Results of the Private Audit of Spain's Banks Are In

The private consultants Roland Berger and Oliver Wyman have finished their audit of Spain's banks. They have come up with a total number required for the recapitalization of the banks that is well below the worst estimates made by others:


Spain's banks would need between 51 billion and 62 billion euros ($64-78 billion) in extra capital to weather a serious downturn of the economy and new losses on their books, two independent audits of the sector showed on Thursday.

The results of the audit from consultancies Roland Berger and Oliver Wyman will now be used by the Spanish government to determine how much of 100 billion euros of available European funds it needs to recapitalize ailing lenders, and then to formalize an aid request to other euro zone countries.

The Bank of Spain said on Thursday the 100 billion euro bailout fund gives a wide margin to correct these capital needs.

It said Spain's three biggest banks would not need extra capital in a stressed scenario, noting that the problems are limited to a small group of Spanish banks for which the state has already started to act. Spain's economy ministry said a more detailed audit would come in September.”


(emphasis added)

Fine. Except, we don't believe it – least of all when the Bank of Spain immediately pipes up to tell everybody how well in hand things are. Neither does Nomura as it turns out. From a Nomura report on the audit results:


“The independent audit of the capital needs of Spanish banks has been released, and the result may be viewed by the market as disappointing. Oliver Wyman and Roland Berger estimated that the current capital deficit is EUR 16-25bn, and that in an adverse scenario this would rise to EUR 51-62bn. This is consistent with the Spanish government‟s view that the EUR 100bn eurozone-level support for bank re-capitalisation will more than meet the system‟s need.

However, the results are unlikely to dispel the markets concerns over the capital deficit in our view. We are concerned that the stress-tests do not represent a sufficiently “stressed” scenario and hence that the capital deficit is under-estimated. (The adverse scenario, for instance, allows core Tier 1 capital to drop to 6% from 9% in the base scenario.) We ourselves assume a capital deficit of over EUR100bn.

However, it is clear that the capital deficit number is significantly below the market's estimate, which tends to start at EUR100bn.”

(emphasis added)

You bet the scenario wasn't 'stressed' enough. These private consultants have been hired by the Spanish government. Their estimates reflect – whether consciously or subconsciously – what their client wants to hear.  We dimly recall that the same consultants published estimates for the capital needs of Ireland's banks that eventually turned out to be far too low. In fact, the amounts became eventually so large that they bankrupted the government (unfortunately we could not find anything on the internet to check how big exactly the gap between the audit estimate and reality was at the time). As we always stress, the losses of the banks are a moving target. It may be possible to ascertain their upper boundary to a reasonable degree of certainty, and in Spain's case it is no doubt significantly above this latest guess.

What we do know for sure is that euro area-wide bank borrowings from the ECB have just hit another new all time high:



ECB lending to euro area banks is at a new all time high (chart via CLSA) – click chart for better resolution.



Nomura also notes that it is by no means certain yet where exactly the € 100  billion for Spain's banks are going to come from:


“From a broader perspective, it is also worth noting that the eurozone also has yet to develop a way to fund the capital deficit. EUR100bn has been pledged to help fund the Spanish re-capitalisation, but the ability of this commitment to be funded via existing mechanisms is questionable:

The Spanish sovereign clearly cannot fund the capital deficit itself.

Investor demand for EFSF debt is in our view insufficient to allow for a significant amount of issuance in a short-space of time. The EFSF also cannot be transformed into a bank (this would require treaty change) and fund via the ECB.

The ESM may see more demand for its debt that the EFSF, although again it will face funding pressure. It can be turned into a bank without Treaty change, but the ECB is for now opposed to funding it in this manner. The more practical issue is that the ESM will not come into being as planned on 9 July. Italy, for instance, has suggested it might not approve the ESM until after the summer recess of parliament.”


(emphasis added)

So things are not as easy as the audit numbers and the Bank of Spain's remarks make it appear.


ECB to Invent its Own Bond Ratings

There has recently been some debate in the euro area over whether the 'big three' rating agencies could somehow be 'reined in' – in short, be kept from issuing negative ratings on euro area sovereign debt. The idea is to make this debt masquerade as something it is not, in the hope that the markets won't be able to look through such a blatant and transparent maneuver. This effort has run into severe criticism from banks and companies and seems to have been shelved for now, or at least significantly diluted.

However, the ECB wants to scrap international credit ratings, at least internally. This is one more step down the road to going from 'bad bank' to 'even worse bank', as this is all about widening collateral eligibility and lowering the haircuts imposed on borrowers.


“The European Central Bank is discussing a medium-term plan to scrap rating rules on euro zone sovereign bonds and instead set their value when used as collateral in lending operations on its own internal assessment, central bank sources said.

With the European Central Bank not yet ready to take over the technical but highly political responsibility for rating sovereigns, the bank's policymakers will also discuss more immediate ways to help Spain and its banks at their meeting on Thursday, such as further widening the types of collateral Spanish banks can use.

The discussion come as Spain braces for a downgrade from small rating firm DBRS, which without a change in ECB rules will trigger an extra 5 percent penalty on Spanish bonds when used to get ultra-cheap ECB funding.

ECB members have heavily criticized the actions of rating agencies during the euro zone crisis and have vowed to reduce reliance on their assessments.

"In the case that the ECB Governing Council decides this, it would reduce the widely criticized influence of Standard & Poor's, Moody's and Fitch," one euro zone central bank source who spoke on the condition of anonymity said. "On the other hand, this could also expand the shrinking pool of collateral which banks in troubled countries have available."

