Sovereign Woes Trigger ‘Lehman II’ Concern for Europe’s Banks

May 19 (Bloomberg) -- Europe’s banks are facing déjà vu as fresh tremors in the debt markets threaten to shake the financial system less than two years after the collapse of Lehman Brothers Holdings Inc.

This time the concern isn’t about subprime mortgages or exotic derivatives, it’s about banks’ holdings of bonds sold by European Union governments including Greece, Portugal and Spain. Pledges of $1 trillion in EU aid have failed to shore up the euro or dispel doubts about the region’s finances.

Investors have punished the shares of European financial firms and driven up the cost of insuring against default by banks and insurers on concern measures aimed at reducing the region’s budget deficits will choke economic growth. In a worst- case scenario, government debt restructurings could erode capital and spark another credit crunch, analysts say.

“There’s a concern this may be Lehman II,” said Konrad Becker, a Munich-based banking analyst at Merck Finck & Co. “The direct risks of writedowns and loan defaults combined with indirect ones such as mistrust between banks could lead to a systemic crisis.”

The rate banks say they charge each other for three-month loans in dollars rose yesterday to a nine-month high. The three- month London interbank offered rate in dollars, or Libor, reached 0.465 percent, the highest since Aug. 5, according to the British Bankers’ Association. The euro fell to its weakest against the dollar since 2006 on May 17.

Subprime Survivors Struck

Banks in Greece, Portugal and Spain, which mostly dodged losses from the financial crisis of 2008, have suffered the biggest share declines. National Bank of Greece SA, the country’s largest bank, dropped 43 percent in Athens trading this year. Spain’s Bankinter SA and Banco Bilbao Vizcaya Argentaria SA, Portugal’s Banco Espirito Santo SA and Italy’s Intesa Sanpaolo SpA each fell more than 28 percent.

The latest debt concerns spread across Europe just as EU economies were returning to growth and banks were emerging from the worst financial crisis since the Great Depression.

The credit crunch that began with the collapse of the U.S. subprime mortgage market and swept away New York-based Lehman in September of 2008 led to $542 billion of writedowns and credit losses for European financial companies, data compiled by Bloomberg show. UBS AG of Zurich and Edinburgh-based Royal Bank of Scotland Group Plc were among financial firms that needed government help to survive.

‘$1 Billion Question’

Greece’s public finances began rattling investors late last year, when the country more than tripled its budget deficit forecast for 2009 to 12.7 percent of gross domestic product. The shortfall prompted European Monetary Affairs Commissioner Joaquin Almunia to say Greece’s finances had become a “concern for the whole euro area.”

On April 22, the EU made an even higher estimate of Greece’s budget deficit for last year: 13.6 percent of GDP.

Standard & Poor’s cut Greece’s credit rating to junk on April 27, and also lowered Portugal to A-. It trimmed Spain one step to AA the following day.

The EU and International Monetary Fund cobbled together a 110 billion-euro ($136.4 billion) rescue package for Greece on May 2 to prevent contagion. About a week later, European leaders drew up an unprecedented emergency fund of as much as 750 billion euros to back countries facing instability and a program of bond purchases by the European Central Bank.

“The $1 billion question is will this money be enough to stabilize the market and entice investors to continue to put money into sovereign debt and also into bank funding,” said Dirk Hoffmann-Becking, an analyst at Sanford C. Bernstein Ltd. in London.

Strangling Growth

Europe’s banks had $2.29 trillion at risk in Greece, Italy, Portugal and Spain at the end of 2009, according to figures from the Bank for International Settlements in Basel, Switzerland. French banks had the most claims, at $843 billion, followed by Germany at $520 billion and the U.K. at $227 billion.

European financial companies hold more than 134 billion euros of Greek, Portuguese and Spanish sovereign debt, according to figures provided to Bloomberg News in interviews and e-mails, or culled from company reports and presentations.

“The first problem is if the sovereign-debt crisis continues, European banks and insurers are going to have to write down their exposure at some point,” said Daniel Hupfer, who helps manage 32.3 billion euros at M.M. Warburg in Hamburg, including shares of Deutsche Bank AG and BNP Paribas SA. “The second is the economy: if European countries focus on saving, that could strangle growth.”

Leaving the Euro

One or more European economies may default on their debt and Greece and other “laggards” in the euro area may have to abandon the common currency in the next few years to spur their economies, New York University professor Nouriel Roubini said in an interview on Bloomberg Television on May 12.

The crisis engulfing the euro area is not over yet as Greece remains the “tip of an iceberg,” Roubini said in an interview with BBC radio broadcast yesterday. “What we’re facing right now in the eurozone is a second stage of a typical financial crisis.”

A restructuring of Greece’s sovereign debt could lead to as much as 75 billion euros of losses for European banks, based on estimates from Frankfurt-based Deutsche Bank.

Josef Ackermann, the chief executive officer of Germany’s largest bank, said in an interview on ZDF television last week that it’s imperative to avoid a restructuring of Greece’s debt for now, even as he expressed doubts about the country’s ability to pay back its borrowings in full.

An Overreaction?

Some analysts say the threat to Europe’s banks is overstated and that the EU’s rescue package will eventually bolster confidence. There’s little evidence so far that sovereign concerns are cutting into profits for most lenders. The 10 biggest banks by market value in the euro region earned almost $15 billion in the first quarter, company reports show.

“Almost all banks beat earnings estimates, but that’s been neglected because of the sovereign-risk issue,” said Johan Fastenakels, an analyst at KBC Groep in Brussels. “Markets are overreacting.”

European stocks gained for the first time in three days yesterday as concern eased that measures to control the region’s debt crisis will curb economic growth. The Bloomberg Europe Banks and Financial Services Index rose 1.8 percent.

Deficit Cutting

Europe’s debt-ridden governments are pushing forward with austerity plans to appease investors and avoid a contagion. Greece agreed to budget cuts amounting to 13 percent of GDP. Spain announced the biggest reductions in at least 30 years on May 12, and Portugal followed a day later, pledging to slash wages and raise taxes. Italian officials said the government may make an extraordinary reduction in public spending. France is slated to submit its latest tax and spending plans to the European Commission, the EU’s executive arm, this week.

European finance ministers said Greece’s debt crisis won’t unleash a continent-wide austerity drive and tip the economy back into a recession. Only high-deficit countries including Spain and Portugal will be ordered to make additional deficit cuts, while budget policies will remain untouched in better-off nations such as Germany and Finland.

“Not everyone will accelerate consolidation in a very uniform way,” European Union Economic and Monetary Affairs Commissioner Olli Rehn told reporters in Brussels after a meeting of ministers from the 16 euro countries yesterday. “That would lead to a very restrictive fiscal stance for the euro area as a whole, which would risk depressing economic growth.”

Political leaders are trying to put to work lessons learned in the subprime debacle.

“The advantage to the subprime crisis is we now are much more aware of how fragile our financial system is and we’re much more aware of what needs to be done to stabilize it,” said Hoffmann-Becking. “On the negative side is just the sheer scale of the sovereign debt problem: it’s larger than subprime. And whilst in subprime you could argue that a government will have to come and step in and save us, there is no government to save the government.”