A Record Amount of Bad Loans

A recent study by Ernst & Young has revealed that euro-land banks in the aggregate now hold € 918 billion ($1.23 trn.) in non-performing loans (7.6% of all loans outstanding). E&Y sees about 15.5% of all loans in Spain and 10.2% of all loans in Italy as likely to be in NPL status (this exceeds the most recent official numbers somewhat).

In light of such staggering numbers, the idea to use the ESM for direct bank recapitalization seems somewhat ambitious. This is especially so as the idea to employ the ESM to take over the costs of already bailed out banks is being pushed by a number of euro area members. No doubt Ireland and Spain would be happy to see that (in fact, Spain is already the 'exception' as the ESM is potentially on the hook for € 100 billion for its banks – but this is structured as a loan to Spain's government, not a direct bank bailout).

The problem is that if the ESM wants to retain its AAA rating, it will have to back any financing it obtains from the markets with far higher guarantees if it rescues banks rather than governments. Given that what has been pumped into ailing euro-zone banks to date already amounts to €300 billion,  its official capacity could be quickly exceeded if these existing bailout commitments were taken over by it.



bank rescue

Taxpayer- funded bank rescues in the euro area so far – the total already amounts to €300 billion, and that is not counting what might be used to bail out Cypriot banks and what may still be required in Italy and Spain (chart via Die Welt).



Ireland has in the meantime been given a bit of breathing space – the ECB has agreed to transforming the Irish promissory notes that were issued for the bailout of Anglo Irish and the Irish Nationwide Building Society into long term government bonds with an average maturity of 34 years and a lower interest rate. This is lowering Ireland's annual budget deficit, but the debt of course remains.

The IMF is also pushing for the ESM to be used to support Ireland's bank bailout, but naturally some in the euro area are balking – among them primarily Germany, which rightly fears it will end up with ever greater commitments, not  a prospect relished by its political leadership in an election year (normally Germany first says no, then says maybe and then says yes, as its desire to preserve the euro area as is seems almost pathological).

In recent weeks, bond yields and CDS spreads on peripherals have continued to decline, pressuring the SovX lower – interestingly, CDS spreads on German debt have increased though (not that they're at a very high level, but it is still interesting that they have gone the other way). The rise in German (and other 'core') bond yields is largely a reflection of the recent 'risk-on' environment, the rise in CDS spreads however more likely expresses the idea that Germany's euro rescue related liabilities keep growing like weeds.




5 year CDS on US treasury debt, German government debt and the Markit SovX index of CDS on 19 Western European sovereigns. CDS on German debt have moved higher since late last year, while the SovX has drifted lower, reflecting the continued decline in CDS on peripheral sovereign debt – click for better resolution.





Charts by: Die Welt, Bloomberg



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