Forget Apple, Slovenia was the real deal

All that matters for the US media is the stock market. Just take a look at the TOP category in Bloomberg or tune into CNBC for… well… as long as you can bear it. And of course many put the “=” sign between the US equities and Apple. Therefore, last week’s premier issue of Apple bonds grabbed all the headlines. Granted, it was a bond, not a stock but it’s Apple so it can still rule the global economic reports. But honestly, in the greater scheme of things this issue had really zero relevance for anything. Yeah, probably the PIMCOs of the world decided to park some cash there expecting that high outstanding value would boost liquidity in the secondary market. Plus, there were some comments about Apple’s tax bill but that’s about it.

I think something considerably more important happened in the small European country of Slovenia.


After several days of roadshowing, the troubled Slovenia decided to open books for 5 and 10y bonds on Tuesday (30 April). Given that in the previous weeks peripheral bond markets rallied like mad, it wasn’t too heroic to assume that the book-building would be quite quick. Indeed, in the early afternoon books exceeded USD10bn (I guess Slovenia wanted to sell something around 2-3bn) and then reached a quarter of what Apple managed to get in its book building. If I were to take a cheap shot I would say that Slovenia’s GDP is almost 10 times smaller than Apple’s market capitalisation* but I won’t.

And then the lightning struck. Moody’s informed the government of an impending downgrade, which has led to a subsequent suspension of the whole issuance process. I honesty can’t recall the last time a rating agency would do such a thing after the roadshow and during book-building but that’s beside the point. That evening, Moody’s (which already was the most bearish agency on Slovenia) downgraded the country by two notches to junk AND maintained the negative outlook. This created a whopping four-notch difference between them and both Fitch and S&P (A-). The justification of the decision was appalling. Particularly the point about “uncertain funding prospects”. I actually do understand why Moody’s did what it did – they must have assumed that the Dijsselbloem Rule (a.k.a. The Template) means that Slovenia will fall down at the first stumbling point. But they weren’t brave enough to put that in writing and instead chose a set of phony arguments.

Anyway, May 1st followed and the book reopened for bids only on Thursday. In the meantime, it was interesting to see what happened in the secondary market: the existing Sloven22 USD bonds got given on Tuesday at 99.00, they were sold just below 98.00 on Wednesday and by the time the books restarted they were firmly on their way towards par. I know markets don’t care about ratings these days but this was a pretty extreme vote of no-confidence for Moody’s.

I took advantage of the fact that May 1st is a holiday across Europe and had a few meetings with fund managers here in London. All of them were telling me the same thing, i.e. that they hope that the downgrade would cheapen the deal by at least 10bp. They “hoped” but didn’t really think that would happen. This sharply contrasts with some analysts’ comments who said that the downgrade could cost Slovenia around 100bp (i.e. from 6 to 7% in yield). Imagine that – some people seriously thought Slovenia would have to pay more than Rwanda (no disrespect, of course).

Then the big day came – books reopened, bids were even stronger than during the first attempt and Slovenia sold 3.5bn worth of 5 and 10y bonds. On Friday, the new Sloven23s traded up by more than 4 points, which means yield fell by more than 50bp from the 6% the government paid. A fairy tale ending.

So why do I think this event was so important? Because it shows how different the perception of European sovereign risk is. I wrote a few times about it (see here and here) partly making fun of people who thought that Slovenia would be the next Cyprus. Now, don’t get me wrong, I don’t think that Slovenia is out of the woods yet. In fact, the 3.5bn cash injection could make the government less eager to push for necessary reforms (for details, do check an excellent summary of a great paper by @GoodRichWatts which can be found here). But the emotional reaction to the Cyprus debacle was ridiculed by the market. In other words, just because something happened in one part of the Eurozone, it doesn’t mean that there will be an impending domino effect, or an outright tsunami.

