record fall in consumption. Gross disposable income rose 2.2%, driven by an historic 41.6% increase in social assistance benefits, due to both an increase in the number of recipients and additional COVID-19 support payments.

But the wages numbers suggest the well-off may have done okay but the poorest did not. The emphasis is mine.

Compensation of employees fell a record 2.5% this quarter. Average compensation per employee rose an 3.1% this quarter reflecting a compositional shift in the work force with reduced employment in part-time and lower paid jobs.

Reserve Bank of Australia

It seems that the RBA has its eyes on the housing market.

Investment in new and used dwellings fell 7.3% in the quarter due to weakened demand and COVID-19 restrictions, the largest fall since December 2000. ( Australia Statistics)

This is because yesterday it announced new moves to pump it up as it copies the Bank of England.

Under the expanded Term Funding Facility, authorised deposit-taking institutions (ADIs) will have access to additional funding, equivalent to 2 per cent of their outstanding credit, at a fixed rate of 25 basis points for three years. ADIs will be able to draw on this extra funding up until the end of June 2021………To date, ADIs have drawn $52 billion under the Term Funding Facility and further drawings are expected over coming weeks. Today’s change brings the total amount available under this facility to around $200 billion.

The first point is that “banks” are so unpopular now that they have apparently had their name changed to “authorised deposit-taking institutions ” or ADIs. That is curious when we are discussing lending rather than depositing. I see the RBA looking at its impact like this.

There is a very high level of liquidity in the Australian financial system and borrowing rates are at historical lows.

Let us go straight to the heat of the action as the RBA is repeating a policy designed to get mortgage interest-rates lower. We see why it has announced an expansion as we note mortgage rates. Variable rates for new borrowers were 3.5% in July last year and were 2.92% this. So we have two contexts of which the first is that they have not moved much when we consider the Cash Rate was also cut to 0.25% and we are seeing QE (of which more later). Also they are relatively high if we look internationally.

The picture looks better for the RBA if we look at fixed-rate mortgages. If we look at ones for up to three-years we see that it fell over the year to June from 3.43% to 2.3% making fixed-rates look attractive to say the least. Apologies for the way they have one set of numbers for the year to July and another to June but I think we get the picture.

There is a chart comparing these rates with swap rates so the cost of the banks intermediation is in fact 2% of the 2.3%.

Comment

There are some particularly Australian features here. Let me address the issue of a boost from trade via this I spotted from @chigrl

India, Australia and Japan on Tuesday agreed to launch an initiative to ensure the resilience of supply chains in the Indo-Pacific, with the move coming against the backdrop of tensions created by China’s aggressive actions across the region.

The creation of the “Supply Chain Resilience Initiative” was mooted by Japan amid the Covid-19 crisis, which has played havoc with supply and manufacturing chains,  ( Hindustan Times)

I doubt that will be welcomed by Australia’s largest customer and that has clear trade implications.

Next let me return to the RBA. As I am a polite man I will call this quite a cheek.

 Government bond markets are functioning normally, alongside a significant increase in issuance.

In fact they are so normal they had to buy a barrel load…….Oh hang on.

Over the past month, the Bank bought a further $10 billion of Australian Government Securities (AGS) in support of its 3-year yield target of 25 basis points. Since March, the Bank has bought a total of $61 billion of government securities. Further purchases will be undertaken as necessary.

Number Crunching

The Governor of the Bank of England Andrew Bailey will be interviewed by the Treasury Select Committee and I have put in a question request.

With Apple now worth more than the UK FTSE 100 will someone please ask the Governor why he is buying Apple Corporate Bonds?

What else could go wrong for the Banks of Italy?

We are overdue a look at the state of play for an old and familiar friend. Except it is the sort of friend written about by Paul Simon.

