Dear readers,
Building further on our report from last week where we pointed out the problems the CEE region is facing we would like to have a brief look at the contamination risk that is now spreading into the EU.
The whiff of worry has been wafting in the wind for a long time now on CEE and Russia, and yesterday the news stepped up a notch as the Austrian Chancellor said he wants to approach the EIB for assistance in protecting its banks exposures to CEE + Russia (CEE-R), and that Austria will call for a European Union initiative to support these banks with the possibilities offered by the European Investment Bank, the ECB and the cohesion fund.
This Austrian move looks ostensibly to be designed to bail out Erste and RZB which are massively exposed to the CEE region : 40 % of Erste and 51 % of RZB’s loan book is exposed to CEE-R. Next to the Big 2 Austrian banks we also have Bank Austria (part of Unicredito) which Bloomberg reckons to be EUR 230 bio exposed to CEE. At present the Austrians have offered a EUR 75 bio repo facility with its banks on very flexible terms (low hair cuts and low rated paper) and a 5 year guarantee on senior debt for up to only EUR 15 bio. Bear in mind that Austria’s GDP is only EUR 285 bio.
The latter is the core of the problem. Similar like Iceland their banks grew above their heads. In the hype of bank bail-outs Austria, with a debt / GDP ratio of around 50 % will need to look for external help because its banking sector’s liabilities are too large. That it is seeking a loan facility over funding its own way out of the problem is a clear indication that this is going to be an EU problem (and probably at a later stage a joint intervention alongside the IMF) and not just a domestic issue country-by-country.
As a consequence we will see the EU, via the EIB, being presented the bill for the repair of Europe and even CEE.
The one million dollar question will be how long they can be put up with this? Other questions to be raised are, what will Italy and Greece do, who have sizeable exposures to the CEE region. Will they be asking for a bail out as well?
Wednesday 28 January 2009
Friday 23 January 2009
Swiss clouds hanging over Central Europe.
Dear readers,
This week we would like to address another imbalance that is shaking up the financial system, more specifically recent strength in the Swiss Franc (CHF).
Several board members of the Swiss National Bank (SNB) have recently expressed their concern on the strength of their Swiss Franc. Even against the EURO the Swiss currency has gained more then 7 % over the last couple of months. The move in September can easily be explained by the Lehman event, where the market went into total risk aversion. The Swiss Franc has been over time one of the ultimate safe heavens together with gold in times of crises.
But the picture against Central European (CE) is even more dramatic. The Polish Zloty (PLN)lost 50%. The Hungarian Forint lost over 36 %, and the Czech Crown fell by more then 32 %. This move is even more dramatic compared to the EURO, but this can easily be explained by emerging markets which were hit quite hard in the second half of the year due to the ongoing crisis and capital repatriation from these countries.
The rally of the CHF against those CE currencies is even more worrisome due to the fact that over the last 5 years local banks have been lending mortgages in other currencies, such as CHF, EUR and JPY. CHF denominated mortgages were the most favourable ones creating a huge potential foreign exchange risk for home owners in Poland – Hungary - Czech Republic to name a few.
On several occasions we have been referring in our weekly commentaries to the imbalances that have been built up in the global financial system. The very lose lending standards that were applied in Central Europe by local banks are one of those. The loans were sold massively to retail / real estate buyers with the teaser that all these countries would benefit from further European integration and as a result their local currency could only strengthen on the back of this. Of course the very low interest rate on the mortgage was the sale argument to close a foreign currency denominated mortgage.
Unfortunately these clients were not realizing they were putting on a similar carry trade like the rest of the investment world was building up year after year. As the chart indicates after the mild recession at the beginning of this decade all these countries started at a phenomenal growth pace. The currencies were strengthening and this gave first home buyers a false feeling of personal wealth creation.
Now that the tide has turned quite rapidly all these mortgage lenders see themselves squeezed between a fall in property prices and a dramatic rise in their outstanding debt they need to pay back. A numerical example will make this whole process more clear:
Suppose client Mikolaj Sikorsky steps to his bank for a mortgage on the house he wants to buy for the amount of PLN 325.000 (ca. EUR 75.000). The bank offers him the choice to either borrow PLN 325.000 at a rate of 9.50 % with a maturity of 20 years, or to borrow CHF 147.725 at a rate of ONLY 3.00 % for 5 years. In the loan agreement is written in small letters the outstanding amount will have to be paid back after 5 years and if during the tenor of the loan agreement the exchange rate of CHFPLN is breached above a level (e.g. 3.00) the loan needs to be early redeemed. As in every mortgage is the case the underlying house will be used as collateral.