Perhaps issues from both Apple and Slovenia have only proved that investors will buy anything that yields. But I strongly believe that in the case of Slovenia we got something much more important in terms of where the crisis in the Eurozone is headed. If you want to be short Europe, feel free to do that but better check whether your story holds first and don’t count on panic spreading quickly.

* Comparing a country’s GDP with a company’s market capitalisation is ridiculous, though because one is flow and the other one is stock. But this sort of comparison is what would get me quoted on Bloomberg so I couldn’t resist. For the record, if you wanted to compare a country’s GDP to anything from the corporate finance world it should rather be sales, in which case Slovenia is a third of Apple.

Systemic ain’t what it used to be

I remember that in the first days after the bankruptcy of Lehman Brothers, many believed that the collateral damage would not be terrible. I distinctly recall asset managers who were still eager to discuss idiosyncratic factors in some emerging markets. Not that I was so much smarter back then – after all, I did not send an email entitled “SELL EVERYTHING”. Of course shortly afterwards came an avalanche and dominoes started falling. All of a sudden everything appeared systemic, even things you wouldn’t normally care about.

Just to give you a few examples from my turf:

  • Iceland was relevant because of huge assets of local banks outside of the country (aka Icesaave);
  • Hungary (and CEE in general) was key for survival of Austrian and Italian banks;
  • Latvia threatened the stability of the banking system in Sweden;
  • Ukraine was a big risk for French banks;
  • The Middle East… well, it’s always considered to be a tail risk anyway.

One could extend this list quite a bit.

Considering the fragility of the financial system back then, any of those factors could’ve spiralled out of control. Therefore we had various programmes, such as the Vienna Initiative which were aimed at ring fencing potential fallout. When that initial phase of panic ended (with the London Summit) we had a brief period of calmness followed by the mighty Eurocrisis.

This one has been very similar to the initial “Lehman” stage. First came Greece, which initially was considered to be not that relevant. That was the case until roundabout the PSI Summit of 2011, which – perhaps inadvertently – wreaked havoc in the system. There was also Ireland with its “bad bank” ideas and the Iberia with all sorts of problems. And then, again, everything became systemic and potentially fatal. The culmination of it all was in my opinion when a) the market went after Italy and b) people wanted the Bund to start trading with a credit premium (search Bloomberg headlines towards the end of 2011 if you want to see that actually was the case).

Like with the Lehman, many people missed the Eurocrisis trade and began making up for that by creating more or less far-fetched implications. I described this mechanism in one of my previous posts about Slovenia. But does anyone really care about Greece or Ireland anymore? I know there’s punting going through in GGBs and some when-in-trouble-double funds made a killing buying Irish bonds but in terms of global significance this is barely relevant. Similarly, we shouldn’t really care about Cyprus, although some people are trying to persuade us it’s yet another reason to buy gold bitcoins and hide.

In this vein, I was actually pretty impressed with recent comments from Jeroen Dijsselbloem. He is right and he knows he can take a bit of a gamble by speaking his mind: not everything is systemic. And if something is then, well, we have the Draghi Doctrine.

Granted, Europe is pretty screwed economically and this won’t change anytime soon but this is a completely different set of issues than forecasting the total annihilation of the financial system. The two most important measures of stress, i.e. the cross-currency basis between EUR and USD as well as the BOR-OIS spread are telling us that we should change the way of looking at European affairs. And maybe this is the answer to a tweet from Joe Weisenthal asking why on Earth is the euro so stable. The euro has plenty of reasons to fall and I have been suggesting short EUR/EM positions lately but systemic just ain’t what it used to be.

But you start to follow the money…

Attention, there are three words generally considered to be offensive used in the following post.

You follow drugs, you get drug addicts and drug dealers. But you start to follow the money, and you don’t know where the fuck it’s gonna take you

– Det. Lester Freamon

This is a pretty famous quote from The Wire that’s been echoing in my head since last weekend, i.e. after the Cyprus crisis grabbed all the headlines. But unfortunately, unlike in the case of Detective Freamon, it wasn’t because I admired the meticulous and hard work people have been putting into trying to figure out the broad consequences.

