Anthony Peters, SwissInvest strategist
I was out of the office on Tuesday which took me away from the madness of the primary credit markets. The torrent of new issues is extraordinary, as if the end of the world were nigh. Yet allocations remain tight.
It is not only investors who are becoming tired of trying, so are sales people in the investment banks who spend all day running around gathering orders for the books, only to find that their clients are not considered in the carve-up.
One of their number reported to me this morning, in some state of despondency, that he had collected £100,000,000 in interest in the £600,000,000 Telefonica subordinated perpetual issue of yesterday, only to have a miserable and depressing total of £1,000,000 allocated to his clients. If you want to see demotivated people, look no further.
Alas, that little early exchange of information should not distract me from two news items I tripped over while catching up. The first was on Bloomberg News and read “Spain Bad Loan Ratio Climbed to Record 12.7% in September” and the other, also with the help of Bloomberg was “Italy Banks’ Bad-Loan Ratio Rises to Highest Since 1999”.
Having trained in the less glamorous world of retail banking when corporate banking was still predominantly part of the boring stuff, I think I know a thing or two about scheduling bad and doubtful debts and the first is that by the time you determine a debt to be doubtful it is, in most cases, already bad. Hence, reported numbers of bad loans have probably been erring on the side of generous throughout the banking crisis and whatever we are seeing is most likely coming to the surface a year or two later than prudence would have required.
The Spanish bad loan ratio is now running at 12.7% and anyone who suggests that the shift there from recession to growth – net of rounding errors it is still going nowhere – will have a meaningful impact on unemployment and hence credit quality has either no experience of the real lending world or has had far too good a lunch. I remind of the huge completed but unsold housing stock and the knock-on effect into every nook and cranny of the Spanish economy.
In Italy, the figure is a lot lower at 7.5% but this seems to be emanating from the small and medium enterprise sector (SME), the heartland of the Italian economy, where the default rate is running at 13.2%. If lending in this key area of the economy dries up, then any hope of sustainable growth and hence meaningful recovery goes down the pan with it.
Telecom Italia
Lending to large corporate entities doesn’t seem to be at risk as the food-fight over the Telefonica hybrid deal proves and which is reflected by the performance of Telecom Italia, its Italian counterpart’s 2073 hybrid bond which was issued earlier in the year. As issues of a certain size, these no doubt will appear in all manner of indices which are used as benchmarks and which consequentially determine that, for index huggers, owning “neutral weight” in said issues represents the risk free option.
I do hope that quoting from the same source twice in a week doesn’t represent plagiarism but it was Mr Tix in his Macronomics BlogSpot who coined the phrase that “The greatest trick European politicians ever pulled was to convince the world that default risk didn’t exist.” I’m sure he was referring to sovereign debt but the rate of lending which we are now seeing through the bond markets must lead me to believe that this now applies to more or less anything issued in the public domain.
However, only those who experienced the sharp end of the demise of the CBO, the collateralised bond obligation, will remember what happens when one forgets to calibrate the risk based on the significantly lower recovery rates on unsecured bonds than on secured loans and even that is now not certain.
There are certainly signs of recovery across parts of the eurozone but these are starting from a very low base. The lending which has now seemingly gone sour was effected when the economies in question were (on paper at least) substantially more productive and future recovery rates, not mentioned so far, will most likely be notably lower than historical ones.
All tolled, the big drag on southern European economies which a moribund banking sector represents should be expected to get worse rather than better. However, as long as the investment community chooses not ask the questions for which it doesn’t care to know the answers, we will soldier on with the unrelenting bid for credit, financial and otherwise.