Debunking myths in the financial system- an annual review

Last week saw Citigroup’s credit conference & an opportunity for investors to catch up with a number of European high yield issuers. For a number of companies the message continues to be one of uncertainty, not least with regard to their banking relationships.

Back in 2008 Richard & I blogged about companies drawing down on bank lines (see here). Companies like CIT were doing so as they were finding it increasingly difficult to fund, whilst the likes of Porsche saw an opportunity borrow cheaply and then deposit the funds at a higher rate.

It seems once again companies are looking to draw down committed facilities. However, rather than being born out of an individual company’s distress, the catalyst seems to be the waning confidence in the banking system. At the very point in time when banks are finding it more difficult to fund their balance sheets and to deleverage, they risk seeing companies call on committed lines, which by their nature are not fully funded.

Which leads nicely into the Tuesday’s annual Sovereign and Financial System Review conducted by our financials team. The meeting focussed on the debunking of myths we feel broadly remain common place amongst investors.

Whilst the substance of the meeting is outside the scope of any one blog, and merely listing the myths taken out of context, I figured  it was a worthwhile exercise anyhow to list those myths that have been debunked over the last 12 months or so, as well as those that continue to circulate:

The myths that are being debunked:

  • No more banks will be allowed to go bust
  • Banks have deleveraged already
  • Banks have already restructured
  • National champion banks will be fine
  • Covered bonds are bullet proof
  • Supra and agency bonds are ‘guaranteed’
  • It’s ok, there’s a bail out fund
  • Germany’s fine- they’ll bail us out
  • Governments will abide by EU treaties
  • Insurance Sector is a ’safe haven’
  • You don’t need to do sovereign analysis
  • Credit analysts can’t do sovereign analysis

The myths that are still believed to varying degrees in the market, or that have appeared recently, and give rise to the most discussion around here at the moment, :

  • It’s easy, just look at the debt/GDP ratio (for sovereigns)
  • It’s ok if you have commodity exports
  • It’s ok if most debt held domestically
  • Just look at net external debt
  • Just look at current account deficit
  • Sovereign debt doesn’t need documentation
  • Eurozone breakup is unthinkable
  • Docs or English law prevents redenomination
  • Foreign bonds are in some way better
  • You can work out impact of Eurozone break up
  • Bond lawyers can tell you what you need to know
  • As long as the bank is profitable, it’s ok
  • XYZ bank is highly profitable based on its net interest margin
  • Capital ratios or non-performing loan ratios are an indicator of solvency
  • Leverage ratio (equity/assets) will be the most useful
  • The yield curve determines how banks do
  • Household leverage is an indicator of problems or a lack thereof
  • Some banking sectors are ‘safe havens’
  • Banks have improved their funding profile
  • Banks have increased their deposit bases
  • Banks have lots of collateral available
  • Banks can always raise secured funding or repo
  • Banks have successfully prefunded maturities
  • National champion banks will be fine
  • Government bad bank structures are working
  • Central counterparties eliminate risk of financial defaults
  • Repo market can value corporate bond collateral
  • Repo market increases transparency
  • Collateralisation has reduced counterparty risk
  • “Too big to fail banks” will still get some sort of support
  • Secured debt will be fine
  • Agencies/supranationals are implicitly guaranteed
  • It’s ok, the banks can just go to the ECB for repo
  • National central banks can’t create credit
  • A crisis is a buying opportunity
  • We’re at the bottom, things will rally now
  • Export/investment will recover quickly
  • Asia/rest of the world will bail us all out
  • Countries with own currencies recover quicker

Congratulations to those of you who made it to the end of that list. I imagine you are an elite few!

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Stefan Isaacs

Job Title: Deputy CIO Public Fixed Income

Specialist Subjects: Bonds

Likes: Football, travel and the prospect of retirement

Heroes: Sir David Attenborough, Bill Shankly and Theodor Herzl

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