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During 2013 Spanish and Italian bonds have had a strong rally, with yields falling to long-term lows. If one looks at MFI balance sheet data from the ECB, the conclusion is that the fall in prices can be attributed to domestic banks using deposit inflows in order to buy government bonds.
The Spanish data show that domestic banks were strong net buyers of government securities through out 2013, with a total of €28.7bn in purchases. These were financed by increased deposits due to inflows by retail customers. Spanish banks do not appear to have been successful in accessing the money and capital markets with both deposits to MFIs and Debt Securities issued flows being negative.
The Italian data are quite similar, with banks increasing their holdings of government securities even more than Spanish banks (a total of €34.1bn during 2013). Domestic credit institutions had a very strong inflow of funds during February and March (almost €60bn), mostly from retail deposits but also from money markets (at least during February). Capital market flows (debt securities) were negative almost €30bn.
Given the ongoing recession in both Italy and Spain and the increasing share of NPLs, domestic banks seem to have adopted a policy of investing any deposit inflows on government securities in a search of yield and relative principal protection (although taking a duration risk). Foreign investors seem to be increasing their positions at a steady pace or at least maintaining them (data on holders for Spain and Italy). As long as deposits keep returning to Spain and Italy and foreign investors are calm the above policy seems to be wining and providing significant capital gains.
Since it’s been a few months since I took a look at periphery NCB balance sheets, it’s time to examine trends during 2013.
Spain seems to be the one driving overall Open Market Operations (OMOs) usage down:
Since December, OMOs have declined from €357.29bn to €270.94bn (-€86.35bn) with 80% attributed to a fall in LTRO usage. It seems that Spanish banks are confident to repay a significant part of their LTRO borrowing from the ECB which, given the low interest rates of LTRO funding and the relaxed collateral rules, imply that market conditions have improved strongly. During the same period, the consolidated Eurosystem OMO funding to European banks has dropped €225bn which means that Spanish banks account for almost 40% of the relevant fall (with another large part accounted by French and German banks).
Looking into the balance sheet at more detail, one observes that use of the deposit facility was €44.2bn in December and only €10.94bn during March, reflecting much lower safety buffers for Spanish banks. This is linked to the drop in Target2 liabilities, from €352,4bn in December to €298.3bn in March (-€54.1bn). Still, liabilities continue to be high, almost 28% of Spanish GDP although they are much lower than their maximum of €428.6bn in August 2012 (a fall of €130.3bn).
The drop in Target2 liabilities is related to the increase in non-residents government debt securities holdings, with registered holdings increasing €30bn since October, from €209.6bn to €240.4bn in February (an almost 15% increase).
Overall, credit conditions have clearly eased during the last few months. Nevertheless, both the situation in the real economy and current NPL figures point to large risks ahead for the Spanish banking system. Spanish banks will probably keep low quality collateral (such as credit claims) parked at the ECB and only use high quality securities in order to borrow in the repo market at low interest rates (since current repo rates are close to 0.02-0.03%).
The Italian case seems to be a bit more muted than Spain. Since December, bank borrowing from the central bank of Italy has dropped only marginally from €271.8bn to €268.2bn with a somewhat larger fall in LTRO usage from €268.3bn to €262bn. This is mainly explained from the fact that Target liabilities only dropped from €255.1bn to €242.9bn. It seems that Italy has decoupled from Spain, probably due to the results of the recent national elections and the inability to form a stable government as well as the fact that government debt figures are moving close to the 130% GDP figure.
This is also reflected on the general government debt statistics which illustrate the fact that non-residents holdings of securities have been extremely steady during the last few months and are much lower than 2011 figures.
The BdE released its balance sheet data for December yesterday. There’s a significant drop in Target2 liabilities to €352.4bn (from €376.3bn in November). Overall, since a peak of €428.62bn in August, liabilities have dropped by €76.22bn, reversing private capital flows (mainly driven by the ‘Draghi-OMT effect’). As a result, Spanish banks managed to create a large deposit facility buffer of €44.2bn (from €24bn in November) and also to reduce their recourse to regular refinancing operations by €7.6bn to a total of €357.3bn. Banknotes and deposits of general government were somewhat lower during this month.
Spanish banks don’t seem to regard the current situation as perfectly stable, something evident from the fact that they increased their deposit facility holdings substantially even though excess reserves pay zero interest (and did not opt to pay down more of their borrowing from BdE). This indicates fear of a possible price shock on their main collateral (government bonds) which would increase their margins with BdE and risk current private capital inflows. Nevertheless, the fact that private financial flows have clearly reversed and the current account deficit has been closing and is now less than -€1bn/month makes the Spanish economy a rather ‘closed’ one. Lower money market and deposit rates as well as the large deposit facility buffer will be supportive of government debt auctions in the near future (although it is possible that the Spanish government might take the route taken during the first months of 2012 when the LTRO effect allowed it to auction off more funds than immediately required and increase its deposits at Bde – something that would lower the Spanish banks safety liquidity buffer).
