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EUROPEAN DEBT CRISIS: WHERE THE BODIES ARE BURIED (THE 13 MOST EXPOSED EU BANKS)

Moving Beyond EBA Conclusions That All is Well

Our view of the European bank stress tests released last Friday is rather dim.  We criticized the leniency of the "adverse scenario" assumptions, noting in particular that the actual deterioration since year-end 2010 is already worse than the "adverse" assumptions in some cases.  (Contact us if you want to see our full note.)

 

While we consider the loss assumptions to be balderdash, the stress tests were valuable in that they disclose a wealth of bank-specific data around sovereign and commercial exposures by country.  Clearly, the greatest default risk is currently in Greece, Portugal and Ireland. Italy and Spain, while on slightly more stable ground, are rapidly deteriorating as well.   

 

In the tables below, we show the exposure to sovereign debt and commercial loans by bank to each PIIGS country. Specifically, we show the top 40 most exposed European banks (among the 91 stress-tested), ranked by gross loans and sovereign debt holdings as a percentage of their Core Tier 1 Capital. Bear in mind that this data is as of December 31, 2010. In addition to showing which banks hold the greatest exposure on a country by country basis, we also show which banks hold the greatest exposure to Greece, Portugal and Ireland collectively, as we view those countries as being at greatest risk for default. Further, we show total exposure to all five PIIGS countries.

 

We highlight in red those banks with 100% or more of their Core Tier 1 Capital in the form of sovereign debt holdings and/or commercial loans to a given country or group of countries. The total exposure groups (all PIIGS) are presented two ways. First, we show exposure sorted by RWA. In other words we show the PIIGS exposure by bank for the 40 largest European banks. Second, we show exposure sorted by % of Core Tier 1 Capital at risk regardless of the size of RWA.

 

Summary Conclusions: 13 of the Top 40 EU Banks Hold Over 200% of their Capital in PIIGS Exposure

We find that there are numerous European banks with over 100% of their Core Tier 1 Capital committed to either PIIGS commercial loans or PIIGS sovereign debt holdings. For example, we found that 18 of the 40 largest European banks held 100% or more of their Core Tier 1 Capital in PIIGS sovereign debt or commercial loans. In 13 of these cases, the banks held more than 200% of their Core Tier 1 Capital in PIIGS sovereign debt or commercial loans. 

 

As a general rule we found that the Nordic banks are the least exposed to PIIGS debt, typically holding less than 20% of their Core Tier 1 Capital, putting them at considerably less risk than the group as a whole.  

 

EUROPEAN DEBT CRISIS: WHERE THE BODIES ARE BURIED (THE 13 MOST EXPOSED EU BANKS) - PIIGS

 

EUROPEAN DEBT CRISIS: WHERE THE BODIES ARE BURIED (THE 13 MOST EXPOSED EU BANKS) - piigs by exposure

 

EUROPEAN DEBT CRISIS: WHERE THE BODIES ARE BURIED (THE 13 MOST EXPOSED EU BANKS) - greece portugal ireland

 

EUROPEAN DEBT CRISIS: WHERE THE BODIES ARE BURIED (THE 13 MOST EXPOSED EU BANKS) - Greece

 

EUROPEAN DEBT CRISIS: WHERE THE BODIES ARE BURIED (THE 13 MOST EXPOSED EU BANKS) - Ireland

 

EUROPEAN DEBT CRISIS: WHERE THE BODIES ARE BURIED (THE 13 MOST EXPOSED EU BANKS) - Portugal

 

EUROPEAN DEBT CRISIS: WHERE THE BODIES ARE BURIED (THE 13 MOST EXPOSED EU BANKS) - Italy

 

EUROPEAN DEBT CRISIS: WHERE THE BODIES ARE BURIED (THE 13 MOST EXPOSED EU BANKS) - Spain

 

Joshua Steiner, CFA

 

