Sunday, December 4, 2011

>GREED & FEAR (Stock Market): Financial Gangrene

Investors this week got a whiff of the ultimate logic of the core contamination trade. This is
that the longer the Eurozone crisis continues, the more likely that it ultimately affects
Germany’s own credit rating. GREED & fear refers of course to the “failed” German bund
auction yesterday. The auction of 10-year German bunds attracted bids totalling only €3.889bn
or 65% of its sales target of €6bn. As a consequence, the 10-year German bund yield surged
by 23bp yesterday to 2.15%.

This is the sort of market pressure that is likely to lead, sooner or later, to German agreement
to a more overt move to monetisation by the ECB. But the German demanded quid pro quo for
such a development will be a move to a more concrete fiscal union, as discussed here
previously. Still as this week’s bond auction makes clear, Frau Merkel cannot wait too long. For
otherwise Germany’s own credit will be undermined by the spreading disease caused by
Euroland’s fault line, namely monetary union without fiscal union. Still for now Frau Merkel has
continued to tolerate this financial equivalent of spreading gangrene. Thus, this week she
seemingly shot down European Commission President José Manuel Barroso’s proposal for
eurobonds. Merkel said in a speech before the Bundestag on Wednesday that “it is extremely
worrying and inappropriate that the European Commission is directing the focus to eurobonds
today,” and that it was false to assume that “collectivisation of debt would allow us to overcome
the currency union's structural flaws”.

Still the pressure continues to mount, even if the French-German bond spread has of late
declined. Thus, the spread between the 10-year French government bond yield and the 10-year
German bund yield, which rose to a euro-era record high of 190bp on 16 November, has since
fallen to 154bp due to a 33bp rise in the German bund yield over the past week (see Figure 1).
Investors should continue to focus on this spread. But they also now need to keep an eye on
the absolute level of bond yields, both in the case of the French and German ten year bonds.
This is because the time has now passed where it only made sense to look at spreads.
Meanwhile, it is becoming ever clearer that the contagion in the Eurozone sovereign bond
markets has been aggravated by the efforts not to trigger CDS payments in the proposed
private-sector “voluntary” Greek debt restructuring. The result has been to motivate banks to
sell their underlying bond holdings since they can no longer be sure that they can hedge these
positions. It is interesting whether this unintended consequence of the latest Greek bailout package has finally caught the attention of European policymakers. It probably has since it finally caught the attention of the editorial writers in the pinko paper today (see Financial Times article “In praise of CDS”, 24 November 2011). Still the damage has already been done.

To read report in details: FINANCIAL GANGRENE

>BANKING SECTOR: Corporate Debt Restructuring (CDR) picks up pace; serves as worrying lead indicator for non-CDR restructured assets

High interest rates, waning business confidence and subdued macroeconomic environment has precipitated increase in restructuring cases over the last couple of quarters. In Q2FY12, total cases referred under Corporate Debt Restructuring (CDR) increased to 19 vs. 16 in Q1FY12. The total CDR amount involved however, went up over 5x QoQ – from Rs56.7 bn to Rs288.9 bn in Q2FY12. Though Q2FY12 figure constitutes only 0.7% of total banking sector advances, the worrying aspect is that CDR may serve as a coincidental indicator for non-CDR cases. Over FY04-FY11, non-CDR restructuring has averaged ~5x the CDR amount. Total amount involved under CDR in H1FY12 was Rs345.6 bn, highest since last 8 years. Further looking at the pace of increase in CDR cases, total restructuring (CDR + Non CDR) is expected to put significant stress on the banking system.

CDR referral delays stress asset recognition and provisioning
Corporate Debt Restructuring (CDR) framework ensures timely and transparent mechanism for restructuring the corporate debts of viable entities facing problems, outside the purview of BIFR, DRT and other legal proceedings, for the benefit of all concerned. The scheme covers
  • Only multiple banking accounts, syndication/consortium accounts, where all banks and institutions together have an outstanding aggregate exposure of Rs100 mn and above.
  • Involves approval by super-majority of 75% creditors (by value) which makes it binding on the remaining 25% to fall in line with the majority decision.

Once a case is referred to CDR, a ‘standstill’ period of 90/180 days is revoked. Within the ‘standstill’ period, both the borrower and lender agree to keep things as they are (standstill) and commit themselves not to take recourse to any legal action during the period. ‘Standstill’ is necessary for enabling the CDR System to undertake the necessary debt restructuring exercise without any outside intervention, judicial or otherwise.

Due to the ‘standstill’ clause, the category of the asset continues to remain as it is in the books of the banks. This prevents banks from making additional provision on account of restructuring (for standard assets) and also help them ‘gain’ additional time period (in the form of standstill period) before the provisioning on restructured accounts hit their profitability.

The accounts of borrowers engaged in industrial activities (under CDR Mechanism, SME Debt Restructuring Mechanism and outside these mechanisms) continue to be classified in the existing asset classification category after restructuring. This benefit of retention of asset classification on restructuring is not available to the accounts of borrowers engaged in non-industrial activities except SME borrowers.

India banking restructured book set to expand
We undertook an exercise to analyze and gauge the cases being referred to CDR cell so as to get a sense on the medium term outlook of banking sector in India, which we believe is troublesome. Number of cases that has been referred to CDR has increased from 35 in the first half of FY12 as compared to 22 in the same period last year. Corresponding amount of loan referred has also increased to Rs345.6 bn in H1FY12 as compared to Rs51.8 bn in H1FY11. However, there is a one-off in H1FY12 due to the total debt of Rs226.2 bn of GTL group (Chennai Network India Limited, GTL Ltd and GTL Infrastructure). Excluding the total debt of GTL group, the total figure still stands at Rs119.4 bn, which is ~2x compared to last year.

In Q2FY12, total amount referred under CDR was Rs288.9 bn. We have tried to estimate the increase in restructuring by various banks in the coming quarters (see table below). Out of the above Rs288.9 bn, our analysis covers only Rs180 bn of debt due to lack of complete data, which is not public.

To read the full report: BANKING SECTOR