Funding Eurozone Banks? Nein Danke

I had intended to go into some detail about the technical and political difficulties in sustaining a complacency about China's growth in the next 12-18 months, but it will have to wait – until tomorrow most likely.

For today, this is what we need to think about: the average CDS price for 5yr European banks has risen to 473 basis points. In other words, the average price of insuring against default risk is 4.73% a year. Meanwhile, 5yr sovereign euro yields have fallen to around 1.43%, so with the best will in the world and a following wind, the average European bank can expect to have to pay around 6.2% for five year money. That's more than double the 2.9% a year that the Eurozone's nominal GDP rose during 2Q11. Anyone think it's about to grow faster?

But remember, that's an average only of those to whom the market is open at any price. You won't for example, find any prices for Irish banks, and precious few for Greek banks.

For those for whom the market is still open, here's what CDS markets are demanding:

Bank	5yr CDS Rate	Nationality
Banco Comercial Portgues (sub)	1825	Portugal
National Bank of Greece	1558	Greece
Banco Comercial Portues	1542	Portugal
EFG Eurobank Ergasias	1429	Greece
Alpha Bank	1414	Greece
Banco Espirito Santo (sub)	1308	Portugal
Banco Popolare (sub)	1225	Italy
Banco BPI	1117	Portugal
Caixa Geral de Depositos	1002	Portugal
Banco Espiritu Santo	995	Portugal
Kazkommerts	925	Kazakhstan
WestLB (sub)	863	Germany
Banco Monte dei Paschi di Siena (sub)	820	Italy
UniCredit SpA (sub)	722	Italy
RBS Plc (sub)	702	UK
Dexia	700	France
Banco Popolare	653	Italy
Societe Generale (sub)	652	France
Commerzbank (sub)	651	Germany
Lloyds Bank (sub)	643	UK
Banca Intesa (sub)	615	Italy
RBS NV (sub)	590	UK
Caja de Ahorros y Monte de Piedad de Madrid	585	Spain
SNS Bank NV (sub)	584	Netherlands
BBVSM (sub)	580	Spain
Halyk Savings Bank	570	Kazakhstan
Santander (sub)	545	Spain
HBOS (sub)	538	UK
Credit Agricole (sub)	517	France
Arab Banking Corp	510	Bahrain
Unione di Banche Italiane	507	Italy

At what point does the insurance become so expensive as to represent a market which is effectively closed? I'd say pricing would be painfully prohibitive for pretty much all of those in the table. This tells us that there's a profound reluctant to taking a credit risk on the subordinated debt of even French, UK and even German and Dutch banks. And the market is closing for the head-office of even some French and Italian banks, as well as the more predictable Spanish and Portuguese banks.

How much does it matter right now? Over the last week, there's been fairly widespread attention drawn first to the fact that no European corporates, let alone banks, have managed to issue bonds since August, and also to research showing European banks it doesn't matter too much, since European banks have completed 90% of their financing this year already. I think I know what the first of those means, but who knows what that second observation may actually mean? Are the financing plans those of dire necessity, or of an ambitious business plan? If the latter, are those business plans the same as they were four months ago?

I am thrown back onto two observations. The first of them is this: as of end-July, ECB data shows Eurozone banks have a loan/deposit ratio of around 113.1%, or 105% if you look just at the position with the private sector. This is barely lower than the 113.9% recorded in July 2010, although the private-sector LDR has come down during the same period from 106.6%. To maintain the current level of loans, European banks either need to attract more deposits, or take on other liabilities – essentially bonds or foreign liabilities. Neither look likely. The bond markets, as we have seen, are unwelcoming. And good luck with attracting foreign liabilities: as of July, they were down 7.6% YoY, or by around Eu 304 billion.

One alternative is to cash in foreign assets, of which the Eurozone's banks have a gross Eu 5.025 trillion, but falling (down 0.5% YoY in July).

The second is to hope, or ensure, that the LDR comes down faster, since a falling LDR amounts to a positive cashflow. It seems impossible to expect that this cashflow can come from the public sector, so it's private sector cashflows which will have to bear the burden. And the problem is, that cashflow is drying up very fast too. Take a look at this: 

What I'm measuring here is the difference between the rise in private sector deposits (cash in) vs the rise in loans made to the private sector (cash out). In the 12m to July, this calculation shows a net cash inflow to the banks of Eu 88 billion. This is chicken-feed compared to the previous crisis-peak of Eu 522 billion in the 12m to September 09. And things are getting worse: in the 6m to July, the net cash inflow was . . . just Eu 1 billion. In the three months to July, there was a net cash outflow of Eu 48 billion (though part of this outflow is seasonal).

From this, we can draw the following conclusions. First, we must expect another severe credit squeeze for Europe's private sector, starting right now. Second, we must expect Eurozone banks to sell-down foreign assets, starting right now. So far as I can tell, these are the only way to square the circle.