Spain too big for EU rescue fund as China recoils

As Spain edges closer to a full sovereign rescue, economists have begun to doubt whether the EU bail-out machinery can raise such large sums funds at viable cost on global capital markets.
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As Spain edges closer to a full sovereign rescue, economists have begun to doubt whether the EU bail-out machinery can raise such large sums funds at viable cost on global capital markets.
China's sovereign wealth fund said it will not buy any more debt in Europe until the region takes radical steps to restore credibility. Photo: Reuters
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While the International Monetary Fund thinks Spanish banks require €40bn or so in fresh capital, any loan package may have to be much larger to restore shattered confidence in the country.


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Megan Greene from Roubini Global Economics says Spain's banks will need up to €250bn, a claim that no longer looks extreme. New troubles are emerging daily. The Bank of Spain said on Thursday that Catalunya Caixa and Novagalicia will need a total of €9bn in new state funds.



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JP Morgan is expecting the final package for Spain to rise above €350bn, while RBS says the rescue will "morph" into a full-blown rescue of €370bn to €450bn over time -- by far the largest in world history.


"Where is the money going to come from?" said Simon Derrick from BNY Mellon. "Half-measures are not going to work at this stage and it is not clear that the funding is available."


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In theory, the European Financial Stability Fund (EFSF) and the new European Stability Mechanism (ESM) can raise a further €500bn between them, beyond the sums already committed to Greece, Ireland, and Portugal. "There is sufficient fire-power available. In addition, the EFSF/ESM can leverage resources," said Christophe Frankel, the EFSF's chief financial officer.
It may not prove so easy to convince global investors to mop up large issues of debt. "Our clients won't touch the EFSF because nobody knows what it really is. They have cut it out of their benchmarks altogether," said one bond trader.


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The Chinese issued their own verdict on Thursday. The country's sovereign wealth fund said it will not buy any more debt in Europe until the region takes radical steps to restore credibility. "The risk is too big, and the return too low," said Lou Jiwei, the chairman of the China Investment Corporation.


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"Europe hasn't got the right policies in place. There is a risk that the euro zone may fall apart and that risk is rising," he told the Wall Street Journal. The EFSF had hoped to sell yuan `Panda bonds' but this may prove hard.


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Eric Dor from IESEF School of Management in Lille said Spain would have to step out of the EFSF as a creditor the moment it asks for funds. This has instant effects on the residual core. Italy's share rises from 19pc to 22pc, and Italy is in no shape to face extra burdens. France's share rises from 22pc to 25pc, and Germany's from 29pc to 33pc.


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"The credibility of the guarantees given to EFSF bonds would collapse. This would cause an incredible turmoil on the European sovereign debt markets," he said.


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Mr Dor said it would be wiser to let the EFSF recapitalise Spanish banks directly but Brussels said on Thursday that this would be illegal. Germany has in case blocked any move towards mutualization of eurozone bank costs, fearing a slipperly slope towards eurobonds and debt pooling.


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Any rescue must be a loan to the Spanish state, even if the money goes to the bank restructuring fund (FROB). The cost will push Spain's sovereign debt even higher. Chancellor Angela Merkel said that she was willing to use the EU's "existing instruments" to tackle the debt crisis. This means use of a precautionary credit line from the EFSF for countries that are deemed healthy but suffering "limited access" to markets.


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This "decaffeinated" rescue -- as it is known in Spain -- avoids the humiliation of EU-IMF "Troika" inspectors and draconian terms. It is a loan-package with dignity, but it still entails a painful volte-face by premier Mariano Rajoy. He vowed a week ago that Spain would not need external help.


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The EFSF had trouble raising funds last year. The spread on 10-year EFSF yields over German Bunds reached 177 basis points in November. Moody's said at the time that the EFSF "cannot meaningfully support the euro area's large government bond markets."



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The fund placed a 3-year bond last week at 1.116pc, compared to 0.15pc for German 3-year debt or 0.69pc for French debt. In effect, the EFSF is already paying a premium, and that was before the Spanish crisis had fully metastasized.


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The permanent ESM may have more luck when it comes into force next month since it will have €32bn of paid-in capital and a stronger mandate, but it is still bearts the stigma of EMU break-up talk.
"If they want anybody to the buy the rescue bonds, they should make them redeemable in the German currency on the day of the redemption: let us call them D-Mark bonds," said Charles Dumas, head of Lombard Street Research.


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The EFSF's Mr Frankel told Euromoney that the financial media was "biased towards the Anglo-Saxon approach" and had not properly taken into account the great improvent in the current account deficits of Club Med states.


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Perhaps, but it is China, Japan, and Saudi Arabia he has to worry about.


