Barnaby Is Right

You may or may not be aware that a big reason behind the current market turmoil, is Europe’s banks. French and Italian banks in particular have been the focus of attention in the past fortnight.

But the problems with banks are not confined to Europe. Consider what one of the best financial blogs in the world had to say recently about the banks of a nation whose economy is disturbingly similar to ours (from Zero Hedge):

Is the next domino to fall … Canada?

While two short months ago, “nobody” had any idea that Italy’s banks were on the verge of insolvency, despite that the information was staring them in the face (or was being explicitly cautioned at by Zero Hedge days before Italian CDS blew out and Intesa became the whipping boy of the evil shorts), by now this is common knowledge and is the direct reason for why the FTSE MIB has two choices on a daily basis: break… or halt constituent stocks indefinitely. That this weakness is now spreading to France and other European countries is also all too clear. After all, if one were to be told that a bank has a Tangible Common Equity ratio of under 2%, the logical response would be that said bank is a goner. Yet both Credit Agricole and Deutsche Bank are precisely there (1.41% and 1.92% respectively), and both happen to have total “assets” which amount to roughly the size of their host country GDPs, ergo why Europe can not allow its insolvent banks to face reality or the world would end (at least in the immortal stuttered words of one Hank Paulson). So yes, we know that both French and soon German CDS will be far, far wider as the idiotic market finally grasps what we have been saying for two years: that you can’t have your cake and eat it, or said otherwise, that when you onboard corporate risk to the sovereign, someone has to pay the piper. Yet there is one place where that has not happened so far; there is one place that has been very much insulated from the whipping of the market, and one place where banks are potentially in just as bad a shape as anywhere else in Europe. That place is…. Canada.

As the chart below shows, which is a ranking of global banks by tangible common equity, lowest first, of the banks with a TCE ratio of under ~4% a whopping 30% are those situated in Canada, the same place where nobody thinks anything can go wrong, and which has been completely spared from the retribution of the bond vigilantes. Something tells us Canadian sovereign CDS, not to mention Canadian bank CDS, are both about to go quite a bit wider.

How do Australia’s banks rate on the Tangible Common Equity (TCE) scale?

Better.

But not that much better.

Take note, dear reader. Here we are about to see a classic example of how our Treasurer wilfully cherry-picks from International Monetary Fund reports.

Here’s what The Goose recently had to say about the IMF’s latest report:

The IMF has just completed a regular review of Australia’s finances.

The Treasurer, Wayne Swan, reported the results.

He said the IMF had noted “our resilient financial system.”

“Australia’s banks are well capitalised, prudently managed, and among the highest-rated in the world,” Mr Swan said.

“The IMF notes that banks have improved their capital positions and reduced their reliance on short-term foreign funding, and that they are well placed to ride out any future financial turbulence in offshore markets,” he added.

Wayne has, as usual, gilded the lily, and put words in the mouth of the “authorities” he quotes.

And, he just “happened” to conveniently forget what else the IMF wrote (emphasis added):

17. Bank profits have recovered and the return on equity for the major banks is now around pre-crisis levels. Capital adequacy has improved, driven both by increases in capital and declines in risk-weighted assets. Common equity as a share of tangible assets has also risen to nearly 5 percent for the four large banks…

Oops.

A TCE of “nearly 5%” is not exactly streets ahead of the Canadian banks. Moreover, “nearly 5%” is actually worse than the 5.42% TCE of Italian bank Intesa Sanpaolo (see ZH chart above), whose shares have been under attack and subject to multiple trading halts in the last fortnight to save it from collapse.

18. Challenges remain, however. Banks may be tempted to take on riskier strategies in an environment of structurally lower credit growth. Household debt remains high (150 percent of disposable income) and a rise in mortgage rates could lead to an increase in bad loans, although current arrears are modest. While we recognize improvements in the composition of banks’ funding structure, their sizable short-term external borrowing still remains a risk. In addition, concentration in the banking sector has increased in the wake of the crisis with the assets of the four large banks now comprising about 75 percent of total bank assets…

Oops.

We have already seen recently, that “riskier trading strategies” is exactly what our banks have been engaged in ( “Fresh Evidence Our Banks In ‘Race To The Bottom’ Means You Can Kiss Your Super Goodbye” ).

21. While banks have reduced their reliance on short-term external borrowing, disruptions in global capital markets could still put pressure on their funding. Therefore, banks should be encouraged to further reduce their short-term borrowing.

Oops.

This reliance on short-term funding is a key reason why Moodys ratings agency downgraded our banks’ credit ratings in May, and warned the govrnment that it must maintain the government guarantee else they will be downgraded further.

And, it is why Fitch Ratings considers Australia’s banks “most exposed” to the European debt crisis.

Funny … I don’t recall hearing Wayne mention any of that.

Do you?

Tags: big four, european debt crisis, government guarantee, IMF, Intesa Sanpaolo, short term funding, TBTF, TCE, wayne swan, wholesale funding