Crunch time?

Courtesy of Bruce Krasting

Possibly the most significant consequence of the EU bailouts last week will be that the “solutions” to the problems in Europe will result in a global credit crunch. To me this outcome is a foregone conclusion. It’s already happening.

The agreements give the EU banks till June 2012 to recapitalize. There are only two possible outcomes. (A) Either the banks sell more common and preferred shares to the public, or (B) they improve their capital ratios by de-leveraging.

It’s simply not possible to sell more shares. The costs (in the form of dilution or 10+% Preferred dividends) make this option a dead end. So the banks will have to get smaller.

Some data points on this from Thompson Reuters Loan Pricing Report today:

French banks have been notably absent from high-profile EMEA loans including the US$6bn loan for commodity trader Xstrata and a $4.7 billion loan for Qatar’s Barzan project financing.

In Asia, BNP Paribas pulled out of an A$2.075 billion (US$2.14bn) refinancing for Australian media company Seven West after being shortlisted as one of the leads.

In the US, Societe Generale declined to participate in a $15 billion, 364-day bridge loan forUnited Technologies Corp.

The $6 billion loan for commodities trader Xstrata had no commitments from BNP Paribas, Societe Generale, Intesa and ING.

"Banks structuring deals are mindful of the reduced demand for dollars – you have to factor in a big drop in appetite from French and Germans." a senior banker said.

The syndicated loan market is not falling apart. At least not yet. Other big lenders have stepped into the hole left by the EU banks. Spreads have widened a bit, they will get wider still. The question is whether credit will dry up in the months ahead. I think it will.

I’m convinced that zero interest rates are adding to the problem of liquidity in the US (and therefore globally). Every month money funds get smaller. More and more money is being put on the side. MM loan funds used to buy up big chunks of deals like the 365 day UT deal. Not any longer.

I have no support from economists in my conclusion that ZERO % = ZERO RISK. In fact, the vast majority of deep thinkers (and most importantly Bernanke) believe that ZIRP is the only path to consider.

My conclusion is that the dual forces of the EU bank asset sales and perpetual ZIRP are going to bring us a very nasty credit crunch. It will be global. Given that the clock on the EU bank recaps runs out in 8 months I would expect to see clear evidence of a crunch by year-end. (Does someone have a quote for “turn of the year” LIBOR?)