Hulbert on Markets
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FRIDAY, JUNE 8, 2012
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Gold Can Finally Redeem Itself
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By MARK HULBERT

Though bullion has disappointed many in recent months, the contrarian sentiment indicators bode well for the metal.
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Take heart, gold traders!



Though bullion's behavior over the last couple of months has been frustrating at best, it's worth remembering that the precious metal is still modestly higher than where it stood at the beginning of the year. That's even the case in the wake of gold's plunge on Thursday after Fed chairman Ben Bernanke said that the Fed would not immediately implement a third round of quantitative easing, or QE3.


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It's also worth remembering that the dejection that currently grips the gold market is a good sign from a contrarian point of view.



Yes, yes, I knowcontrarian analysis has been bullish on gold at least since mid-March, and so far gold has failed to respond. After having frustrated gold traders for nearly three months, why should contrarian analysis suddenly prove to be on target now?



My answer: Gold's recent weakness in the face of favorable sentiment conditions is extremely rare -- so rare as to be the exception that proves the rule. In fact, there has been only one other time over the last three decades when bullion performed as poorly in the wake of bullish-sentiment conditions. And it soon thereafter rebounded smartly.





Consider the average recommended gold-market exposure among a subset of short-term gold timers tracked by my Hulbert Financial Digest (as measured by the Hulbert Gold Newsletter Sentiment Index, or HGNSI).



Let's turn the clock back to mid-March, which is when contrarian analysis turned bullish on gold.
That bullish turn was prompted by an extraordinary exodus of gold timers away from the bullish to the bearish camp. Over the 14 trading sessions from late February until March 19, during which time gold fell by around $140 an ounce, most of the previously bullish gold timers I monitor threw in the towel.



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The HGNSI plunged from 51% to -16%, with this negative level indicating that the average short-term gold timer was now advising his clients to allocate a sixth of their gold-oriented portfolios to going short.



In my three decades of tracking gold-market sentiment, I hardly ever had witnessed a 67-percentage-point drop in average exposure level in just 14 trading sessions. That is what led contrarian analysis to conclude that the sentiment winds had shifted to begin blowing in the direction of higher-gold prices.


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The anticipated gold rally never materialized, however. To the contrary, from March 19 until the end of May, bullion dropped another $120 per ounce, or 7%. The PHLX Gold/Silver index, a group of precious-metal mining stocks, fell even further, dropping more than 12% over the same period.




To determine how unprecedented and unexpected gold's behavior was, I scoured the historical record for any other instance in which bullion dropped as much in the wake of similarly bullish-sentiment conditions. I came up with just one since mid-1985, which is when the HFD began measuring gold-market sentiment.



That historical parallel dates to the last couple of months of 1997 and first trading sessions of 1998. After frustrating contrarians over that three-month period in which sentiment conditions were favorable, gold proceeded to turn in very handsome gains -- 7% over the subsequent month and a full 10% over the subsequent quarter. The XAU's corresponding gains were even more spectacular -- 15% over the next month and 30% over the subsequent quarter.



To be sure, gold's experience in 1998 provides just one data point. So if that were the only basis for contrarians' current confidence, you'd have every reason to be skeptical.





So as a reality check, I submitted all three decades' worth of daily HGNSI readings to rigorous econometric testing. Those tests confirmed that, at the 95% confidence level that statisticians often use to determine if a pattern is genuine, lower-HGNSI readings tend to be followed by higher-gold returns than in the wake of high-HGNSI levels—just as contrarians have contended over the years.



The bottom line? There has been only one other time over the last three decades in which gold, in the face of favorable sentiment conditions, frustrated contrarians for as long as it has over the last couple of months. And gold rebounded sharply following that prior occasion.



Contrarians even more confidently than before now believe that gold is poised for a significant rally.


ECONOMY
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Updated June 8, 2012, 11:31 a.m. ET
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Housing Agency to Sell More Troubled Loans
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By NICK TIMIRAOS





The Federal Housing Administration, struggling to manage a growing glut of delinquent home mortgages, plans to ramp up sales of the loans to investors, a move that could stave off foreclosure for thousands of homeowners.




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The government agency, which is expected to announce the bulk sale program Friday, has more than 700,000 loans in default, amounting to more than 9% of the $1 trillion in loans it insures. Bulk loan sales are one way the FHA could reduce the backlog of potential foreclosed properties it will have to take back and resell.
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Mortgage-finance giants Fannie Mae and Freddie Mac as well as banks have shied away from bulk mortgage sales despite heavy interest from investors because they would have to sell the loans at such deep discounts. Instead, they modify the mortgages, and if that doesn't work they sell the homes individually, often through foreclosure.