Hello darkness, my old friend
I’ve come to talk with you again

It has been like a game of snakes and ladders except without the ladders. Ironically the Deputy Governor of the Bank of Italy chose March 18th as the day to rebut this. Yes the day central bankers around the world were crossing their fingers that the US Federal Reserve was going to step in and rescue the world financial system. That was in line with the time when Prime Minister Renzi told investors that shares in Monte Paschi would be a good investment. Anyway let me hand you over to Deputy Governor Luigi Federico Signorini who wrote to the New York Times to say.

Plenty of evidence points to a substantial strengthening of Italian banks in the recent years.

The collapses? The bailouts? The share price falls?

I must credit him in one regard as it takes a lot of chutzpah to mention “Asset Quality” when discussing the Italian banks. Also the sharper-eyed maybe be wondering where the problem was moved too?

The share of NPLs in banks’ total loans continues to fall, also thanks to large-scale disposals made by a large number of banks.

That game of pass the parcel must have seen the music stop.

Also the ECB had to buy off someone and it is still a lot.

Sovereign exposures. At the end of January banks’ holdings of sovereign bonds amounted to €316 billion, or 9.8 per cent of total assets; in early 2015 they peaked at €403 billion.

Is it rude to point out that with the surge in the Italian bond market ( the ten-year is 1.1%) that the banks have been partially deprived of the one area where they could have made some money?

Profitability. In 2019 the profitability of Italian banks was broadly in line with that of European peers

That bad eh?

The next bit has been highlighted by me in parts.

While the annualized ROE, at 5.0 per cent net of extraordinary components, is still below the estimated cost of equity, benefits are expected from ongoing restructuring and consolidation. The process is especially string among small cooperative banks, and the new framework is expected to strengthen their capacity to attract investors.

As the whole sector is extraordinary I am not sure what excluding it leaves you. Also we have been expecting benefits from “restructuring and consolidation” for a decade now. Finally their ability to attract investors could hardly get much worse…..

Bringing it up to date

On Tuesday the ratings agency DBRS Morningstar took a look. How are the profits our Deputy Governor was so keen on doing?

In H1 2020, Italian banks (UniCredit, Intesa Sanpaolo, Banco BPM, Banca MPS, UBI Banca, Credito
Valtellinese, and BP Sondrio) reported an aggregate net loss of EUR 464 million compared to a net profit
of EUR 6.2 billion in the same period of 2019.

Next we find something really rather familiar from the overall banking saga.

For the time being, the bulk of LLPs ( Loan Loss Provisions ) is still related to Stage 1 and Stage 2 loans, as the relief measures currently in place have been preventing the build-up of new NPLs. However, when these support
measures began to ease, we would expect a more significant migration of Stage 1 loans into Stage 2
(i.e. credit risk has increased significantly since initial recognition) and Stage 3 loans.

So bad loans become sour loans, NPLs and now LLPs. That is revealing in itself. The process leaves the ratings agency worried about next year.

When comparing with some European peers with higher provisioning levels, we consider it
possible that larger provisions may be required for Italian banks, should default rates from performing
loans increase more than expected.

So that’s a yes then.

The situation is complicated as we wait for the government Covid response plays to wind down.

Based on the latest data released by the Bank of Italy, as of July 24, the applications for a debt
moratorium from households and companies reached 2.7 million, up from around 660,000 requests
reported in early April, but not significantly changed compared to end-May and mid-June . The outstanding loans under moratoria amounted to EUR 297 billion, equivalent to around 15% of the total
performing loans at end-2019.

Plus this.

In contrast, we have observed the requests for loans backed by a State guarantee surging remarkably in
the same period. As of August 4, the requests for State-guaranteed loans amounted to over 944,000,
corresponding to a total consideration of around EUR 77 billion, or approximately 4% of the total net
customer loans at end-2019.

I know there are elements of stereotyping here so apologies for that, but can anyone genuinely say that they are not wondering how many of these loans are fraudulent? Like the way the Mafia took control of the extra virgin olive oil market, basically if you bought some from Italy your chances of actually getting it were 50/50.