Our client Mr. Sikorsky (not) surprisingly chooses for the CHF denominated mortgage and receives from Polanska Banka the amount of CHF 147.725. However to close the deal with the current owner of the house he needs to convert this CHF into PLN which is now trading at 2.20, since the seller does not want to have CHF. The transaction goes very smoothly, since Polanska Banka is quite happy to assist Mr. Sikorsky in all this. Even paying the monthly CHF interest rate goes without any problems, since he notices that in PLN the amount debited from his account is less and less every month.
However during his summer holiday at the Black Sea in August, he receives a call from the bank that his account is in overdraft, and that he needs to credit his account since there are not enough funds available to pay the monthly amount on his mortgage. Although the amount is negligible it was a bit awkward since he got used to pay the monthly amount to the bank at an ever lower PLN amount. Basically what happened was that the CHF in the mid of the credit crisis of last summer was starting to rise, and effecting our clients monthly payments.
By October things get worse, and Mr. Sikorsky notices he is now paying 25 % more every month since last May and he will have to change his expenditure pattern. Later that month he receives a call again from the bank, saying there might be a problem with the loan. The CHFPLN exchange rate has been rising aggressively (2.60) and although there is no reason to panic yet they would like to have a discussion with him whether he would have extra funds available in case for additional collateral, if not (and still highly unlikely) his house might have to be confiscated in case the CHFPLN would touch 3.00.
Even if all things stay the same for now, Mr. Sikorsky will have to take into account that in 3 years time the repayment of his mortgage at maturity is going to be more expensive. The problem is our client borrowed CHF 147.725 which he converted immediately into PLN in order to close his housing deal. At the current rate he will have to buy PLN 384.085 in order to give the CHF amount back to the bank. This is PLN 59.090 (or 18%) more then he initially paid for his house. In order to prevent to lose more money he starts to convert part of his savings already in CHF to prevent to make things worse.
The above described story is not fiction, and neither it’s something to laugh with. This happened and is happening to a lot of people in Central Europe. Basically what happened above is that our client was sold a forward currency contract on a margin call basis.
Just to give our dear readers an idea of the extend of the problem, only in Poland up to apx. PLN 88 bio – or EUR 20 bio – was lent to Polish mortgage borrowers in foreign currency denominated amounts. The total amount for the whole region – Central and Eastern Europe – is estimated at $ 1.6 TRILLION tied to the consumer and not the corporate market. (source: Morgan Stanley)
With access to capital now drying up worldwide, banks have stopped lending in foreign currencies and are calling in outstanding debts as they look to raise capital anywhere they can. This has left a lot of consumers unable to pay back their mortgages and increasing the concern of potential default of Central and Eastern European countries’ foreign currency related debt.
It is also due to this kind of exposure that the credit agencies red flagged Allied Irish bank, which was a heavy lender into Central and Eastern Europe. A total exposure of $ 1.5 trillion is at the expense of Euro-zone, Swiss and Swedish banks who were lending massively to these countries on this basis.
This explains the nervousness of the SNB as their currency is getting squeezed in the turmoil and they would use the intervention weapon to turn the tide. If this is going to help is another question, as history proves little success in these operations. Once a currency starts to slide there is little a central bank can do. Ask the BoE…
I wish you a very nice relaxing weekend.
Gino Landuyt
This week we would like to address another imbalance that is shaking up the financial system, more specifically recent strength in the Swiss Franc (CHF).
Several board members of the Swiss National Bank (SNB) have recently expressed their concern on the strength of their Swiss Franc. Even against the EURO the Swiss currency has gained more then 7 % over the last couple of months. The move in September can easily be explained by the Lehman event, where the market went into total risk aversion. The Swiss Franc has been over time one of the ultimate safe heavens together with gold in times of crises.
But the picture against Central European (CE) is even more dramatic. The Polish Zloty (PLN)lost 50%. The Hungarian Forint lost over 36 %, and the Czech Crown fell by more then 32 %. This move is even more dramatic compared to the EURO, but this can easily be explained by emerging markets which were hit quite hard in the second half of the year due to the ongoing crisis and capital repatriation from these countries.
The rally of the CHF against those CE currencies is even more worrisome due to the fact that over the last 5 years local banks have been lending mortgages in other currencies, such as CHF, EUR and JPY. CHF denominated mortgages were the most favourable ones creating a huge potential foreign exchange risk for home owners in Poland – Hungary - Czech Republic to name a few.