BdE published the balance of payments for September 2012 (and 2012Q3). Developments are quite positive. Regarding the current account:
The goods balance is now firmly below the -€3bn/month threshold. Compared to -€31bn in the Jan – Sep 2011 period, the balance was -€22,13bn. It’s quite positive that most of the improvement is attributed to larger goods exports (+€5.7bn to €170.52bn) than lower imports (-€3.2bn to €192.65bn). The balance in services was also improved by €3.45bn. Total goods and services balance is now +8.17bn compared to -4.15bn a year ago.
A very large improvement came from the income balance which registered at -€16.61bn, down €2.7bn from last year. After growing to more than -€3.1bn during July, the balance dropped below -€1bn during August and September most probably driven by the ‘ECB effect’.
Current transfers were -€8.07bn compared to -€6.84bn in J-S 2011 and the capital account was €3.92bn after €4.17bn a year ago. Overall, the current+capital account deficit is now mainly driven by the income deficit.
The financial account was also quite positive during September. Portfolio investment turned strongly positive during September (+€9.75bn after a +€2.34bn in August and -€10.82bn in July), a strong display of ECB ‘powers of persuasion’. Large inflows were registered in the general government category while ‘other sectors’ also had a positive balance after a long time (+€3.34bn after -€2.78bn in August) and MFI outflows continued dropping with September reading below -€2bn.
The largest change was in the other investment balance where investment on MFIs went from -€21.52bn during August to €4.93bn in September, marking the return of Spanish banks in the Euro interbank market.
External adjustment is definitely making progress in the case of Spain (with exports showing healthy increase) while ECB actions allowed for a complete U-turn on capital outflows. How long the ECB effect will last is an open question.
The Bde released its economic bulletin for November 2012. A few data sets that are of interest are the following (I will try not to duplicate previous comments which were made based on data of the September Economic Bulletin):
The investment outlook is one of definite deterioration both in construction and equipment, especially since 2011Q3. Domestic demand is dropping 3-4%, something which is reflected in demand for imported goods and services. Exports are showing positive rates of growth but reflect the Euro wide recession since the double digit rates of 2010 are now closer to 3%. This is also quite evident in export (by region) data:
After rebounding strongly during 2010 and most of 2011, both EU/Euro and OECD exports are quite stagnant in 2012 with only other regions (China, OPEC, other American countries) providing increased demand. Since most of Spanish exports are towards the first two group of countries, the data (along with current macro projections for the relevant regions) do not provide an optimistic short-term future perspective for an export-led recovery.
Household final consumption deflators are still around 2.5% making a CPI-based REER devaluation rather difficult. What is interesting is the fact that import deflators are more than double export deflators. Depending on the import share of exports this fact could create difficulties in maintaining current export deflators in the long-run without any further drop in employee compensation and/or profits.
Labour force participation rates seem quite constant in the long run which means that changes in unemployment mostly happen because of employment and not participation changes. There’s a worrying trend of outright negative population change during 2012 which could be a sign of emmigration.
Another problem is the fact that all sectors of activity show negative employment changes with industry and construction leading the way with large (double digit in the case of construction) rates.
Even services (which account for the largest part of Spanish GDP) are now in deeply negative territory (-3.5%) which makes finding employment in a different sector (for instance moving from construction to services) extremely difficult. Large unemployment numbers are most likely to persist until domestic demand rebounds substantially.
BdE released data on financing in the Eurosystem for October 2012. On the BdE balance sheet front developments are quite positive. Both MRO and LTRO funding of domestic credit institutions was lower (-€33bn) with most of the drop attributed to lower MRO credit (-€23.4bn). Reserves increased a bit with the deposit facility growing to €25.3bn from €21.75bn in September. The main source of lower funding needs were lower Target2 liabilities which dropped €36.2bn to €383.6bn, back to June levels. Deposits to general government remained quite low at €4.4bn. Overall, the BdE balance sheet suggests easing of money market conditions for Spanish banks.
In the case of financing to the private sector (households and non-financial corporations) developments were mixed. September effective lending flow for households was still quite negative at €2.84bn (down a bit from €3.83bn during August) with housing dropping €2bn, while NFC lending actually registered a positive effective flow of €1.06bn after a strong drop of €11.17bn in August. This made the total quarterly drop much lower and allowed the Spanish economy to register a mild GDP drop. It will be interesting to see if this change persists in the coming months.