Here is the explicit view on what is expected to happen next.

Whilst the combination of moratoria and State guaranteed loans represent strong relief measures in the
near term, we still believe that the currently challenging scenario will result in a rise in NPLs starting
from 2021, once the moratoria have expired. We note that in Q2 2020 some of loans under moratoria
moved to Stage 2 from Stage 1.

The Financial Times

It produced a long read on banking and seemed to try to avoid Italy but from time to time it popped up.

Centuries-old national champions Barclays (€17.4bn), Deutsche Bank (€15.6bn) and Italy’s UniCredit (€17.2bn) are collectively worth less than Zoom, the $72bn (€61bn) videoconferencing company founded in 2011.

Unicredit had been presented as a type of national champion and there was also a rather familiar development.

 In July, Italy’s largest retail lender Intesa Sanpaolo succeeded in a €4.2bn hostile takeover of local rival UBI Banca, marking the largest European banking deal since the financial crisis.

Which financial crisis please?

Comment

Let us take a look at what Queen might describe as “you’re my best friend” in this saga which is Monte Paschi. According to Johannes Borgen it plans this.

1) Sell defaulted loans to AMCO (with the EC’s blessing, hum.)

2) Take a capital hit and risk being below cap requirement. 3) But that’s ok, because there will be less loan losses because of the sale of defaulted loans to AMCO

Please hold fire on the issue of there being yet another rescue vehicle for the Italian banks for now and stay with Monte Paschi.

Sounds good? Well, there’s a slight problem here. In H1 2020, Monte took a total 520m€ of loan losses. Of the 520m, only 95m were from defaulted loans. Can anyone explain how the sale to AMCO will significantly reduce provisions? Because I’m missing something here.

In a nurshell that is the Monte Paschi saga because if you go through the numbers you are always missing something and sometimes quite a lot.

Now let me return to the subject of rescue vehicles. Here is a @gianluca1 describing one effort.

In 2016 Ita banks created a fund (Atlante) to help few bad banks clean their loan book from NPLs It was funded by all banks pro rata

Result: catastrophic risk of 2/3 banks was extended to all good banks due to perceived unlimited underwriting of risk of bad banks.

Then there was Atlante2 as well. More recently as he points out there has been Amco.

few years ago…it is the former SGA used to liquidate Banco di Napoli NPL

Fitch Ratings looked at Amco at the end of May and I think we have found someone with a sense of humour.

AMCO is a debt purchaser and servicer with nearly EUR25 billion of assets under management and a leading position in the unlikely-to-pay (UTP) loans sector.

Also.

Support Incentives: Government incentives supporting AMCO are underpinned by the fact that AMCO’s viability is central to its “patient approach” to the management of non-performing loans.

Patient approach sums up the whole episode really……Or to put it another way the can they kicked landed in the middle of the next crisis. I guess it would be like some sort of time warp meaning Apollo 13 landed in the middle of the Covid-19 pandemic.

 

The RBA is financing the Australian government as well as pumping the housing market

It is time for another trip to a land down under as even commodity rich Australia has found its economy affected by the Covid-19 pandemic. It raises a wry smile as I used to regularly reply to the World Economic Forum which periodically trumpeted Australia’s lack of a recession that with its enormous resources that was hardly a surprise and thus meant little about economic policy. However we eventually found something which did create a recession. From the Reserve Bank of Australia earlier.

The Australian economy is going through a very difficult period and is experiencing the biggest contraction since the 1930s. As difficult as this is, the downturn is not as severe as earlier expected and a recovery is now underway in most of Australia. This recovery is, however, likely to be both uneven and bumpy, with the coronavirus outbreak in Victoria having a major effect on the Victorian economy.

I would be careful about saying things are not as bad as expected after the reverse in Victoria if I was the RBA. So let us send our best wishes to those affected there as we note the detailed breakdown of the forecasts.