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But FHA rules provide less flexibility on how troubled mortgages can be modified, leaving very little room to cut loan balances. Officials figure that if they sell defaulted loans to an investor for at least the same price as it would cost to foreclose, investors can take more aggressive steps to modify the mortgages, such as reducing principal, to keep the borrower in the houseall without raising costs for the government. If the borrower resumes making payments, the investor could later resell the loan for a profit.




."There will be an incentive for a modification that isn't able to be done under the current system," said Carol Galante, the FHA's acting commissioner. "It will be cost-effective for the FHA....It will be better for the communities."



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For now, the FHA says it plans to sell up to 5,000 defaulted mortgages every quarter. In a small pilot sale in April, the agency sold 279 loans to buyers that paid around $19 million, representing around a third of the outstanding loan balances. It sold about 2,200 loans last year through the program.




.Ms. Galante said the FHA didn't yet have firm data on what share of the loans sold to investors involve the resumption of mortgage payments by delinquent borrowers, or what proportion of borrowers are still living in the houses under a new arrangement with the investor.






The FHA has faced big losses on sales of foreclosed properties, which could make loan sales attractive. The agency now loses about 64 cents on every $1 on mortgages that go through foreclosure. If defaulted loans sell at that discount, the sales won't add to the FHA's losses.



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Investors can't foreclose for six months after buying the FHA-backed loans. Under the agency's revamped "distressed asset stabilization program," they must also agree not to resell for three years at least half the homes backing the loans they buy.






The changes are designed to deter "vulture" investors that buy defaulted loans with the aim of quickly evicting the homeowner and reselling the home.



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"We are trying to change, frankly, the behavior of who's interested in buying these notes," Ms. Galante said.




.The FHA doesn't make loans but insures loans made by lenders that meet certain standards.



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Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved


Will U.S. Banks Cut Their Dividends Due To Basel III?

May 18, 2012

by Dividendinvestr



In a just-released report, Fitch Ratings estimates that the world's largest banks will have to come up with additional $566 billion in order to meet new capital adequacy requirements according to Basel III capital provisions. The report says 29 global systemically important financial institutions (G-SIFI), including major U.S. banks, will have to allocate 23% more in capital provisioned for potential loan losses. For a median bank, this amount would equal to no less than three years of retained earnings. The ratings house suggests that the pressure to meet the new requirements may constrain the banks' share repurchase programs and dividend payouts.




Most U.S. banks have already taken steps to bolster their capital adequacy. The popular Federal Reserve's bank stress tests have shown that the 19 bank holding companies participating in the tests "have increased their tier 1 common capital levels" by nearly 81% between the first quarter of 2009 and the fourth quarter of 2011. "The tier 1 common ratio for these firms, which compares high-quality capital to risk-weighted assets, has increased to a weighted average of 10.4% from 5.4," over the same period, says the Fed press statement about the last round of bank stress tests. In the process, U.S. banks have reduced their dividend payouts from 38% of net income in 2006 to 15% of net income in 2011.




Will the new Basel III rules force the U.S.-based dividend-paying G-SIFIs to slash their dividends in the future? For most institutions, the answer is likely no. According to new Basel regulations, banks will have to boost their tier 1 common capital ratios to a minimum of 9.5% by 2019 (see the image below). The U.S.-based G-SIFIs have already raised their ratios to levels above or close to the upcoming capital adequacy requirements (see the chart below). Moreover, the U.S.-based banks noted below are expected to see a relatively robust growth in earnings over the next five years. This will facilitate the banks' efforts to meet or sustain the new minimum ratios. Still, some banks, such as Bank of America (BAC) -- which is expected to grow its bottom line modestly -- may cut dividends if they appear to be unsustainable and the measure becomes necessary in order to meet new capital requirements.


Click to enlarge all images.Source: Moody
Source: Moody's Analytics.





JPMorgan (JPM) is a $132 billion multinational G-SIFI and the largest U.S. bank by assets. The bank holds $2.27 trillion in assets, including $59.6 billion in cash. It pays a dividend with a yield of 3.34% and a dividend payout ratio of 22%. The bank has attractive valuation; its forward P/E is at a low 7.7, compared with the banking industry ratio of 10.1. This G-SIFI is expected to grow its earnings per share (EPS) by an average of 7.3% annually over the next five years. The bank is currently a focus of investor interests due to a $2 billion and rising trading loss in the bank's synthetic credit portfolio. In regard to this loss, the Department of Justice has opened a criminal investigation. The shares of the company are trading at $34.70, more than 15% below the price level before the loss announcement. Among guru investors, Ken Fisher and George Soros are bullish on JPMorgan.




