In some quarters, the sovereign debt crisis in Europe is being billed as the second coming of the credit meltdown - complete with dire warnings that the problems could turn into another contagion spreading to the entire global banking system. It's a scary story, says Pierre Lapointe, but the numbers don't support it.
Mr. Lapointe, global macro strategist at Brockhouse Cooper in Montreal (who has been producing some of the most thought-provoking big-picture market research in the country recently), said in a report this week that based on data about the exposure of the world's banks to the debts of the so-called PIGS (Portugal, Ireland, Greece, Spain) countries where the debt risks are most acute, a repeat of the subprime contagion would be virtually impossible.
"For banks, the PIGS debt problem is nowhere as important as the subprime debacle was," he wrote. "The estimated writedowns in PIGS loans … is more than 20 times smaller than during the 2007-2008 credit crunch."
SMALLER WRITEDOWNS SEEN
Mr. Lapointe noted that according to the International Monetary Fund, the subprime crisis is expected to have resulted in $2.28-trillion (U.S.) in worldwide bank writedowns when all is said and done. That is equal to 4.1 per cent of their total exposure to loans and related securities. In the United States, the epicentre of the subprime collapse, bank writedowns have represented 8 per cent of residential mortgages and mortgage-backed securities.
By contrast, the Bank of International Settlements has estimated total global bank exposure to PIGS debt at $2.57-trillion. For their PIGS-related impact to reach the same scale for the world's banks as the subprime crisis, they would have to write down an unfathomable 89 per cent of their PIGS exposure, Mr. Lapointe said.
"Under the hypothesis that the loss rate would be similar to the subprime crisis … the estimated writedown in PIGS loans could reach $105-billion," he said. That's a mere 4.6 per cent of the writedowns the banks took from the subprime meltdown.
What's more, as Goldman Sachs researchers noted this week, the banks themselves are in much better shape to absorb a hit than they were two years ago.
"Banks are much less exposed to troubled assets and less reliant on short-term funding, holding around five times more cash on their balance sheets," Goldman's Alberto Gallo wrote.
BANKING ON CANADA
Mr. Lapointe added that the banking sector's PIGS debt is concentrated in Europe: Euro zone and British banks account for 78 per cent of the total global exposure. Japan and the United States hold another 17 per cent, leaving just 5 per cent for the rest of the world combined. Coincidentally, it is in countries in this "rest of the world" category, including Canada, where the soundest banking systems in the world reside, according to the World Economic Forum.
"But the recent market jitters have put unjustified pressure on the banking industry in countries with sound banking practices," he said. "We recommend an overweight position in Swiss, Canadian, New Zealand and Australian banks."