Morgan Stanley’s European Strategy team, headed by Graham Secker, put out an interesting note on the rising cost of capital on Monday.
And it’s not a cheery read if you happen to be a sovereign issuer, given the shift of private-sector debt into the public sector.
According to the MOST analysts, the most important macro theme for the next few years will likely be the ease (or difficulty) at which sovereigns pay down the deficits they’ve incurred during the course of the financial crisis.
Greece, unfortunately in that case, may only be a taster of what’s to come. As the analysts note:
Greece may well prove to be a taste of things to come, in our view. However, the speed and extent of any contagion are hard to predict . We think that the 50-year+ low in government bond yields (real and nominal) seen in this cycle will not been seen again for many years to come. In effect, the size of the public debt burden means that the ‘risk-free rate’ has become more risky.
And here’s a rather enlightening chart produced by the bank to illustrate which countries are likely to come under more pressure than others in this regard:
Collectively in Europe, Morgan Stanley notes EU banks have something in the region of $1,000bn in debt to rollover in the next two years. Due to the contagion factor from Greece, this will have to take place at a much higher cost of capital.
In the irony of the day, however, the analysts forecast it will be the banks that have substantial scope to buy much of that government paper.
Not that they won’t be inclined to charge for it (emphasis FT Alphaville’s):
Many investors look to the banks as a natural source of demand for sovereign debt going forward, but we think this is likely to come at a cost in terms of less credit availability in the wider economy and lower ROEs for the banks themselves.
A fact that Morgan Stanley’s analysts say — irrespective of where rates go — will lead to a higher cost of capital for all.
To recap: That would be banks over-charging sovereigns for the debt they incurred by rescuing the banks.
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Ambrose Evans-Pritchard in Telegraph has some more informations form this report:
European banks face showdown over €1 trillion of debt
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."
European banks face showdown over €1 trillion of debt
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."
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