Fears have faded away
Southern European government yields declined considerably during 2012 and the bond market is open again for states and banks from these countries. Does this mean that the sovereign debt crisis is resolved in Europe? This was one of the questions Lars Kirkeby, Chief Analyst at Norwegian Industrials, answered during his presentation at Nordea Bank in Luxembourg.
Never say never again. This is certainly true for the decidedly indestructible Silvio Berlusconi, who in December 2012 announced his comeback. What happened after this announcement? Lars Kirkeby, Chief Analyst at Nordea in Norway explains, “The markets had been relatively quiet for more than twelve months until former Italian Prime minister Silvio Berlusconi announced his return to politics. The debt market reacted straight away and the credit default swaps (CDS) on Italian debts, on Italian banks and corporations, literally exploded. This is the perfect illustration of a risk factor, which is quite hard for an analyst to measure”.
Banks and corporations in countries like Italy, Spain and Portugal have access to the bond market again. Lars Kirkeby wonders why, since nothing has changed over the course of the last 15 months. These countries are still loaded with debt, so he feels that investors are finding themselves in a scary situation. “Maybe the markets have become tired of talking about this”, he reckons.
Fact is that the volatility in markets has declined quite a lot. The popular “fear index” known as the VIX (Chicago Board Options Exchange Market Volatility Index) is often referred to when describing the level of volatility in the capital markets. VIX are currently trading at levels not seen before the emergence of the subprime crisis. The flooding of liquidity from the European Central Bank (ECB) back in late 2011 and early 2012 had an enormous effect on the liquidity market. “What happened is that the ECB supported the European banks with liquidity and the same banks bought back their own debts at a discount. This is very positive but it is not a long-term solution to the sovereign debt crisis”.
We haven’t seen any signs of a liquidity crisis this time around. There was no panic behaviour in money markets, European banks have had satisfactory access to US dollars and the cash infusion from the ECB has flooded the markets with liquidity.
If you compare the current situation with the collapse of Lehman Brothers, the setting in September 2008 was dramatic, with limited access to US dollars in regional money markets because American banks were holding back their dollars. “Looking at the index comprising credit default swaps on 25 European banks and insurance companies, you can see that the last 18 months have been a hell of a ride for investors” as Lars Kirkeby puts it.
The index hit an all-time high in November 2011 with trading levels at around 360 basis points (bps). No wonder the primary credit market for European banks was more or less shut down during the autumn of 2011, but things have changed since. There has been a significant spread tightening from May 2012, falling from 300 bps to 130. The Nordea expert thinks that the trend will continue. Why?
“The markets are full of liquidity, interest rates are low and there is little fear of defaults”. Historically, the Norwegian bond market has been like an island: not caring much what is going on elsewhere. Volatility is lower in Norway compared to global standards because of a solid banking system with few defaults. But things have changed; since the autumn of 2011, the Norwegian market has strongly correlated with the European market.
There was an all-time high issuance of investment-grade corporate debt in Norway in 2012. The main driver is banks’ tighter lending standards. However, bank financing still constitutes 80% of all corporate financing in Norway. Lars Kirkeby remarks that it is the small and medium sized companies that will have to foot the bill, because their access to credit has become more complicated.
“I feel sorry for the many SME’s who have no access to capital markets and they are at the mercy of banks, who can charge them as much as they want to get a loan because they can’t access the bond market”. In the long run, this is not positive for Norway’s economic growth because small and medium sized companies are large contributors to it. CW