Sure, the blogosphere’s reaction last weekend was marvelous and in my opinion helped to stabilise markets this week, but alas it’s not really an event in the eurozone if you can’t draw some explosive (and most of the time daft) parallels. Before we get to those I’d like to say a few words about origins of such a situation.

Haircut of depositors in Cyprus took the market by surprise. And by market I mean investors and traders but also the caste of research professionals whose job is to… well… try and forecast such events. Obviously, there is nothing wrong with being caught off guard from time to time and it’s the reaction to such a surprise that matters. The natural instinct of people who had not predicted what happened in Cyprus is to play it down and suggest to fade any adverse market reaction. The twisted logic here is “had it really been so important, I would’ve surely seen it coming and since I didn’t then it must be unimportant“. I’m sure there’s a name for such a behaviour in psychology but I can’t be bothered to search. In my opinion, this is the most common reaction.

If this first – let’s call it – line of defense fails and the person in question finally acknowledges that the surprising event could turn out to be quite important then another mechanism kicks in: they try and look for potential spillovers. The thinking is more or less that “ok, I may have dropped the ball here but have a look at those cascade effects that the market is missing“. I have been quite appalled to see that happening throughout the most of this week.

It usually starts with some pretty straightforward conclusions. In the case of Cyprus, people began assuming that we will inevitably have a run on the island’s banks and that it could lead to similar developments in Portugal, Spain, Italy or even Ireland. Right, because that’s what the Irish people do…

The next step in this “following the money” process was to figure out whose deposits will be cut in Cyprus. The answer to that seems to be “Russian” (although I would caution against making such a generalisation). This would look something like this…

You guys, let’s try and see how this affects Russia. Oh, here’s one: VTB is one of the most important Russian banks and it also has a subsidiary in Cyprus. Sell, Mortimer, sell! What? VTB bonds have sold off? Well then why don’t we sell bonds issued by VEB. It’s a big state-owned bank and while it has really nothing to do with Cyprus, there’s only a one letter difference to VTB so it’ll do. Oh, and did I just say it’s state owned? Mate, where’s your bid in 50m Russia30s?

Let’s move on. Cyprus is a small, country with problems in the banking system. Those problems partly stem from the immense inflow of dirty money in the past. After the Cypriot financial system reopens whatever is left of it will inevitably flee. What if it goes to Latvia, which is already a popular short-break destination for the Russians and which will soon enter the eurozone itself? (…unfortunately the person explaining to me what would happen next lost me completely and so I can’t follow this particular money trail to the end). By the way, the Latvian authorities had to start swearing that they wouldn’t end up like Cyprus. There’s no smoke without fire, anyone?

And finally, my very recent favourite…

There must be a small country in the eurozone, which has some problems with its banks and which we could sell. Hang on, what’s this little thing east of Italy that no one really knows about but occasionally makes some noises in the media? Slovenia! OMG, this is so exciting! Banks in Slovenia have NPLs reaching 20%? Some of them did not meet the ECB stress tests? The government recently collapsed and there’s a risk of an early election? I guess we’ve found a retirement trade. And don’t bother me with details that assets of the Slovenian banking system are only around 135% to GDP or that the total government financing needs for this year are projected by the IMF at 7.7% of GDP (slightly below Germany, Austria or Finland). Who cares that if the IMF’s forecasts are to be believed then Slovenia will meet both fiscal Maastricht criteria next year as it still has debt to GDP below 60%. And also, I’ve never believed in this cyclically-adjusted primary surplus mumbo jumbo…

Right, and when you’re done selling Slovenia, maybe we should look into Slovakia – there’s gotta be some connection!

I have started with a quote by Lester Freamon and I will end with one. Fifth series, episode three (entitled “Not for attribution”):

Shit like this actually goes through your fucking brain?