Allison Kaptur


European Risk Monitor: Italian Yields on the Rise

Positions in Europe: Long Germany (EWG); Short Italy (EWI); Short EUR-USD (FXE)


Bearish Enough?  We’re getting incrementally more bearish on European sovereign debt contagion, which we’ve expressed by being short Italy and the EUR-USD in the Hedgeye Virtual Portfolio, as the focus turns closer to the heart of Europe:  Italy and Spain.  Here are our updated risk factors weighing on our outlook for Italy and the broader Eurozone over the last week:

 

1.   Yields and CDS Spreads—The Italian 10YR government bond yield is now flirting with the 6% level, having crossed it early last week (before coming in slightly into week-end) and again jumping around the line today.  As we show in the government yield and cds charts below, the 6% level or ~ 525bps CDS line have proven critical breakout lines for Greece, Portugal, and Ireland that shortly after violation necessitated bailout packages. An Italian breach of this 6% yield line could prove particularly damaging for not only the yield demanded at future sovereign bond auctions, but given Italy’s elevated debt exposures the Eurozone’s current temporary EFSF bailout facility of €250 Billion is far underfunded to handle an Italian rescue package. We’d expect headline risk to continue to power both yields and CDS spreads higher over the near and intermediate term, especially as the European community is undecided on how to handle contagion (more below).

 

European Risk Monitor: Italian Yields on the Rise - chart 1

 

European Risk Monitor: Italian Yields on the Rise - chart 2

 

2.    “Sizing” Market Sentiment – With Italy’s economy 3X the size of the combined economies of Greece, Portugal, and Ireland, and with some €1.9 Trillion of debt, or 120% of GDP, which ranks Italy second behind Greece with the largest debt as a % of GDP in the Eurozone [Greece = 144%], market sentiment could turn violently, especially as we learn more about the country’s banking exposures across the region.

 

3.   Austerity’s Timing – While both houses of the Italian Parliament approved a €47 Billion austerity package late last week, essentially €40 Billion in tax hikes and public sector spending and wage cuts are back loaded to 2013/14. In our opinion, this back loading is at odds with a market that is looking for clear-cut signals that Italy has a firm grip on reducing its debt and deficit loads over the near term. The continued erosion in PM Berlusconi’s credibility, including a recent scandal with his Finance Minister, adds only further downside risk. While the case can be made that Italy is in a “better” fiscal spot than a Greece or Portugal with a 4.5% budget deficit (compared to 10.5% and 9.1%, respectively), Italy is heading up against some significant debt maturity repayments in the coming months.

 

4.   Looming Debt Schedule—As the chart below shows, Italy must make debt maturity payments (principal + interest) of ~ €201Billion into year-end, with payments in the months of August and September particularly steep.  For reference, Greece, Portugal, and Ireland have combined debt payments of €62 Billion for the remainder of the year. Weaker demand for future debt issuance and higher interest rates could well snowball and further roil investors.  

 

European Risk Monitor: Italian Yields on the Rise - chart3

 

5.   EU Stress Tests, Part II Disappoint- As Josh Steiner and our Financials Team noted in a post on 7/14 titled “Lunacy: Previewing Tomorrow’s EU Stress Tests”, the tests revealed nothing about the current state of banking exposures as both the balance sheet data and risk assumptions reflected data as of December 31st, 2010. Critically, the tests did not consider assumptions on sovereign defaults, change in ratings, and valuation haircuts were only applied to held-for-trading bonds for each bank, that is, those that are already marked-to-market. We see more downside to Italian bank stocks as more layers of the onion are pulled back.

 

 

Broader Notes on from the Eurozone:

In short, we continue to see gargantuan politicking efforts by Eurocrats to deflect the pressing risks across the region. Over the weekend Trichet told the FT Deutschland that again he’s not working under the assumption that a Eurozone country defaults, a stance that prevents him from having to address the real (and possibly near) concern that a ratings agency rates a peripheral country’s credit in default. A rating of default throws a wrench in ECB collateral requirement rules and debated bank restructuring of peripheral debt.