The ECB released the latest monetary developments data for September 2012. As always I tend to focus on the asset side (loans) rather than the liabilities (deposits and debt securities).
What we see is that loans to households are still in a negative path while loans to non-financial corporations registered a significant negative flow of -€20bn for September. That’s equal to more than 0,2% of Euro 2012 GDP. The total quarterly figure for private lending (adjusted for sales and securitisation) is close to -€15bn which point to rather weak internal demand.
The ECB also released MFI balance sheet data per country. I ‘ll focus on Spain and Italy.
Spain saw a continued decline in loans to the private non-financial sector, with the total loan assets (not adjusted for sales and securitisation) dropping -€5,1bn, compared to a -€14.9bn decline in August and -€13.1bn in July which could be regarded as stabilization. Holdings of general government securities increased in September by €11.6bn reversing course from a fall of €12.7bn during July and August, pointing to a helpful effect from the ECB OMT announcement. On the other hand, holdings of ‘Other euro area residents’ securities continued falling. They lost €35.8bn since June (and €3.8bn in September) which makes one wonder if the increase in government securities holdings had more to do with portfolio rebalancing.
On the liability side, Central Government deposits increased to €51bn (compared to €32.1bn in August) while deposits saw a healthy increase of both deposits and repos. Debt securities issued saw a decline of almost €8bn during September.
In the case of Italy private non-financial sector borrowing remained negative, falling €6.3bn this month after a fall of €10.6bn in August. Only Non-monetary financial intermediaries saw an increase in their loans. After stabilizing their holdings of government securities during the summer, Italian MFIs also increased them by €9.9bn during September with holdings of other euro area residents securities declining €4.4bn in the same month.
Regarding liabilities, both deposits and repos saw an increase by €22.8bn and €7.3bn respectively with debt securities issued declining only slightly.
In general, the OMT effect seems strong in the case of Italy and Spain but euro area credit creation is negative and the monetary union appears to remain in recession.
BdE released data on doubtful loans for August today. The total was €178.58bn compared to €173.24bn in July (+€5.34bn), following an increase of €4.87bn in the previous month. If one fits exponential trends for the total of 2011 and for the March – August 2012 period, the calculated rates of increase are 2.14% for 2011 and 3.98% for 2012 with roughly the same R² of around 0.97. In other words, so far 2012 has seen a doubling of the rate of increase. Based on the trendline, doubtful loans will be around €210bn by the end of the year, increasing by another €30bn by then.
Data on equity and impairment allowances was also released. Net profits are still highly negative (-€10.7bn) while impairment allowances increased by €4.24bn to €106.77bn. The banks stress test used a figure of €110bn, which seems to be only a month away.
Overall, the data point to a deep recession (especially if effective flows on loans are taken into account) which makes recapitalizaton urgent. Based on the projected end-2012 figure of €210bn in doubtful loans and €110bn in impairment allowances, capital needs for 2012 are close to €100bn, especially since banks do not appear to be producing any profits. This will probably mean a combined use of a ‘bad bank’, burden sharing by subordinated and hybrid debt holders and a large part of the €100bn EFSF loan. So far, the projected €60bn capital needs seem optimistic as long as banks do not produce profits and are able to dispose of assets without further losses.
On a related macro note, the Spanish Treasury has made August debt data available. Total average interest rate is now 4.12% (compared with 4.02% in March) while total central government debt is €608.2bn, producing an annual interest of roughly €25bn, or around 2.4% of GDP, without counting debts of other branches of the government. Just for comparison, on January 2011 the corresponding figures were 3.74% and €548.6bn making the annual interest equal to €20.5bn, an increase of 0.5% of GDP.
What is really negative is the data on the government debt market turnover. Although the T-Bills market has held steady, government bond market turnover outright transactions have dropped to almost half compared to the first months of 2012 (when the LTRO effect was strong), while repo turnover went from €39bn in February to €26bn during the summer. It will be interesting to see the market September figures.
BdE released data on financing of the Eurosystem, basically the BdE balance sheet and data on financing by credit institutions. Regarding the BdE balance sheet the latest data, the first after the ECB announcement of the OMT are quite positive:
Both MRO and LTROs were lower in September, a total reduction of €11.7bn which is a significant amount. This was reflected in the Target2 balance which dropped by €8.77bn to €419.85bn (still a very large deficit) as well as in the banknotes demand which was €2.03bn lower. Deposits to general government on the other hand registered a new low of €4.04bn (a €2.4bn reduction), pointing to government cash troubles, while credit institutions deposits and current accounts were €1.33bn lower. Since funds at the deposit facility do not earn interest anymore it seems that banks used the Target2 inflows as a source of funds to lower their loans from BdE, rather than to increase their liquidity buffers.