In the baseline scenario, output falls by 6 per cent over 2020 and then grows by 5 per cent over the following year. In this scenario, the unemployment rate rises to around 10 per cent later in 2020 due to further job losses in Victoria and more people elsewhere in Australia looking for jobs. Over the following couple of years, the unemployment rate is expected to decline gradually to around 7 per cent.

So they are expecting lower falls than in Europe but there is a familiar rebound next year which frankly feels based on Zebedee from The Magic Roundabout rather than any grounding in reality.

Financing The Government

Like so often this is what it boils down too.

At its meeting today, the Board decided to maintain the current policy settings, including the targets for the cash rate and the yield on 3-year Australian Government bonds of 25 basis points.

So even resources rich Australia found itself unable to resist the supermassive black hole pull of ZIRP and central bankers being pack animals. I suspect as I shall explain in a minute they have stopped slightly short of 0% because of fears for the banking sector. But the crucial point we are noting here is the control agenda for the bond market which mimics in concept if not level that applied by the Bank of Japan.

Why does the government need financing? Well there is this.

Government bond markets are functioning normally alongside a significant increase in issuance.

As to how much the Australian Office of Financial Management reinforced this last week.

On the 3rd of July we announced a weekly issuance rate for Treasury Bonds of $4-5 billion, with a weekly rate of issuance for Treasury Notes of $2-4 billion. We are confident this guidance will be reliable until the October Budget; absent of course a sharp unanticipated change in the fiscal position.

The major shift in fiscal policy is highlighted here.

Although to date we have only announced a weekly issuance rate and new maturities, the current plan for gross Treasury Bond issuance this year is around $240 billion.  This will comprise about $50 billion to fund maturing debt and $190 billion of net new issuance.  This is materially higher than the $128 billion issued last year, although almost $90 billion of that was issued in the last quarter.

So a near doubling as they went from not being that bothered about issuing debt.

Less than six months ago the AOFM was rationing issuance to best manage a market maintenance objective.

To a spell when they could not issue at all.

Temporary loss of access to funding markets is certainly something we had thought possible (and indeed likely at some point), but combined with the scale and timing of the increased pandemic financing task it was a more sobering experience than we could have imagined.

They would have been burning the midnight oil before International Rescue arrived.

We will never know how long the market would have taken to recover had the RBA not intervened.

If we return to the RBA statement let me present you with two outright lies.

Government bond markets are functioning normally alongside a significant increase in issuance.

If they are then why is this needed?

The yield has, however, been a little higher than 25 basis points over recent weeks. Given this, tomorrow the Bank will purchase AGS in the secondary market to ensure that the yield on 3-year bonds remains consistent with the target. Further purchases will be undertaken as necessary.

Then the next lie.

The yield target will remain in place until progress is being made towards the goals for full employment and inflation.

Actually it will remain in place until the government no longer needs financing. This may be open ended as we note that the only place which has this ( Japan) only ever seems to do more and never less. The initial salvo in Australia was this.

To date, the Reserve Bank has bought around $47 billion of government bonds ( April 21st)

The Precious! The Precious!

In another example of pack animal behaviour they have pretty much copied and pasted a Bank of England policy.

The Reserve Bank has established a Term Funding Facility (TFF) to offer three-year funding to authorised deposit-taking institutions (ADIs).

So they are avoiding calling them banks. Oh and whilst they get this.

to reinforce the benefits to the economy of a lower cash rate, by reducing the funding costs of ADIs and in turn helping to reduce interest rates for borrowers.

You may note how bank costs are “reduced” whereas it is “helping to reduce” them for others. We know who it will help and it is not these.

The scheme encourages lending to all businesses, although the incentives are stronger for small and medium-sized enterprises (SMEs).

Well not unless they are in the mortgage or house price market. For those unaware of the UK situation when the policies were applied here small business lending did nothing but in a “completely unexpected development” mortgage rates plunged and lending surged.

