Before we get too euphoric over the European Union’s $1 trillion rescue plan, take a look at these names. They’re distressingly familiar.
Fortis (FORSY). Dexia (DXBGY). Societe Generale (SCGLY). BNP Paribas (BNPQF). ING (ING). Barclays (BCS). Deutsche Bank (DB).
Remember them? They were so neck-deep in the Lehman/American International Group/mortgage-backed assets debacle that they required government bailouts. (Deutsche Bank may quibble. It got its cash from American International Group (AIG), so technically I suppose it didn’t get government money, but since the AIG payout used cash from a government bailout of that company, I think it’s a distinction without a difference.)
And now? Well, they all make the short list of European banks most at risk in the Greek debt crisis.
Still. Even after the $1 trillion rescue.
The plan announced by European Union politicians over the weekend is a bailout plan, remember. That implies that there are banks they might be in need of rescue. The plan really doesn’t change the risky assets on these bank’s balance sheets into gold or German bunds. The hope is that by putting the rescue plan in place, investors won’t sell the bonds of Greece and Spain and Portugal and push banks loaded up with these bonds into deeper trouble.
But it’s only a hope. And if you want to understand why European leaders were so anxious to get this deal done before the financial market’s opened on Monday May 10 look at this list.
Want to know how dangerous the Greek (soon to become the Greek/Spanish) crisis is? Look at these banks.(For more on Spain’s progress to crisis see my post http://jubakpicks.com/2010/05/06/spanish-interest-rates-climb-as-the-country-takes-another-step-toward-crisis/ )
Want to understand why this is serious but not a replay of the chaos that followed on the collapse of Lehman Brothers? Look at these banks.
Want to know why investors are right to worry about contagion and the risk that other banks will catch what these banks have? Look at these banks.
Okay, let’s start with the data on how much money is at risk at each bank. (The Financial Times put this all together in a table in their Thursday, May 2010 paper.)
Fortis holds $5 billion in Greek bonds. Dexia holds $4 billion. Societe Generale $5.2 billion. BNP Paribas $8 billion. ING $4.6 billion. Barclays $6 billion. And Deutsche Bank $2.6 billion.
Altogether a hefty $35.4 billion in Greek bonds.
Now I know that seems like a lot of money but in the scale of recent financial crisis it’s not all that much. In fact, if you compare these amounts to what it took to bailout these banks in the aftermath of the Lehman bankruptcy, then $35.4 billion is pocket change.
The governments of Belgium, the Netherlands, and Luxembourg bailed out Fortis to the tune of $16 billion or so The Dutch government injected $13.4 billion into ING. France, Belgium, and Luxembourg put $9 billion into Dexia. France bought $13.9 billion in debt securities from six banks, including Societe Generale and BNP Paribas, and then later lent an additional $7.4 billion to BNP Paribas.
I think you get the idea.
But on another scale these sums seem absolutely large enough to recreate the dynamic that made the post-Lehman crisis so devastating. The basis of the post-Lehman crisis was fear. Banks that had become accustomed to finding their capital in the financial markets by selling short-term commercial paper found themselves forced to borrow for shorter and shorter time periods as buyers of bank debt tried to limit their risk by extending money for as few days as possible. Eventually those few days turned into no days and these banks found themselves unable to get financing at all.
Something similar had started to happen in the European banking sector in the days before the rescue. Banks were increasingly unwilling to lend to each other for any period longer than overnight. Of the almost $600 billion that turns over every day in the Euro zone money market sector 90% was now lent not for 90, 30, 14 or even seven days but overnight.
The fear that’s behind the unwillingness to lend comes from massive uncertainty. Some banks look in trouble even if you look at just Greek debt and use a relatively strict but straight forward measure such as the ratio of Greek debt to tangible net asset value. (Net asset value is the value of a company’s assets that remains after all liabilities have been subtracted. Tangible net asset value excludes intangible assets such as goodwill by assuming that such assets are worthless.) At Fortis Greek debt equals more than 60% of tangible net asset value. At Dexia the ratio is 30%. Both numbers are high enough to make potential buyers of short-term paper from these banks shy away.
But even banks with much lower ratios such as Societe Generale, BNP Paribas, ING, Barclays, and Deutsche Bank where Greek debt represents from a little more than 10% (at Societe Generale) to just over 5% (at Deutsche Bank aren’t worry free.