On several occasions we have been referring in our weekly commentaries to the imbalances that have been built up in the global financial system. The very lose lending standards that were applied in Central Europe by local banks are one of those. The loans were sold massively to retail / real estate buyers with the teaser that all these countries would benefit from further European integration and as a result their local currency could only strengthen on the back of this. Of course the very low interest rate on the mortgage was the sale argument to close a foreign currency denominated mortgage.
Unfortunately these clients were not realizing they were putting on a similar carry trade like the rest of the investment world was building up year after year. As the chart indicates after the mild recession at the beginning of this decade all these countries started at a phenomenal growth pace. The currencies were strengthening and this gave first home buyers a false feeling of personal wealth creation.
Now that the tide has turned quite rapidly all these mortgage lenders see themselves squeezed between a fall in property prices and a dramatic rise in their outstanding debt they need to pay back. A numerical example will make this whole process more clear:
Suppose client Mikolaj Sikorsky steps to his bank for a mortgage on the house he wants to buy for the amount of PLN 325.000 (ca. EUR 75.000). The bank offers him the choice to either borrow PLN 325.000 at a rate of 9.50 % with a maturity of 20 years, or to borrow CHF 147.725 at a rate of ONLY 3.00 % for 5 years. In the loan agreement is written in small letters the outstanding amount will have to be paid back after 5 years and if during the tenor of the loan agreement the exchange rate of CHFPLN is breached above a level (e.g. 3.00) the loan needs to be early redeemed. As in every mortgage is the case the underlying house will be used as collateral.
Our client Mr. Sikorsky (not) surprisingly chooses for the CHF denominated mortgage and receives from Polanska Banka the amount of CHF 147.725. However to close the deal with the current owner of the house he needs to convert this CHF into PLN which is now trading at 2.20, since the seller does not want to have CHF. The transaction goes very smoothly, since Polanska Banka is quite happy to assist Mr. Sikorsky in all this. Even paying the monthly CHF interest rate goes without any problems, since he notices that in PLN the amount debited from his account is less and less every month.
However during his summer holiday at the Black Sea in August, he receives a call from the bank that his account is in overdraft, and that he needs to credit his account since there are not enough funds available to pay the monthly amount on his mortgage. Although the amount is negligible it was a bit awkward since he got used to pay the monthly amount to the bank at an ever lower PLN amount. Basically what happened was that the CHF in the mid of the credit crisis of last summer was starting to rise, and effecting our clients monthly payments.
By October things get worse, and Mr. Sikorsky notices he is now paying 25 % more every month since last May and he will have to change his expenditure pattern. Later that month he receives a call again from the bank, saying there might be a problem with the loan. The CHFPLN exchange rate has been rising aggressively (2.60) and although there is no reason to panic yet they would like to have a discussion with him whether he would have extra funds available in case for additional collateral, if not (and still highly unlikely) his house might have to be confiscated in case the CHFPLN would touch 3.00.
Even if all things stay the same for now, Mr. Sikorsky will have to take into account that in 3 years time the repayment of his mortgage at maturity is going to be more expensive. The problem is our client borrowed CHF 147.725 which he converted immediately into PLN in order to close his housing deal. At the current rate he will have to buy PLN 384.085 in order to give the CHF amount back to the bank. This is PLN 59.090 (or 18%) more then he initially paid for his house. In order to prevent to lose more money he starts to convert part of his savings already in CHF to prevent to make things worse.
The above described story is not fiction, and neither it’s something to laugh with. This happened and is happening to a lot of people in Central Europe. Basically what happened above is that our client was sold a forward currency contract on a margin call basis.
Just to give our dear readers an idea of the extend of the problem, only in Poland up to apx. PLN 88 bio – or EUR 20 bio – was lent to Polish mortgage borrowers in foreign currency denominated amounts. The total amount for the whole region – Central and Eastern Europe – is estimated at $ 1.6 TRILLION tied to the consumer and not the corporate market. (source: Morgan Stanley)
With access to capital now drying up worldwide, banks have stopped lending in foreign currencies and are calling in outstanding debts as they look to raise capital anywhere they can. This has left a lot of consumers unable to pay back their mortgages and increasing the concern of potential default of Central and Eastern European countries’ foreign currency related debt.
It is also due to this kind of exposure that the credit agencies red flagged Allied Irish bank, which was a heavy lender into Central and Eastern Europe. A total exposure of $ 1.5 trillion is at the expense of Euro-zone, Swiss and Swedish banks who were lending massively to these countries on this basis.
