The need for debt to equity conversions is an inescapable reality

Sir, Martin Wolf writes: “It will be crucial to deal with debt overhangs. As the OECD stresses, converting debt into equity will be an important part of this effort”, “A light shines in the gloom cast by Covid” December 1.

Indeed, with so much corporate debt in being pushed down by Covid-19 into junk rated territory, both debtors and creditors will need massive debt to equity conversions, in order to buy the time needed to reactivate assets, before these also become junk. And whether highly indebted companies, are important and viable enough to merit help from taxpayers, from money printers or from banks, by grants or other means, the proof in the pudding is precisely first seeing hefty debt to equity conversions.

The credit rating agencies could also be helpful by indicating how much of each investment grade rated bonds that has been downgraded to junk, should be converted into equity so as to have the remainders of those bonds recover an investment grade rating.

Now, with respect to the restructure emerging and developing countries’ debts, given the current very low interest rates, we unfortunately do not count with the highly discounted US 30 years zero coupon bonds, those which helped create the guarantees that allowed the Brady bonds to become so useful when restructuring many Latin American debts in 1989. 

@PerKurowski

Though meteorologists announce rain, regulators allow banks to operate as if the sun shines.

Sir, Tommy Stubbington writes: “A coronavirus-linked credit rating downgrade by Fitch prompted speculation that Rome was headed for ‘junk’ territory” and “Italy is the most heavily indebted major eurozone country, and yet it can fund itself for free”; “Italy’s interest-free bonds enjoy strong demand as buyers bet on ECB support” October 14.

Mark Twain (supposedly) said: “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it looks to rain” and, if now revisiting banking, Twain could just as well opine: “A bank regulator is a fellow that allow banks to hold little capital when the sun is shining, so banks can pay high dividends and buy back stock, but wants banks to hold much more capital, the moment it starts to rain”

But, Twain, in the case of Italy, or any other Eurozone over-indebted sovereign, would not be entirely correct, because even though credit rating meteorologists now warn about heavy rains, EU authorities still decree sunshine, and even though Italy cannot print euros on its own, they allow their banks to hold its debt against zero capital.

Sir, does Stubbington ignore this? I’m not sure, but Upton Sinclair also held that “It's difficult to get a man to understand something, when his salary depends on his not understanding it.” That could perhaps apply to him… and, sorry, perhaps to you too Sir.

https://teawithft.blogspot.com/2019/06/the-still-ticking-0-risk-weight.html

Thanks to bank regulators, if in need, there are now way too little defences to deploy in a countercyclical way

Sir, you hold that there are “reasons to be wary [as bank] regulation is, once again, being eased just at the moment when it ought to be tightened” “Easing financial controls is cause for wariness” March 11.

In support: “Many market participants, moreover, think credit and market cycles are at their peak — just the time when counter-cyclical defences might be deployed”

Sir, is it really when markets are at their peak that we should kick off its drop, by tightening regulations? At the peak of the market, what we really should have is our ordinary defences, like bank capital, to be at their highest levels, so that adequate counter-cyclical defences can be deployed if needed. Are these defences now at the highest? Absolutely not!

Why? Among others, the results from an absolute incapacity to comprehend the pro-cyclicality of many regulations, such as those of the risk weighted/ credit ratings capital requirements for banks. These are based on the ex ante perceptions of risk when times are good, and not on the ex post possibilities when times are less good. The result, in terms of deployable counter-cyclical defences, is total unpreparedness.

Sir you write: “A Financial Times series has highlighted the risks of the rapid expansion of credit to lowly rated, more indebted companies.” No that is wrong! It were the “good times”, made possible by low interest rates and huge liquidity injections, which allowed for too many securities to be rated, ex ante, as being of investment grade, which caused a rapid expansion of credit. What, ex post, perceived rougher times cause, is a rapid expansion of those securities becoming rated as junk.

@PerKurowski

Does not common sense dictate that in good times we want our banks to be weary about what they perceive as safe? Does not what’s seen as risky take care of itself?

Joe Rennison writes: “Investors and rating agencies have warned that companies might struggle to refinance huge debt burdens, resulting in downgrades from triple B into high yield or “junk” territory.” “BIS sounds alarm on risk of corporate debt fire sale” March 6.

What does that mean? Namely the risk that ex ante perceptions of risk might, ex post, turn out really wrong.

Also, “Bond fund managers could then have to sell the bonds as many are bound by investment mandates barring them from holding large amounts of debt rated below investment grade. ‘Rating-based investment mandates can lead to fire sales,’ warned Sirio Aramonte and Egemen Eren, economists, in the BIS quarterly review released yesterday.”

And what does that mean? Clearly procyclicality in full swing! Just like the insane procyclicality caused by the risk weighted capital requirements for banks.

Sir, does not common sense tell you that in good times we want our banks to be weary about what they perceive as safe, as what they perceive as risky takes care of itself? And in bad times, do we not want our banks not to be too weary of the risky, and burdened with having to raise extra capital when it could be the hardest for them?

Sir, so what are regulators doing allowing banks to hold less capital against what they in good times might wrongly perceive as safe, and imposing higher capital on what they would anyhow want to stay away from, especially in bad times?

Sir, for literally the 2,781 time, why does not the Financial Times want to dig deeper into unavailing what must be the greatest regulatory mistake ever? 

Are you scared of then not being invited to BIS’s Basel Committee’s and central banks’ conferences? “Without fear and without favour” Frankly!

@PerKurowski

There is a world of difference between “ultra-safe-AAA-rated junk” and “risky-junk”

Sir, Gillian Tett asks us to “Remember the lessons of the rush into “junk” in 2007”, March 15.

Does she mean that ultra-safe AAA rated junk, which banks were allowed to purchase or lend against holding only 1.6 percent in capital, meaning they could leverage 62.5 to 1 their equity, or does she refer to other junk?

She writes “many banks are reducing loans to risky corporate names because of new capital regulations” and that is not correct. Banks have been reducing loans for a long time to what is perceived as risky, and this because of "old" Basel II regulations, which allowed them to have very little capital for what was perceived as safe. And now, when some of those perceptions turned out to be very wrong, and they were left with little capital, they just have no choice but to run away even more from "risk-land" into "safe-land".

She also writes “So far the short-term money that has gone into the corporate debt world does not appear to be associated with too much leverage; this makes the picture notably different from the asset-backed commercial paper market or repo sector in 2007”.

Yes, indeed there is a difference, and that is explained by the difference between “ultra-safe-AAA-rated-junk” and “risky-junk”. It is always the former which is the most dangerous, though our current sad crop of bank regulators just forgot or preferred to ignore that.