The same data release also provides statistics on loans to households and non-financial corporations. Both series show a clear pattern of negative credit growth. Effective flows for household loans (till August) were -€22.8bn (compared to -€21.48bn for the total of 2011) and -€48.29bn for non-financial corporations (compared to -€25.41bn for 2011). In total, the negative flow is equal to €71.09bn which points to an annual flow of -€100bn (more than double that of 2011). That’s around 9.5% of GDP which coupled with a current account deficit of 3% GDP equals to a drag of almost 12.5% of GDP. Since the annual budget deficit will probably register close to 7% of GDP, the data show that the 2012 recession will be quite deep. In my view, the -2% projections are actually optimistic since the drag from private debt repayment is extremely large and government austerity measures quite heavy. Just for comparison, during 2011 the effective flow was -4.4%, the current account -3.5% while the government deficit 8.5% with the real GDP growth rate at 0.4% so this extrapolation seems reasonable.
Lastly, data is also available on profit-loss accounts of credit institutions till 2012Q2:
What is evident is the fact that profit before tax has turned strongly negative since 2011Q3, around 2-2.5% of the adjusted average balance sheet. Unless there’s a strong rebound in economic activity and loan demand or if capital outflows totally reverse course I ‘m not so sure why someone would look forward to Spanish banks posting profits in the near future, something which makes their capital needs larger.
The BdE released the Spanish banks stress tests results on Friday. The total capital needs are expected to be a bit less than €60bn under the adverse scenario (cumulative 6.5% fall in GDP). Only banks with 37% of total bank assets are the ones with negative capital, with the rest not having any problems:
Actual capital needs will be even lower since banks will move assets to the ‘Bad Bank’ and the government will impose ‘burden sharing’ on hybrid and subordinated debt holders. Subordinated bonds are around €41.6bn while hybrid debt is €23.6bn. As a result, a large part of the capital relief can actually come from losses on such instruments. These losses and bank resolution are scheduled to be completed by the end of 2012.
RoW currently holds around €180bn in bonds and €408bn in deposits with MFIs so these steps will probably help in limiting any further capital outflows out of Spain, as long as the remaining bank liabilities are considered safe.
One problem of the stress tests (which was raised by zerohedge) is the fact that there’s a very important role played by the ‘capital buffer’. Total losses under the adverse scenario are projected at €270bn, with €110bn covered by existing provisions, €59bn by new profits and €36bn by the capital buffer (which is actually a total of€ 73bn):
The capital buffer is basically the result of bank deleveraging. Banks are expected to dispose of assets, thus lowering their risk adjusted capital needs. Still, the size of the capital buffer corresponds to an extreme asset disposal. Currently, Spanish MFIs hold a total of €3.6tr in assets. Their borrowing from BdE is already around €412bn while they also have €408bn in debt securities issued. How much of their €782bn deposits to MFIs is securitized is difficult to know but it’s obvious that a large part of their assets are already pledged as collateral. By disposing of assets banks will have to ackowledge any losses due to the difference between the booked value and the price they ‘ll manage to get at the market, losses that will lower their capital base and the final capital relief.
What is worrying is the fact that the capital buffer is actually very important even for banks that are considered to have excess capital. Santander has a capital excess of €25.3bn with €22.7bn in the capital buffer, while BBVA a capital excess of €11.2bn with €13.4bn in the capital buffer (under the adverse scenario). Caixabank & Banca Cívica have €5.7bn against €8.9bn, KutxaBank €2.2bn against€ 3.4bn, Sabadell & CAM €0.9bn against €4.7bn and Unicaja & CEISS €0.13 against €3.62bn. It’s rather strange that excess capital under the adverse scenatio is actually higher for the first two banks than under the baseline.
Overall, one should probably consider the capital buffer figures extremely optimistic. Actual capital needs might be even double the €60bn figure which will lead to large losses on hybrid and subordinated liabilities.
The Spanish government might end up with a fiscal safety buffer of €20-30bn out of the original €100bn EFSF loan which will help with covering its financial needs for the rest of 2012. Given that foreigners now only hold 1/3 of the total government debt and the Spanish Treasury held a bit less than €40bn in deposits in August i think that it’s a safe bet to suggest that it will be able to cover any bond redemptions for 2012. This fact might push any actual bailout into 2013, especially given important regional elections in the next few months.