So far just over 27 billion Australian Dollars have been supplied via this route.

Comment

Much here is familiar as we see a central bank implicitly financing its government and pumping up the housing market too. The RBA must have thought all its Christmases had come at once when the Aussie bond market had trouble at the shorter maturities and it could intervene at a place likely to impact on mortgage rates. It must feel the banks need help or it would have cut the official rate to 0%.

Thus has led to a money supply surge with narrow money going from 909 billion in June of last year to 1260 billion on June of this. Quite a shift for an aggregate which we had noted in the past was going nowhere and at times had fallen.

Switching to external events the Aussie Dollar or as some call it the little battler has been doing well. The trade weighted index which went as low as 49.9 on a day familiar to regular readers but the 19th of March for newer ones is now 61.4. As for influences I guess the relative hopes for the economy are in play as well as this.

Preliminary estimates for July indicate that the index increased by 0.9 per cent (on a monthly average basis) in SDR terms, after decreasing by 0.2 per cent in June (revised). The non-rural and base metals sub-indices increased in the month, while the rural sub-index decreased. In Australian dollar terms, the index decreased by 0.2 per cent in July.

Over the past year, the index has decreased by 12 per cent in SDR terms, led by lower coal, iron ore, LNG and oil prices. The index has decreased by 12.1 per cent in Australian dollar terms. ( RBA earlier today)

So an improvement for the resources base and looking ahead Gold is 7.5% of the index. Although the compilers of the index have just reduced its weight from 8.7% and will now find themselves in the deepest dark recesses of the RBA bunker where the cake trolley never goes.

Back to the banks and their troubles

Tucked away in the Covid news over the past few business days has been one of our longest running themes. The original credit crunch story was one of the banks and their collapse and supposed renewal or as they are officially described these days a state of being “resilient”. On this road we saw interest-rate cuts on a grand scale and then central bank bond buying ( QE) to reduce longer-term interest-rates and bond yields. This was to boost their balance sheet via the assets that they have ( loans to us) which are improved by house prices being higher. Actually it did not work so then we saw the various credit easing policies to more directly support this area. The UK opened with the Funding for Lending Scheme which cut mortgage rates by up to 2% according to the Bank of England. Since then we have seen ever more negative bond yields including in the UK as well as the Euro area providing a direct subsidy to banks via the latest TLTROs offering -1% to qualifying banks. Oh and you qualify basically by being a bank in these circumstances.

Except that in spite of all of that we never really achieved “escape velocity” for the banks. They muddled on continuing to be a milch cow for directors and the like but a corner was always about to be turned on a Roman road and we have all been singing along to Talking Heads.

We’re on a road to nowhere
Come on inside
Taking that ride to nowhere
We’ll take that ride
I’m feeling okay this morning
And you know
We’re on the road to paradise
Here we go, here we go

Perhaps the most extreme example has been the Italian banks which have seen a litany of rights issues, a private-sector bailout ( Atlante) which made the stronger banks weaker. and outright bailouts which ignored Euro area rules. All that can-kicking crunched straight into the Coivid-19 pandemic. But if we return to the UK we have had our own issues.

HSBC

This morning what is our largest bank these days has released its results and we are immediately placed om alert by the use of the word “resilient”.

Our performance in the first half of 2020 was heavily impacted by the COVID-19 outbreak. In Asia, our business was resilient, demonstrating the strength of our operations.

So resilient in fact that profits fell by 65%.

Reported profit before tax fell 65% to $4.3bn, amid higher expected credit losses and other credit impairment charges (ECL) and lower revenue. Reported ECL of $6.9bn were $5.7bn higher than in 1H19

As you can see we have had “bad loans” “sour loans” “non performing loans” and now “ECLs”. Indeed the use of an acronym is an especially worrying portent.

