Value Walk - Mark Melin - 21 November 2016
Whisper talk during Brexit was that EU was going to have financial issues with their banks
Perhaps the man who at times can be the most anti-consensus thinker and then at times spew the bank’s herd thinking is Steve Eisman of “Big Short” fame. He didn’t disappoint in a recent interview he gave to The Guardian, but his comments are even more interesting when connecting dots to Wall Street whisper talk.
During the Brexit debate, when Wall Street bank analysis sent pretty much the same message that Brexit would be a disaster and was unlikely to succeed, independent financial analysts thought differently.
This analysis mostly had nothing to do with their personal rejection of the “establishment” or sending a political message as it did with unemotional financial considerations that were being ignored. To sum up what turned out to be the correct Brexit analysis was that the European Union had little discussed financial problems on the horizon, much of it resulting from a shaky regional banking sector.
Their analysis wasn’t discretionary or opinionated as much as logical. In part, banks in the European Union were teetering on insolvency and were likely to require a massive bailout that was generally being underestimated. This was a topic little discussed in the mainstream at the time, but more in whispers as oddly are many important issues. The European Union was already a financially diverse family with the wealthiest country, Germany, having benefited greatly from a common currency while many countries, Greece, Italy and Portugal, piled up debt, much of it now insolvent.
This is where Steve Eisman’s analysis enters the picture.
Steve Eisman: Italian banks in trouble, “Europe is screwed”
Eisman notes the massive problems in the European banking sector, pointing specifically to Italy but also giving a nod to Deutsche Bank. The whisper talk months ago was that Italian banks were going to require a bigger bailout, it was just a matter of when and who would take responsibility. Initial bailout numbers were said to be woefully on the optimistic side as a battle emerged as to the EU or Italian government taking bailout responsibility. (Interestingly the Italian Referendum is, in part, designed to assist the government in bailout out the banks.)
Eisman, for his part, draws a relative value contrast to the UK banking sector – analysis that was, in part, discussed during the Brexit debate but was mostly muted in the mainstream.
The problem in Europe, on the surface, is non-performing loans. In Italy in particular, Eisman notes that loans in default have not been fully written down by the banks. These loans, which account for billions upon billions in assets on bank balance sheets, have been discounted by nearly 50% — but they should be written down to nearly 20%. If this was done, however, the EU picture, particularly in Italy, would change greatly.
“Europe is screwed. You guys are still screwed,” Eisman told the Guardian. “In the Italian system, the banks say they are worth 45-50 cents in the dollar. But the bid price is 20 cents. If they were to mark them down, they would be insolvent.”
Eisman doesn’t name the specific banks that are in part carrying an estimated €360 billion in bad debts. Guardian journalist Patrick Collinson, however, notes that of the 51 banks involved in the European Banking Authority’s “stress test,” Banca Monte dei Paschi di Siena was determined to be the weakest. The bank was also the subject of an odd suicide scandal were unanswered questions are similar to a Swiss suicide surrounded by derivatives and a former Deutsche Bank executive.
Steve Eisman publicly points to a relative value dispersion noted in whispers during Brexit
Looking at Europe, Eisman, in part, sees a relative value trade emerging, with the UK on the buy side and the EU on the sell side, which is a thought that coalesces with independent Brexit analysis to an extent.
“I’m not really worried about England’s banks,” says Eisman. “They are in better shape than most in Europe.”
In the US, Eisman’s comments relative to big bank non-cleared derivatives has been positive, saying that despite the gross notional derivatives exposure rising dramatically since 2008, the bank derivatives are no longer a problem. Eisman did not provide details and his analysis in this regard deviates from other market professionals who note the troubling gross notional disclosure that is many multiples of the world economy still remains nontransparent.
Perhaps one day Eisman will face tough questions from a knowledgeable derivatives professional. And perhaps not.