 

The next calendar catalyst of note is this Thursday’s emergency EU summit to address a new rescue plan for Greece, pegged around €115 Billion. Over the weekend Germany Chancellor Angela Merkel told the FT that she will only attend “if there is going to be an agreement on a new rescue plan for Greece”, while recent discourse suggested a plan would come in mid-September.  Merkel said “she wished to avoid any Greek debt rescheduling, but underlined that the key to a deal would be substantial voluntary involvement of private creditors in easing the Greek debt burden.”

 


EUR-USD

We’re sticking to our bearish outlook on the EUR-USD. Our immediate term TRADE levels are $1.39 to 1.42, with the intermediate term TREND line clearly broken at $1.43.

 

 

European Financials CDS Monitor 

Not surprisingly, bank swaps in Europe were mostly wider last week.  37 of the 38 swaps were wider and 1 tightened.   ISDA ruled that the Bank of Ireland experienced a credit event (restructuring), triggering a settlement on the credit default swaps.  Accordingly, swaps are not trading this week for Bank of Ireland. 

 

European Risk Monitor: Italian Yields on the Rise - chart 4

 

Stay tuned as this volatile soap opera charges on.

 

Matthew Hedrick

Analyst


Breakdown: SP500 Levels, Refreshed

POSITION: No Position SPY

 

Both the TRADE and TREND lines for the SP500 are currently broken. That’s not good.

 

Across durations, here’s the SP500 setup (it’s a Bearish Formation – bearish TRADE, TREND, and TAIL): 

  1. TAIL = 1377
  2. TREND = 1319
  3. TRADE = 1301 

At the same time, the VIX has broken out into what we call a Bullish Formation (bullish TRADE, TREND, and TAIL): 

  1. TRADE = 18.98
  2. TREND = 17.59
  3. TAIL = 19.39 

So what do you do with that? I usually start with what you don’t do – don’t start playing the “valuation” game. Valuation isn’t a catalyst in a Bearish Formation. In many cases, it sucks you in early. Being early can be painful.

 

In the immediate-term, I have a loose TRADE line of support for the SP500 at 1291 and a VIX level of resistance of 22.93. Stay hedged.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Breakdown: SP500 Levels, Refreshed - 1


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ANOTHER SOLID WEEK IN MACAU

After 17 days, Macau remains on track to hit our July estimate of HK$22.5-23.5 billion of gross gaming revenues (GGR), up 42-48% YoY. 

 

 

Table revenues were HK$12.4 billion for those 17 days, averaging HK$729MM per day.  Average daily revenues for the past week were below that of the first 10 days but that was anticipated in our projection.  The first 10 days contained 40% weekend days versus only 29% for the past week.

 

MPEL looks like the clear market share winner here in July with a 220bp increase in share over its post Galaxy Macau average share.  LVS and MGM seem to be struggling thus far.  We don’t have the Mass vs VIP vs hold breakdown but we are guessing that MGM market share loss was hold related while LVS continues to lose VIP volume share. 

 

WYNN reports earnings tonight and we are anticipating a big beat and positive commentary about July.  MPEL should post the biggest Q2 beat and management should communicate a significant amount of forward optimism given the July performance of City of Dreams and Altira.   

 

ANOTHER SOLID WEEK IN MACAU - Macau July


Weekly Latin America Risk Monitor: Market Likes Socialism

Conclusion: Last week equity investors bid up the socialist economic policies of Venezuelan president Hugo Chavez and Peruvian president Ollanta Humala. Moreover, the BRL’s negative divergence calls attention to a longer-term issue for the Brazilian economy.

 

This is the second installment of our now-weekly recap of prices, economic data, and key policy action throughout Latin America. We’re aiming to keep our prose tight here, so if you’d like to dialogue more deeply regarding anything you see below, please reach out to us at .

