In which FT Alphaville gets to ask once more why the sovereign crisis in Greece, where Greek banks are in danger, isn’t setting off contagion in Emerging Europe.
Where exposure to Greek banks happens to be rife.
In fact, we aren’t getting contagion at all at the moment. If anything, there’s a disconnect which has only got more massive with time.
We all know that Greece CDS has blown out recently. It hit 1600bps on Tuesday. Although it’s been far less noted that spreads on Romania and Bulgaria stayed fairly range-bound below 250bps. Indeed spreads are at their lowest since the financial crisis, while credit market interest and activity have dropped off too. Lisa Pollack provided these charts of spreads, net notional and activity on Tuesday (we’ll get to why South Africa is there in a second):
And seriously, just to reiterate, both countries’ spreads haven’t been reacting to the risk of a Greek default for a long time.
But in a short time, Greece will be made to restructure its debt or watch it go into default. In some way. Since it’s not clear how the country’s banking sector could fund itself (let alone remain capitalised) given ECB objections to taking defaulted bonds as collateral in that scenario, we still don’t get why the spreads are quieter than ever. Greek banks can’t fund ==> subsidiaries can’t fund ==> the Romanian/Bulgarian sovereign suddenly finds itself in bank rescue territory.
For Greece’s banking sector is, to a large extent, Romania’s and Bulgaria’s banking sector. A couple of charts from Nomura’s emerging market economists on Tuesday (click to enlarge):
And Nomura make this highly interesting point on funding:
Currently, Romanian bank subsidiaries (in Romania particularly given the relative liquidity availability, but also in Bulgaria to a lesser extent) have been funding their parent companies in the local market. Since April last year Greek bank funding costs have been higher in their own domestic market than in Romania. This amount of borrowing has partly been behind RONs relative strength (or to be more exact the NBR has used such outflows as a method of strengthening the currency through relaxed currency policy control) as well as draining liquidity from the local market at a time when rates were already rising (to start with last year at least)…
Presenting the Vienna Initiative Mk 1, reversed.
There are a lot of ironies here. Romanian and Bulgarian subsidiaries of Greek banks are pretty well capitalised (which is one reason for the sovereign CDS not to move) but largely that’s because their parent institutions supported their subsidiaries under the original Vienna Initiative, in 2009. After all, these countries’ property markets were set to tank at that point, and there have been lingering doubts on the region’s private balance sheets ever since.
Now, not only is the Vienna Initiative capital flow effectively going the other way round, Greek lenders are supposed to still be committed to maintaining exposure towards eastern Europe, keeping that kind of doubt in the background. Which is difficult when Europe is talking about a second Vienna Initiative for these banks!
Nomura points out the flaw in both this conseqence of exposure, and a few other scenarios where Greek banking ties become a problem:
– A new Vienna Initiative: Despite an event in the Greek banking system those same banks are still required to maintain capital exposure into Emerging Europe. EBRD and EU provide support and other incentives to make this happen. Such a move however would be difficult and impose additional burdens on an already highly stressed Greek banking sector.
– Business slowdown (least bad outcome): Greek banks severely constrain lending in domestic subsidiaries as parent company funding crowds out domestic business. This is anti-growth for Romania and Bulgaria, though arguably it has already started to occur.
– Greek bank consolidation (bad outcome): Greek banks are forced to consolidate, perhaps into some form of good bank/bad bank set-up. Consolidation causes asset sales in Bulgaria and Romania. With limited foreign interest likely, government or domestic money would be needed, meaning net currency outflow. If a sale was not possible capital withdrawal would then be likely.
– Capital withdrawal (very bad outcome): Greek banks are forced to draw down capital from subsidiary banks to shore up their own balance sheets. The capital flight causes balance of payments stress (requiring reserve utilisation and in Romania’s case potentially tapping the precautionary SBA).
– Subsidiary default threat (very bad outcome): Removal of parent company support causes domestic banks to default but EBRD and the Romanian/Bulgarian government step in and nationalise or cause consolidation within Romania to absorb the bank.
– Outright parent company default (worst outcome): Parent company support is removed, capital is withdrawn, there is a fire sale of Emerging Europe assets. (Even if Greek banks were nationalised or bailed out would the Greek government really want to support Romanian and Bulgarian subsidiaries?)
Nomura note that whichever of the six scenarios happen (and a few of them are probably going to coincide) they will all degrade sovereign credit. So the bank is proposing a CDS trade of buying Romania or Bulgaria and selling South Africa.
Why South Africa?
South Africa has lots of problems, but it doesn’t have the big problem Greece is landing Romania and Bulgaria with right now, Nomura say.
Which is large, external, private debt… (chart via Nomura):
…At risk of going public.
Between Greek default and dodgy Russians – FT Alphaville