This explains the nervousness of the SNB as their currency is getting squeezed in the turmoil and they would use the intervention weapon to turn the tide. If this is going to help is another question, as history proves little success in these operations. Once a currency starts to slide there is little a central bank can do. Ask the BoE…
I wish you a very nice relaxing weekend.
Gino Landuyt
Wednesday 14 January 2009
Those Letter of Credits...
Dear readers,
First of all a Happy New Year. We had a bit of a delay to kick-start the year, but here we finally are with our first newsletter for the year. We would like to pick up the themes of our last letter in December and update our statements with some numbers and facts. For those who were still wondering that the light at the end of tunnel was near will quickly change their mind and realize it is the light of a train that is coming at high speed from the other side of that tunnel…
Just to freshen up the memory the four major topics we expected for 2009 were:
• Further de-leveraging of banks
• Increase of defaults and write downs of corporate debt
• Deteriorating conditions in Central and East Europe
• Second round of re-capitalizing banks
We are only 2 weeks in the new year and we see a couple of these themes crystallizing themselves already. The deteriorating conditions for Central and East Europe were already confirmed this week with the horrible industrial production numbers for the Czech Republic. They came out at their lowest point ever since inception in 1993 : - 17,4 % for the month of November against – 7.6 % the month before. Bear also in mind that the market consensus was – 8.9 %. This will also be a good indication to e.g. the Q4 GDP numbers in the US at the end of this month. People will be surprised how bad that number is going to be. Expectations are still at around – 6.5 %, but market consensus is clearly still underestimating the impact and or damage done after the Lehmann failure. We are clearly dealing with the nuclear fallout of that Financial China Syndrome.
Commercial trade came to a stand still after Lehmann’s event and I already pointed out in one of my weekly newsletter for the bank in October that the problems we were facing in the commercial paper market at the time were dramatic, but the sniper of the tightening credit conditions would be the Letter of Credit (LoC’s) which were frozen by banks.
To remind you about the importance of a LoC, in simple terms it is a document issued by a financial institution presented to another financial institution to obtain release of goods (commodities – household articles – food etc). If banks refuse to give you a LoC, you would simply have no economy.
Below is an article in the Financial Post of Canada that was written on the 10th of October.
“The credit crisis is spilling over into the grain industry as international buyers find themselves unable to come up with payment, forcing sellers to shoulder often substantial losses.
Before cargoes can be loaded at port, buyers typically must produce proof they are good for the money. But more deals are falling through as sellers decide they don't trust the financial institution named in the buyer's letter of credit, analysts said.
"'There are all kinds of stuff stacked up on docks right now that can't be shipped because people can't get letters of credit,' said Bill Gary, president of Commodity Information Systems in Oklahoma City. 'The problem is not demand, and it's not supply because we have plenty of supply. It's finding anyone who can come up with the credit to buy.'
"So far the problem is mostly being felt in U.S. and South American ports, but observers say it is only a matter of time before it hits Canada. 'We've got a nightmare in front of us and a lot of people are concerned it's going to get a lot worse,' said Anthony Temple, a grain marketing expert based in Vancouver.
"Access to credit is key to the survival of maritime trade and insiders now say the supply is being severely restricted. More than 90% of the world's trade by volume goes by ship. 'The credit crisis has made banks nervous and the last thing on their minds is making fresh loans,' Omar Nokta, an analyst at investment bank Dahlman
Rose, said in an interview with Reuters.
"While shipping has always been a cyclical industry whose fortunes rise and fall with the global economy, analysts said the current crisis over the drying up of credit is something they have never seen before."
A good indicator for the shipping industry is the Baltic Freight Index, which gives investors a good idea of supply and demand of shipped goods. That index decimated over the last couple of months. To come back to our example of the Czech Republic, the volume of industrial orders came in at – 30.2 %, which suggests that production figures in the months to come will get worse.
We can extrapolate those numbers for other countries or regions who are highly export driven as well. And if we are talking about export, we need to look at China too. Their exports suffered the deepest drop in a decade in December, -2.8 %. Keep in mind these are official numbers from the Chinese government. The real numbers will probably be even worse.
The news came as the World Economic Forum held its annual meeting in Davos this week and warned that a ‘hard landing’ is in the making, with annual growth dropping even below 6 %. If you look at the import number ( -21.3%) it clearly is a sign that also domestically China is falling of a cliff. If the Chinese economy is hit by slowing international trade volumes, its domestic economic activity is even slowing at a faster pace. Of the total of 130 million migrant workers already 10 million of them have been sent back to the country to start planting rice again.