 

PRICES

 

Week-over-week, the equity markets voted “yes” for the socialist economic policies of Venezuelan president Hugo Chavez (Venezuela Stock Market Index +5.8%) and newly-elected Peruvian president Ollanta Humala (Lima General Index +2.2%). We used the strength in Peruvian equities to short the EPU in our Virtual Portfolio. In the FX market, the Brazilian real (BRL) brought up the rear (-0.9% wk/wk), largely due to the newly imposed capital controls introduced by the central bank (see details below). From a credit perspective, CDS spreads widened on a regional basis with Colombia leading the way from a percentage change perspective. On major callout from our cross-asset-class correlation analysis is the incredibly high positive correlation  developing between the MSCI Latin American Equity Index and the US 10yr Treasury Note (r² = 0.92 on a 3wk basis).

 

Weekly Latin America Risk Monitor: Market Likes Socialism - 1

 

Weekly Latin America Risk Monitor: Market Likes Socialism - 2

 

Weekly Latin America Risk Monitor: Market Likes Socialism - 3

 

Weekly Latin America Risk Monitor: Market Likes Socialism - 4

 

Weekly Latin America Risk Monitor: Market Likes Socialism - 5

 

KEY CALLOUTS

 

Brazil: Central bank president Alexandre Tombini iterated that it would take “six to nine months” for the “full effect” of their tightening to be felt. It’s clear the Bovespa (-14.2% YTD) is pricing this slowdown in growth over the next 2-3 quarters. Last weekend (7/9-7/10), the central bank dramatically increased reserve requirements for Brazilian banks’ short-dollar positions. The move is designed to reduce the Brazilian banking system’s net short exposure the USD by a third. On a long-term TAIL basis, we are concerned that the central government’s intervention in the FX market will limit the country’s growth relative to consensus expectations. Simply put, at 16.5% of GDP, Brazil doesn’t save enough gross national savings to account for the large projected acceleration in fixed capital formation over the next 3-5 years.

 

Mexico: It was a great week for Mexico from a economic data standpoint; April Gross Fixed Investment growth accelerated to +7.2% YoY, May Industrial Production growth accelerated to +4.6% on a YoY basis and +1.1% on a MoM basis, and June ANTAD Same-Store Sales growth came in much faster at +4.2% YoY (vs. -0.9% prior). Central bank governor Ron Carstens has shown his Keynesian resolve over the last three years by keeping Mexico’s benchmark interest rate at an all-time low and we believe market expectations for tighter monetary policy will continue to be extended into the future as Mexican CPI fails to breach the central bank’s  full-year 2011 target of 4%.

 

Chile: Despite June CPI sequentially accelerating to +3.4% YoY, the Chilean central bank used “signs of moderation” in domestic output, demand, and its labor market to hold its benchmark interest rate flat at +5.25%. This is counter to what the central government is seeing, as evidenced by them raising their 2011 GDP growth forecast +50bps to 6.6%. Our models put us closer to the central bank, and we expect to see a protracted slowdown in the rate of Chile’s YoY GDP growth in the quarters ahead. Look for that to weigh on its currency, the Chilean peso (CLP), which has been Latin America’s best performer over the last year (+15.9%). On the flip side, a bullish breakout in copper prices supported by a positive reevaluation of Chinese demand is (CLP/copper positive correlation: r² = .90 on a 3wk basis) is incrementally supportive of the CLP.

 

Peru: Aside from the move we made in our Virtual Portfolio on Friday (short EPU), the key callout from Peru this week is that its monthly Real GDP index slowed in May to +0.5%, which was the slowest MoM growth rate in over a year. Weak business investment (perhaps due to the uncertainty surrounding June’s presidential election) is cited as a culprit for the slowdown. Given that the business-unfriendly Ollanta Humala did indeed win, we expect to see further weakness here over the intermediate term as Peruvian corporations take a wait-and-see approach towards Humala’s economic policy. We expect foreign investors to do the same, and we expect Humala to eventually reveal himself as the far-left-leaning socialist the market ascribes him to be.

