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.
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. ¾”The current correction phase in equities is not over: there may be rallies but we recommend selling into strength.”
By Ambrose Evans-Pritchard
Published: 6:00AM GMT 23 Feb 2010
Source: The Telegraph