Here is the view of Group Chief Executive Noel Quinn

“We are helping our customers navigate their own path through uncertainty and acting with pace and decisiveness to adapt HSBC to an environment in which no business can afford to stand still.”

I wonder if he had any idea what that means?

Tucked away in his section we do get a snapshot of the economy as we note this.

Lending decreased by $18bn in the first half.
Customers initially drew on new and existing
credit lines in the first quarter in response to
the Covid-19 outbreak, but began to pay these
down in the second quarter as circumstances
changed.

So for all the rhetoric about recovery and banks helping we see that HSBC has in fact retrenched in loan terms. Also we get another insight to the rise in saving we have noted before.

Deposits rose by $93bn in the first
half, as customers increased their cash
reserves and reduced their spending
during lockdown.

This bit is also revealing.

Geopolitical uncertainty could
also weigh heavily on our clients, particularly
those impacted by heightened US-China and
UK-China tensions, and the future of UK-EU
trade relations.

Firstly Brexit is no longer at the top of the list which is both good and bad. But for HSBC we are reminded of its Far Eastern presence and footprint which is also good and bad. The Hong Kong bit is plainly bad right now and as for China well the jury remains out.

Royal Bank of Scotland

Things were so grim here that the only solution was provided by the way that the leaky Windscale nuclear reprocessing plant became the leak-free Sellafield. So let me welcome the Nat West Group which of course is a type of back to the future.

However, NatWest Group has a robust capital position, underpinned by a resilient, capital generative and well diversified business.

( Chief Executive Officer Alison Rose)

This means that they are worried about their capital position and exposure to some areas. There are five key messages about this bank of which one caught my eye.

Focused on generating shareholder value. Committed to resuming capital distributions when appropriate

As a UK taxpayer I note that I was invested in this bank at around £5 and the share price as I type this is £1.06 so I think we as taxpayers should ask them to focus on something else!

The numbers are pretty poor.

H1 2020 operating loss before tax of £770 million and operating profit before impairment losses of £2,088 million.
● Net impairment losses of £2,858 million in H1 2020, or 159 basis points of gross customer loans, resulted in an expected
credit loss (ECL) coverage ratio of 1.72% across the Personal and Wholesale portfolios.

In essence banking is losing money whilst punting the markets or perhaps front running the central banks is doing well.

In comparison to H1 2019, across the retail and commercial businesses income decreased by 9.0% whilst NatWest Markets income excluding asset disposals/strategic risk reduction, own credit adjustments (OCA) and notable items increased by 44.4%.

Lloyds

When it reported last Thursday things looked not so bad for a while.

Trading surplus of £3.5 billion, a reduction of 26 per cent compared to the first six months of 2019, providing still significant
capacity to absorb impairment impacts of the coronavirus crisis

But if you looked further down.

Statutory loss before tax of £602 million and statutory profit after tax of £19 million, both impacted by income
developments and the increased impairment charge. Tangible net asset value per share of 51.6 pence.

Mr and Mrs Market do not seem convinced by that asset value as the share price is 26 pence. Surely this is an enormous opportunity for the directors to invest their own money based on their own published view? In the case of CEO Antonio Horta-Osario his £6.3 million a year would provide a solid boost.

Bank in the real world the hype.

Loan to deposit ratio now 100 per cent, providing significant potential to lend into recovery, with a strong liquidity position

becomes this.

Loans and advances at £440 billion were stable compared to the year end but reduced by £3 billion in the second quarter

Barclays

Rather than go through the figures we can focus on the gap between tangible net assets per share of £2.84 and a share price of £1.01 as I type this.

 

Comment

When all this began the incoming Governor of the Bank of England assured us it would be different this time.

Well, I would just add that, as many of you know, we are still dealing with some of the more painful elements of the consequences of the last crises for small firms, and we don’t want that again, thank you, and there’s a very clear message to the banks-, and, by the way, which I think has
been reflected in things that a number of the banks have already said. So, it’s important to take that into
consideration, that, you know, you have all the resources and all the wherewithal to see through this
issue, the shock, and to support the economy and to support businesses, and that’s a very strong
message.