 

Argentina: The Argentinean government filed criminal charges against an independent research firm for reporting “false” inflation statistics. Further, the IMF gave the country a 180-day ultimatum to dramatically improve the quality of its economic data, which many believe to drastically understate CPI and overstate GDP. Should the Argentinean government fail to comply with the deadline, a soft threat of “necessary measures” was issued. We believe all countries make up the numbers to some extent, but Argentina is widely considered the poster-child in this regard.

 

Venezuela: Ailing president Hugo Chavez continued on his socialist, inflationary bend, this time forcing the central bank to transfer another $1.5B of international FX reserves to an off-budget development fund designed to finance infrastructure investment. This would take the YTD total amount injected into the “Fonden Development Fund” to $3.5B and the lifetime total north of $40B (since 2005). It’s not surprising to see that such injections have had a profound impact on Venezuela’s CPI, currently running over +25% YoY. Still, Chavez plays ignorant, saying alongside the announcement, “In the past, the central bank didn’t want to give resources to the government, [and] they refused citing inflation and using monetary stability as an excuse. It was the IMF running things. Now we’re free. That’s independence.” Perhaps “independence” is Venezuelan code for “inflation”.

 

Darius Dale

Analyst


TALES OF THE TAPE: CMG, MCD, GMCR, YUM, MSSR, BOBE, DRI, KONA

Notable news items and price action from the restaurant space as well as our fundamental view on select names.

 

MACRO

 

It’s not a great time to be an American consumer as confidence in Washington’s ability to run the country effectively wanes.  No doubt the current debt ceiling debate is doing little to boost consumers’ perception of their representatives.

 

On Friday, it was reported that confidence fell 7.7 points sequentially to 63.8 in June, the biggest decline since March and the lowest level since March 2009.  The expectations component led the decline, dropping 9 points to 55.8 (lowest level since March 2009) and the assessments of current conditions dropped 5.7 points to 76.3 (lowest level since November 2009).  This is not a shock to anyone paying attention to the data; the economic drivers of confidence remain very weak.

 

TALES OF THE TAPE: CMG, MCD, GMCR, YUM, MSSR, BOBE, DRI, KONA - UofM CCS 1 08 to 7 11

 

TALES OF THE TAPE: CMG, MCD, GMCR, YUM, MSSR, BOBE, DRI, KONA - subsector table

 

 

QUICK SERVICE

  • CMG (7/19) and MCD (7/22) report earnings this week.  The MCD results, in particular, will be important for the QSR space price action into the weekend.  These stocks have both hit all time highs recently.  Any disappointing results could bring some meaningful price corrections.
  • GMCR’s first ever TV commercial is airing this summer.
  • YUM traded down 1.5% on strong volume during Friday’s trading session.       

 

FULL SERVICE

  • MSSR - Tilman J. Fertitta announced that he is terminating, effective immediately, his previously announced tender offer to acquire, through his affiliate LSRI Holdings, Inc., a subsidiary of Landry's, all shares of common stock of McCormick & Schmick's Seafood Restaurants, Inc. in order to participate in MSSR's previously announced sale process.
  • BOBE - My bottom line is that sale-leasebacks don’t create shareholder value.  There are numerous examples in the retail/restaurant sector that validate this thought.  Just ask CBRL!
  • DRI’s Red Lobster ads are working.  The recent example of the TV commercial promoting the Four Course Seafood Feast was, according to Nielsen’s Recall Index, the sixth most remembered “new ad” of June 2011.
  • KONA traded up 4.2% on accelerating volume.

TALES OF THE TAPE: CMG, MCD, GMCR, YUM, MSSR, BOBE, DRI, KONA - stocks 718

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


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