The one million dollar question will be whether the danger of social unrest, where we warned for in our last newsletter in December, might break out sooner then expected.
First of all a Happy New Year. We had a bit of a delay to kick-start the year, but here we finally are with our first newsletter for the year. We would like to pick up the themes of our last letter in December and update our statements with some numbers and facts. For those who were still wondering that the light at the end of tunnel was near will quickly change their mind and realize it is the light of a train that is coming at high speed from the other side of that tunnel…
Just to freshen up the memory the four major topics we expected for 2009 were:
• Further de-leveraging of banks
• Increase of defaults and write downs of corporate debt
• Deteriorating conditions in Central and East Europe
• Second round of re-capitalizing banks
We are only 2 weeks in the new year and we see a couple of these themes crystallizing themselves already. The deteriorating conditions for Central and East Europe were already confirmed this week with the horrible industrial production numbers for the Czech Republic. They came out at their lowest point ever since inception in 1993 : - 17,4 % for the month of November against – 7.6 % the month before. Bear also in mind that the market consensus was – 8.9 %. This will also be a good indication to e.g. the Q4 GDP numbers in the US at the end of this month. People will be surprised how bad that number is going to be. Expectations are still at around – 6.5 %, but market consensus is clearly still underestimating the impact and or damage done after the Lehmann failure. We are clearly dealing with the nuclear fallout of that Financial China Syndrome.
Commercial trade came to a stand still after Lehmann’s event and I already pointed out in one of my weekly newsletter for the bank in October that the problems we were facing in the commercial paper market at the time were dramatic, but the sniper of the tightening credit conditions would be the Letter of Credit (LoC’s) which were frozen by banks.
To remind you about the importance of a LoC, in simple terms it is a document issued by a financial institution presented to another financial institution to obtain release of goods (commodities – household articles – food etc). If banks refuse to give you a LoC, you would simply have no economy.
Below is an article in the Financial Post of Canada that was written on the 10th of October.
“The credit crisis is spilling over into the grain industry as international buyers find themselves unable to come up with payment, forcing sellers to shoulder often substantial losses.
Before cargoes can be loaded at port, buyers typically must produce proof they are good for the money. But more deals are falling through as sellers decide they don't trust the financial institution named in the buyer's letter of credit, analysts said.
"'There are all kinds of stuff stacked up on docks right now that can't be shipped because people can't get letters of credit,' said Bill Gary, president of Commodity Information Systems in Oklahoma City. 'The problem is not demand, and it's not supply because we have plenty of supply. It's finding anyone who can come up with the credit to buy.'
"So far the problem is mostly being felt in U.S. and South American ports, but observers say it is only a matter of time before it hits Canada. 'We've got a nightmare in front of us and a lot of people are concerned it's going to get a lot worse,' said Anthony Temple, a grain marketing expert based in Vancouver.
"Access to credit is key to the survival of maritime trade and insiders now say the supply is being severely restricted. More than 90% of the world's trade by volume goes by ship. 'The credit crisis has made banks nervous and the last thing on their minds is making fresh loans,' Omar Nokta, an analyst at investment bank Dahlman
Rose, said in an interview with Reuters.
"While shipping has always been a cyclical industry whose fortunes rise and fall with the global economy, analysts said the current crisis over the drying up of credit is something they have never seen before."
A good indicator for the shipping industry is the Baltic Freight Index, which gives investors a good idea of supply and demand of shipped goods. That index decimated over the last couple of months. To come back to our example of the Czech Republic, the volume of industrial orders came in at – 30.2 %, which suggests that production figures in the months to come will get worse.
We can extrapolate those numbers for other countries or regions who are highly export driven as well. And if we are talking about export, we need to look at China too. Their exports suffered the deepest drop in a decade in December, -2.8 %. Keep in mind these are official numbers from the Chinese government. The real numbers will probably be even worse.
The news came as the World Economic Forum held its annual meeting in Davos this week and warned that a ‘hard landing’ is in the making, with annual growth dropping even below 6 %. If you look at the import number ( -21.3%) it clearly is a sign that also domestically China is falling of a cliff. If the Chinese economy is hit by slowing international trade volumes, its domestic economic activity is even slowing at a faster pace. Of the total of 130 million migrant workers already 10 million of them have been sent back to the country to start planting rice again.
The one million dollar question will be whether the danger of social unrest, where we warned for in our last newsletter in December, might break out sooner then expected.
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