Wednesday, 16 November 2011

Who is still holding toxic Italian debt ?

The Italian yields have cooled-off a bit, revolving around the 6.50%-7.00% area, partially due to the ECB rather frequent interventions and on the news that Mario Monti, a former European Commisioner, will lead the Italian government.  Spanish yields on the 10y benchmark are still high up there at 6.31% after recent weak macroeconomic news and French 10 year bonds rose today to 3.72%. The most solid European country, Germany, which reported today a 0.5% quarterly increase in GDP and its 10 year yields stand at 1.81%. Who is taking this loss ?

Why is Italian debt toxic ?

While the posibility of Italian and French banks, which hold large amounts of Italian debt, to become the next "Too big to fail banks", Italy as a country is definitely "Too big to bail" due to its Eur1.84 trillion public debt. The current 10 year yields are definitely unsustainable for the long term because the service burden of rolling over short term debt may become to high at one point, thus triggering a partial or a total default.

Source: Bloomberg

European Banks cutting exposure

As reported by the Daily Telegraph, Europe's largest bank as measured by assets in management, BNP Paribas has cut its holding of Italian bonds by 40% in the three months to the end of September. It has also applied a voluntary haircut (or mark-down) of 60% on its dead-man-walking Greek bonds. Dutch banking group ING has also cut its Italian exposure by 54% to Eur 3.38 billion, 31% of its Greek debt holdings  and 28% of the Spanish ones.

British bank Barclays, has also been cutting its sovereign debt positions by 31%, from Eur 11.6 billion close to Eur 8 billion in what may be describet as a massive deleveraging. The question here is: Who are their counterparties? Who has been buying European debt, when everybody is selling ?

Blackrock Funds

The world largest asset management company, with assets of over US$3.65 trillion across equity, fixed income, cash management, alternative investment, real estate and advisory strategies, was rumored to hold large amounts of Italian debt, effectively betting on a large scale ECB bailout. While they may be right on the short term (ECB is allowed to make minor market purchases, but not full scale monetizations like the US QE1 and QE2), on the long term, the EFSF (at which Italy is one of the largest guarantors) is not going to be able to guarantee, nor will it be able to purchase much of the Italian debt (currently standing at more than 120% of GDP). More from Bloomberg:

BlackRock Inc., the world’s biggest money manager, said it’s “comfortable” holding intermediate Italian bonds as a surge in yields triggers concern the collapse of the government will force the nation to seek a bailout.

“Our view has been that a solution to stabilize European sovereign and financial markets is very far from conclusion, and thus, maintaining very nominal exposures to some of the countries with substantial refinancing needs was the right portfolio posture,” BlackRock Chief Investment Officer Rick Rieder said in an e-mailed statement to Bloomberg News.
In a separate Bloomberg television interview on Oct. 21, Rieder said BlackRock remained a buyer of Italian government debt as European policy makers were set to gather to address the region’s sovereign debt crisis. “Italy is attractive,” Rieder said during an interview on “InBusiness With Margaret Brennan” on Bloomberg Television that day. Euro finance ministers meet on Oct. 21, followed by ministers from all 27 European Union countries the following day.

We are encouraged that policy makers appear to be meeting and addressing the challenges implicit in some of the recent proposals, and think these debt levels require policy movement and decision-making,” Rieder said in the statement today. “We are optimistic that this will happen over time, but still think that markets will be stressed until that time comes, and thus are maintaining a very conservative posture.”

JP Morgan and Goldman Sachs

As reported today by Bloomberg, the two US investment banks and world largest credit derivatives traders have sold protection (basically Credit Default Swaps) on a notional amount of more than $5 trillion worldwide. It is not very clear how much of this $5 trillion is in European debt, especially Greek debt, but purchasers of such CDS contracts may find themselves in deep trouble as ISDA (the regulating body for credit derivatives) can discretionary decide what is an what isn't a credit event. For example the 50% Greek haircut was decided not to be a credit event by ISDA, and it is not surprising considering that among ISDA primary members we find the world largest CDS sellers: JP Morgan, Goldman Sachs and Deutsche Bank. Bank of America, Morgan Stanley and Citigroup don't list the CDS exposure on a gross basis in their SEC fillings.

MF Global went belly up due to a massive Italian bond bet

One of the worlds largest brokerage houses and US Treasuries primary dealers went into bankruptcy earlier this month as big bets on Italian debt has provoked a liquidity crisis. Jon Corzine, a former Goldman Sachs executive, and CEO of MF Global is accused of segregating customer accounts and using them as a margin for transactions with JP Morgan. All the 1066 employees of MF Global are now long fired and customer accounts in value of $520 million are still missing.

Who else is still at the punchbowl ?

While the ECB is still continuing purchases of Italian bonds and the EFSF may start one day to guarantee coupon payments, it is still unclear who else is still bullish on these bonds.  

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