Wells Fargo (WFC) is a $168 billion multinational diversified financial institution. With assets of $1.3 trillion, it is the fourth largest bank in the U.S. by asset size. The bank holds some $19.4 billion in cash. Wells Fargo pays a dividend yield of 2.7% and has a dividend payout ratio of 20%. The bank has favorable valuation. It is currently trading at 9.5 times its forward earnings, compared with the industry's ratio of 10.1. The bank is expected to grow its EPS robustly over the next five years, with an average growth rate of 10.5% per year. The company is popular with famous investors Warren Buffett and Daniel Loeb.




Bank of New York Mellon (BK) is a $25 billion G-SIFI and the 11th largest U.S. bank by assets. According to Global Finance magazine, it is also ranked the world's 25th safest bank, the only U.S. bank in the top 25 list. The bank pays a dividend with a yield of 2.5% and a dividend payout ratio of 25%. The company has attractive valuation, featuring a forward P/E of 9.2, below the industry average of 10.1. Analysts expect the bank's EPS to grow energetically by an average of 12.4% per annum over the next five years. The stock price is currently down some 14% from the beginning of the month. Famous investors Warren Buffett, Ken Fisher, and Mario Gabelli are all bullish about this global bank.





State Street (STT) is a $20.5 billion financial services company and one of the G-SIFIs. With assets of some $217 billion (including $61.1 billion in cash), it is the 13th largest financial company in the U.S. State Street, both a bank and an asset manager, pays a dividend with a 2.2% yield. It has a dividend payout ratio of 21%. This financial services company is trading at 10.4 times its forward earnings, compared to 10.1 for the banking industry and 12.8 for the asset management industry. In April, the bank stated that it would repurchase some $1.8 billion in shares through the first quarter 2013. The bank's latest dividend payout is back to its split-adjusted high. The company's shares are down 10.5% since the beginning of May. State Street's EPS is expected to increase, on average, by 10.7% a year over the next five years. The company is popular with fund manager Donald Yacktman.




Goldman Sachs (GS) is a $49 billion multinational investment banking and securities trading firm. It has some $923 billion in assets, including $120 billion in cash. This G-SIFI is the fifth largest U.S. financial institution by asset size. The investment bank pays a dividend yield of 1.8%, with a payout ratio of 20%. Its forward P/E is 8.2, below the banking industry ratio of 10.1 and the investment services ratio of 10.8. The bank is currently trading at $98.40 a share, nearly 15% below the price levels on May 1. The company is expected to grow its EPS by 11.7% annually over the next five years. Among fund managers, this investment services company is popular with Ken Heebner and Andreas Halvorsen, both of whom initiated positions in the company in the first quarter 2012.




Morgan Stanley (MS) is a $27 billion global financial services firm and one of the G-SIFIs. The company has $750 billion in assets, including $76.8 billion in cash. It is also seventh largest U.S. financial institution by asset size. Morgan Stanley pays a dividend with a yield of 1.4%. Its dividend payout ratio is 41%. With regard its valuation, the company is trading at $13.60, some 6.4 times its forward earnings. This compares with the ratio of 10.8 for the investment services industry. The stock has fallen about 22% from the beginning of May and nearly 36% since late March. Morgan Stanley is forecast to grow its EPS by an average of 14.6% a year over the next five years. Investment gurus Ken Fisher and Ken Heebner are bullish about this company.




Bank of America is a $76 billion bank with $2.1 trillion in assets (including some $120 billion in cash). By asset size, the bank is the second largest financial institution in the United States. Bank of America pays a small dividend yield of 0.50%. In 2011, it had a dividend payout ratio of 400% of its annual EPS. The dividend does not look sustainable, taking into consideration the new Basel capital requirements. The bank is expected to expand its EPS by an average of 7.2% a year over the next five years. Investment genius David Tepper of Appaloosa Management is bullish about the stock, while Ray Dalio sold out his stake in the company in the first quarter 2012.




Citigroup (C) is a $79 billion multinational, diversified financial services company and one of the G-SIFIs. With assets of $1.87 trillion it is the third largest financial institution in the United States. The bank pays a dividend with a negligible 0.1% yield and a minute payout ratio of 1%. The bank recently failed to meet capital requirements under the Federal Reserve stress tests, reported back in March 2012. Its stock has dropped almost 20% since the beginning of May and, cumulatively, about 30.5% since mid March. Analysts forecast that Citibank will grow its EPS by an average rate of 9% per year over the next five years. The bank is popular with George Soros, David Tepper, and Andreas Halvorsen, while it is out of fashion with Ray Dalio and Julian Robertson of Tiger Management, both of whom closed out their stake in the company in the first quarter.