Perilous Times
European banks face showdown over �1 trillion of debt
European banks need to roll over �1 trillion (�877bn) of debt over the
next two years at a much higher cost and in direct competition with
hungry sovereign states, according to a report by Morgan Stanley.
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By Ambrose Evans-Pritchard
Published: 6:00AM GMT 23 Feb 2010
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The bank has advised clients to prepare for chillier times as monetary
tightening begins in the US and China, causing major spill-over effects
in Europe.
Roughly �560bn of EU bank debt matures in 2010 and �540bn in 2011. The
banks will have to roll over loans at a time when unprecedented bond
issuance by governments worldwide risks saturating the debt markets.
European states alone must raise �1.6 trillion this year.
"The scale of such issuance could raise a significant 'crowding out'
issue, whereby government bonds suck up the vast majority of capital,"
said Graham Secker, Morgan Stanley's equity strategist. "The debt
burden that prompted the financial crisis has not fallen; rather, we
are witnessing a dramatic transfer of private-sector debt on to the
public sector. The most important macro-theme for the next few years
will be how easily countries can service and pay down these deficits.
Greece may well prove to be a taste of things to come."
Lenders will have to cope with a blizzard of problems as new Basel
rules on bank capital ratios force some to retrench. State guarantees
are coming to an end, which entails a jump of 40 basis points in
average interest costs. They must wean themselves off short-term
funding as emergency windows close, switching to longer maturities at
higher cost.
Worries about Europe's second-tier banks help explain why Berlin is
warming to plans for a �25bn rescue for Greece. Germany's regulator
BaFin has warned that �522bn of German bank exposure to state bonds in
Portugal, Italy, Ireland, Greece and Spain may pose a systemic risk if
contagion causes "collective difficulties of the PIIGS states".
A BaFin note obtained by Der Spiegel said Greece could be the trigger
for a "downward spiral in these countries, as in the case of
Argentina", leading to "violent market disruptions".
Citigroup said Europe's 24 largest banks must raise �720bn over the
next three years, in a world where investors want a higher return for
risk. "This could eventually drive up funding costs meaningfully," it
said.
It said a mix of higher credit spreads, rising rates, and Basel III
rules could "eat up" 10pc of bank earnings. While most lenders can
cope, it will dampen economic recovery.
Morgan Stanley said the benchmark cost of capital � known as the
'risk-free rate' � is rising because governments themselves are
becoming a riskier bet, with ripple effects through the entire economic
system.
Investors should be cautious about corporate bonds, sectors such as
transport, media and telecoms with high net debt to equity ratios and
certain countries. The net debt to equity of the corporate sector is
189pc in Portugal, 141pc in Spain, 85pc in Italy, and 82pc in Greece,
compared to 46pc for Germany, 39pc for Britain and 26pc for Sweden.
Morgan Stanley expects equities to prosper, but not until the current
"growth scare" is digested by the markets. �"The current correction
phase in equities is not over: there may be rallies but we recommend
selling into strength."