Many of you may also recall when he said that they could lend 13 times as much to support businesses. Meanwhile the releases above show falls in bank lending.

Yet the blundering goes on.

Nationwide re-joined stalwart lenders such as HSBC to offer 90 per cent deals last month, exclusively for first-time buyers, with an additional condition.

Buyers will need to prove that at least 75 per cent of their deposit has come from their own savings, ruling out deposits that have been gifted entirely from parents.

For a bank the issue is repayments not deposits.

With all this success and resilience we should be……oh hang on.

Podcast

The ECB bails out the banks yet again, the Euro area economy not so much

One of the battles in economics is between getting data which is timely and it being accurate and reliable. Actually we struggle with the latter points full stop but especially if we try to produce numbers quickly. As regular readers will be aware we have been observing this problem in relation to the Markit Purchasing Manager Indices for several years now. They produce numbers which if this was a London gangster movie would be called “sharpish” but have missed the target on more than a few occasions and in he case of the Irish pharmaceutical cliff their arrow not only missed the target but the whole field as well.

Things start well as we note this.

The eurozone economic downturn eased markedly
for a second successive month in June as
lockdowns to prevent the spread of the coronavirus
disease 2019 (COVID-19) outbreak were further
relaxed, according to provisional PMI® survey data.
The month also saw a continued strong
improvement in business expectations for the year
ahead.

As it is from the 12th to the 22nd of this month it is timely as well but then things go rather wrong.

The flash IHS Markit Eurozone Composite PMI rose
further from an all-time low of 13.6 seen back in
April, surging to 47.5 in June from 31.9 in May. The
15.6-point rise was by far the largest in the survey
history with the exception of May’s record increase.
The latest gain took the PMI to its highest since
February, though still indicated an overall decline in
business output.

Actually these numbers if we note the Financial Times wrong-footed more than a few it would appear.

The rise in the eurozone flash Composite PMI in June confirms that economic output in the region is recovering rapidly from April’s nadir as restrictions are progressively eased. ( Capital Economics )

Today’s PMI numbers provide further evidence of what initially looks like a textbook V-shaped recovery. As much as more than a month of (full) lockdowns had sent economies into a standstill, the gradual reopenings of the last two months have led to a sharp rebound in activity. ( ING Di-Ba)

The latter is an extraordinary effort as a number below 50 indicates a further contraction albeit with a number of 47.5 a minor one. So we have gone enormous contraction , what would have been called an enormous contraction if they one before had not taken place and now a minor one. But the number now has to be over 50 as the economy picks up and this below is not true.

Output fell again in both manufacturing and
services, the latter showing the slightly steeper rate
of decline

On a monthly basis output rose as it probably did at the end of last month, it is just that it is doing so after a large fall. The one number which was positive was still way too low.

Flash France Composite Output Index) at 51.3
in June (32.1 in May), four-month high.

For what it is worth the overall view is as follows.

We therefore continue to expect GDP to slump by over 8% in 2020 and, while the recovery may start in the third quarter, momentum could soon fade meaning it will likely
take up to three years before the eurozone regains
its pre-pandemic level of GDP.

Actual Data

From Statistics Netherlands.

In May 2020, prices of owner-occupied dwellings (excluding new constructions) were on average 7.7 percent up on the same month last year. This price increase is higher than in the previous months.

Well that will cheer the European Central Bank or ECB. Indeed ECB President Lagarde may have a glass of champagne in response to this.

 In May 2020, house prices reached the highest level ever. Compared to the low in June 2013, house prices were up by 47.8 percent on average in that month.

Staying with the Netherlands and switching to the real economy we see this.