The decision on more immediate changes to help funding-squeezed Spanish banks, such as expanding the range of debt-backed securities or government-backed bank bonds, remains wide open, said another central banker.”


(emphasis added)

So from now on, they'll just make this stuff up as needed. The German Bundesbank won't be amused.


Bond Buying Intervention Rumors

Both Spain and Italy are pining for some kind of intervention that brings down their bond yields (they have fallen in recent days on speculation that something of that sort will be forthcoming).

One day there is a rumor that Germany will 'agree' to bond buying by the EFSF/ESM (which is not really necessary, since they already can do that – but the government concerned must apply for this type of help), the next day it is denied again. This off/on rumor has been circulating for a few days now.

What is clear is that Mario Monti is on his last legs politically, as he is about to lose the support of Berlusconi and with him Berlusconi's party. Monti also no longer enjoys the overwhelming public support he once called his own.  As a result he is lately quite insistent that the ECB, or at least someone, should buy Italy's bonds. His latest idea is to combine the ECB and the ESM – the ECB is supposed to buy the bonds, while the ESM guarantees them. However, the German Bundesbank and other central bank officials have already said that this won't be possible, as it would amount to the kind of back-door debt monetization that is expressly forbidden by the ECB's statutes.

OK, so there will be no bond buying by the ECB. But then we are left with the EFSF and ESM, which –  as Nomura notes above –  are not even capable of swinging the rescue of Spain's banks between them for lack of funding!

Not to mention that Italy is supposed the be the third largest contributor to these bailout vehicles.  What to do, what to do? According to Mrs. Merkel and Mr. Schäuble 'we need more Europe'.

Perhaps it would be better if we had a little less of it. Ever since the EU's founding, the subsidiarity principle has been chipped away bit by bit. Mind, we do believe that free trade, free movement of capital and open borders are essential and important achievements. But here is a little comparison that shows you quickly and easily what isn't (hat tip to one of our readers at Seeking Alpha):


Pythagoras' theorem – 24 words.

Lord's Prayer – 66 words.

Archimedes' Principle – 67 words.

10 Commandments – 179 words.

Gettysburg address – 286 words.

US Declaration of Independence – 1,300 words.

US Constitution with all 27 Amendments – 7,818 words.

EU regulations on the sale of cabbage – 26,911 words


How on earth did we ever buy and sell cabbage before there were such edicts from the bureaucracy in Brussels?


Selected Credit Market Charts

Below is a selection of our customary update of credit market charts: CDS on various sovereign debtors and banks, bond yields, and euro basis swaps. Charts and price scales are color coded (readers should keep the different price scales in mind when assessing 4-in-1 charts). Where necessary we have provided a legend for the color coding below the charts. Prices are as of Thursday's close.  There hasn't been much change since yesterday's intra-day update, but bond yields in Italy and Spain have declined further, while  CDS spreads ticked up slightly at the close.

Included is also a long term chart of euro basis swaps – this shows that  the Fed-ECB currency swap line has been successful in bringing down dollar funding costs for euro area banks from their previous panic wides.



5 year CDS on Portugal, Italy, Greece and Spain – click chart for better resolution.



5 year CDS on France, Belgium, Ireland and Japan – click chart for better resolution.



5 year CDS on Germany (white) , the US (orange) and the Markit SovX index of CDS on 19 Western European sovereigns (yellow) – click chart for better resolution.



Three month, one year, three year and five year euro basis swaps – a long term chart that shows where they now are relative to 2008 and the 2011 panic – click chart for better resolution.



10 year government bond yields of Italy, Greece, Portugal and Spain – Spanish and Italian yields have pulled back still further – click chart for better resolution.



Another interesting chart we have come across: gold exports from Hong Kong to China (via CLSA). These exports have increased notably – click chart for better resolution.



Addendum1: A Contrarian Buys Greek Stocks

There was an interesting article on Bloomberg about George Elliott, a lonely hedge fund manager who is buying Greek stocks, in fact has started a fund for the sole purpose of buying up bargains in Greece's battered stock market. He has an interesting method of getting investors interested in his fund and his comments on buying the seeming basket case certainly ring true to us:


“In March, Elliott met with the investment chief of a family office in London who said within seconds of sitting down that the firm had no interest in giving money to a hedge fund wagering on Greece. The executive merely wanted to hear his story, Elliott, the founder of Naftilia Asset Management Ltd., said in a telephone interview from his office in Athens.

Elliott, 39, responded by asking a few questions of his own, including whether the executive had invested in Russia after its 1998 currency crisis, in Argentina 10 years ago after the nation defaulted on its debt or in the Standard & Poor’s 500 Index (SPX) in March 2009, when the benchmark plunged to its lowest point in 13 years. Finally, Elliott questioned whether the family office’s investment chief had ever bought shares of Apple (AAPL) Inc. In all cases, the answer was no.

“Then you are not qualified to be discussing Greece with me because you have missed the best investment opportunities over the past 20 years,” Elliott retorted.


(emphasis added)

Well, this is exactly right. Once a market has fallen by 90%, it is time to look for opportunities, no matter how dire the news backdrop is. At this juncture the market has already discounted everything except an asteroid strike. Uncertainty and risk may be very high, but this is always the case near major lows.

Addendum 2: Famous Last Words

And lastly, here is something a friend sent us by e-mail – who is not what, or rather, was not what, and when (say that ten times real fast :) ). 



Not even Uganda wants to be Spain anymore …

(Via Hamilton Capital)





Charts by: Bloomberg, CLSA



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