Remember that so far I’ve looked only at exposure to Greek debt. Spanish debt is increasingly looking like an asset to avoid—and there’s a lot more of it floating around the European banking system than there is of Greek debt.
French and German banks are the most exposed to the Greek debt crisis of any in Europe. Barclays Capital pegs the total exposure of banks in those two countries at $103 billion. (Think about that to explain the outrage of German and French taxpayers. They know they’re being asked to bailout their banks–again–in the $1 trillion rescue plan.)
In comparison Spain needs to roll over almost $300 billion in debt just in 2010. And since Spain has a relatively low savings rate and relatively large government and trade deficits about 45% of Spanish debt is held by foreigners. (For more on the relative size of the Spanish and Greek crises, see my post http://jubakpicks.com/2010/04/28/how-much-could-it-cost-to-bailout-greece-portugal-and-spain-would-you-believe-630-billion/ )
If that exposure was spread evenly across the globe or even across Europe, even that amount of debt wouldn’t be nearly so worrisome. But as the Greek numbers show, a few banks can wind up holding a disproportionately heavy part of the bag. The seven banks on my short list hold total Greek debt equal to about 34% of the total debt held by German and French banks.
Some bank or banks could be on the hook for a bigger than average chunk of Spanish debt. If you could figure out who that bank might be, you would certainly avoid doing business with it. And if you can’t pinpoint the risk, the most reasonable option is to act as if everybody were a potential risk and not do business with anyone.
Even if you knew exactly what everybody’s dollar exposure to Greek and Spanish debt was, you still wouldn’t know who had bought hedges on some of that risk—and who had taken on even more risk by selling those hedges. Financial risk insurance, we learned during the Lehman collapse, is only as solid as the company selling it. And since this part of the derivative market is by and large private and opaque, you can’t really know who is hedging and how much and with what counterparties. Refusing to do business with anyone or to buy anyone’s debt, even the shortest term debt, seems like an even better idea.
Which, of course, is why any rescue plan had to guarantee everybody. The only way to remove investors’ and traders’ worries if they can’t be sure who is at risk is to make sure that everyone is part of the bailout. Potentially, at least.
And it’s yet more attractive because it’s not just the aggregate amount of Greek and Spanish debt, and the long or short position after all the hedges are netted out makes the difference between a bank that’s in a painful but survivable jam and one that’s in danger of going under.
Local Spanish banks—not the big players like Banco Santander (STD) but the smaller regional banks—are big owners of Spanish government debt and are now finding it just about impossible to raise capital in the financial markets. But this isn’t as fatal a problem as it might seem because these banks historically have raised much of their capital the old fashioned way—from customers depositing money with the bank. These banks may be sitting on a large pile of Spanish debt relative to their size but their actual risk may well be lower than a bigger institution such as Deutsche Bank that has a relatively weak deposit gathering apparatus. (On the other hand, the big Spanish banks like Banco Santander have been aggressively going after the depositors of these small banks. I told you figuring out who is at risk is complicated.)
Thinking back to the post-Lehman crisis and looking at the current group of seven banks on this short list gives you a way to benchmark this crisis. Remember that several German state banks went under in that crisis but their troubles didn’t threaten the global financial system. Few of the institutions on this list play a big enough role in the global system of parties and counterparties that their troubles would cause a crisis in New York or Tokyo. Two possible exceptions are Societe Generale and Deutsche Bank. The banks were the top two recipients of cash from American International Group (which, of course, got that cash from the federal government, which got it from tax payers) to settle derivative contracts. Societe General received $4.1 billion and Deutsche Bank $2.6 billion, according to documents released by AIG on March 19, 2009. Those payments were larger than the $2.5 billion Goldman Sachs (GS) received from AIG.
So as the European debt crisis moves to its next stage in Spain (yes, inspite of the rescue plan, Spain still needs to figure out how to cut its deficit) , I’d keep an eye on those two banks and on the two big international banks based in Spain, Banco Santander and Grupo BBVA. I think the danger of contagion escaping the Euro zone and infecting other financial markets is limited to just that handful of banks.
At least until the United Kingdom and the United States face their days of reckoning for their debt.
Full disclosure: I do not own shares of any of the companies mentioned in this post in my personal portfolio.