According to figures released by Statistics Netherlands (CBS), in April 2020 consumers spent 17.4 percent less than in April 2019. This is by far the largest contraction in domestic household consumption which has ever been recorded by CBS. Consumers mainly spent less on services, durable goods and motor fuels; on the other hand, they spent more on food, beverages and tobacco.

If we try to bring that up to date we see that if sentiment is any guide things have improved but are still weak.

At -27, the consumer confidence indicator in June stands far below its long-term average over the past two decades (-5). The indicator reached an all-time high (36) in January 2000 and an all-time low (-41) in March 2013.

Moving south to France we were told this earlier today.

In June 2020, the business climate has recovered very clearly, in connection with the acceleration of the lockdown exit. The indicator that synthesizes it, calculated from the responses of business managers from the main market sectors, has gained 18 points, its largest monthly increase since the start of the series (1980).

The jump is good news for the French economy although the rhetoric above does not match the detail.

At 78, the business climate has exceeded the low point reached in March 2009 (70), but remains far below its long-term average (100).

The situation is even worse for employment.

At 66, the employment climate still remains far below its May 2009 low (73), and, a fortiori, its long-term average (100).

Oh and staying with France I know some of you like to note these numbers.

At the end of Q1 2020, Maastricht’s debt reached €2,438.5 billion, a €58.4 billion increase in comparison to Q4 2019. It accounted for 101.2% of gross domestic product (GDP), 3.1 points higher than last quarter, the highest increase since Q2 2019.

Just as a reminder the UK measuring rod is different and tends to be around 4% of GDP lower. But of course both measures will be rising quickly in both France and the UK.

Comment

Let me now switch to a speech given earlier today by Philip Lane of the ECB.

 Euro area output contracted by a record 3.6 percent in the first quarter of the year and is projected to decline by a further 13 percent in the second quarter. While growth will partially rebound in the second half of this year, output is projected to return to the level prevailing at the end of 2019 only at the end of 2022.

In fact all of that is open to doubt as the first quarter numbers will be revised over time and as discussed above we do not know where we are right now. The forecasts are not realistic but manufactured to make other criteria such as the debt metrics look better than otherwise.

Also there is a real problem with the rhetoric below which is the cause of the policy change which was the Euro area economy slowing.

Thanks to the recalibration of our monetary policy measures announced in September 2019 – namely the cut in our deposit facility rate, enhanced forward guidance, the resumption of net asset purchases under the asset purchase programme (APP) and the easing of TLTRO III pricing – sizeable monetary accommodation was already in place when Europe was confronted with the COVID-19 shock.

As that was before this phase he is trying to hide the problem of having a gun from which nearly all the bullets have been fired. If we cut through the waffle what we are seeing are yet more banking subsidies.

The TLTRO programme complements our asset purchases and negative interest rate policy by ensuring the smooth transmission of the monetary policy stance through banks.

How much well here was @fwred last week.

ECB’s TLTRO-III.4 : €1308bn The Largest Longer Term Refinancing Operation ever………Banks look set to benefit, big time. All TLTRO-III will have an interest rate as low as -1% between Jun-20 and Jun-21, resulting in a gross transfer to banks of around €15bn. Most banks should qualify. Add tiering and here you are: from NIRP to a net transfer to banks!

So the banks get what they want which is interest-rate cuts to boost amongst other things their mortgage books which is going rather well in the Netherlands. Then when they overdose on negative interest-rates they are bailed out, unlike consumers and businesses. Another sign we live in a bankocracy.

Apparently the economy will win though says the judge,jury and er the defence and witness rather like in Blackadder.

An illustrative counterfactual exercise by ECB staff suggests that the TLTRO support in removing tail risk would be in the order of three percentage points of euro area real GDP growth in cumulative terms over 2020-22.

Austria

I nearly forgot to add that Austria is issuing another century bond today and yes I do mean 100 years. Even more extraordinary is that the yield looks set to be around 0.9%.

The Investing Channel