Posted by on February 5, 2017 9:13 pm
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Categories: Bond Business Capital Markets Corporate Leverage Currency Economy Economy of the European Union Euro europe European Banking Authority European Central Bank European System of Central Banks European Union Eurozone Financial crisis of 2007–2008 fixed non-performing loans PIMCO Recession Stock market crashes

Back in September, Tad Rivelle, Chief Investment Officer for fixed income at LA-based TCW, said in a note that “the time has come to leave the dance floor”, noting that “corporate leverage, which has exceeded levels reached before the 2008 financial crisis, is a sign that investors should start preparing for the end of the credit cycle.” Ominously, he added that “we’ve lived this story before.” Five months later, the FT reports that TCW, which is also the US asset manager that runs the world’s largest actively managed bond fund, has put its money where its bearish mouth is, and has eliminated its exposure to eurozone bank debt over fears these lenders are “excessively risky.”

In an interview with the FT, Rivelle said the company began to reduce its exposure to debt issued by eurozone lenders following the UK’s vote to leave the EU last June. In the first half of last year TCW, which oversees $160bn in fixed income strategies, had around $2bn invested in European bank debt. This has fallen to less than $500m since the Brexit vote, most of it in UK banks.

Rivelle, who previously was a bond fund manager at PIMCO, said his biggest concern was the number of toxic loans held by eurozone lenders, which amount to more than €1 trilion. Last month Andrea Enria, chairman of the European Banking Authority, said the scale of the region’s bad-debt problem had become “urgent and actionable”, and called for the creation of a “bad bank” to help lenders deal with the issue. Rivelle said: “The [eurozone] banking system [has] a bad combination of negative rates, slow growth and lots of problem non-performing loans. It is inherently prone to a potential crisis should global economic conditions, or European economic conditions, worsen. [These are] the preconditions of a potential banking crisis.”

Continuing his bearish bent, Rivelle added that there is a 50% likelihood of another global recession within the next two years, removing any incentive to invest in the eurozone banking sector within that timeframe. The forthcoming French presidential elections in April, which could see Eurosceptic candidate Marine Le Pen come to power, and the problems facing the Italian banking system, are additional risks for eurozone banks this year.

“[The likelihood of another recession] is an unbearable level of risk for European banks, given they were not recapitalised [following the last financial crisis]. They are over-levered, and you are not well paid to underwrite the risks. We view continental European banks as being excessively risky.”

As the FT adds, other asset managers have acknowledged that political risks in Europe this year, including the French elections and German elections in September, could intensify pressure on eurozone banks. PIMCO owner Allianz has conveniently created the following graphic summarizing just that.

Some other opinions:

Iain Stealey, fixed income portfolio manager at JPMorgan Asset Management, the US investment house that oversees $1.8 trillion in assets, said: “The main [concern] in the eurozone is political risk. We’ve got the French elections in April and May, and the German elections [in September]. At the moment, the market is a little bit risky. [The French elections] could be a risk to eurozone bank debt.”

Amundi, Europe’s largest listed fund house, is considering reducing its exposure to French banks ahead of the presidential election, according to Hervé Boiral, head of European credit at the asset manager.

However, several asset managers highlighted reasons for optimism about Europe’s banking sector, including the likelihood that the European Central Bank will begin to scale back its bond-buying programme at the end of 2017, and potentially raise interest rates next year. The central bank’s record-low interest rate policy has hurt banks’ profitability as they have earned less money against customers’ deposits.

Mr Stealey, whose $2.7bn global bond fund has 5 per cent of its assets invested in European financials, said: “We have been in and out [of eurozone bank debt] over the past year, but at the moment we are looking at it as an opportunity. Overall the European economy is picking up.”

While concern about European exposure ahead of a flurry of political event risks is understandable, it is not quite clear where the capital will be allocated to instead, especially now that Trump’s honeymoon with capital markets is souring (see Dalio, Goldman), and it is possible that the US will become the next source of capital flight at least until such time as much more clarity on Trump’s policy implmentation is available.

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