European governments need 1.8 trillion of debt funding and roll-over funding in the markets in 2011 in order for everything to stay “healthy”. We are speaking here, it should be stressed, about normal rather than emergency funding. At the same time, Europe’s banks, for their part, also need to recapitalize themselves, or at least to raise their capital reserves to the level demanded by Basel III. Where is this debt financing to come from?
The ratings agency, Fitch, recently published a short note on The European Debt Investor Landscape, in which it pointed out that there are a number of factors in play that could cause investors that have traditionally been ready to take European government paper to rethink their asset allocation strategies – much to the disadvantage of Europe’s governments. The three biggest classes of investor in European sovereign debt are insurance companies (30%), pension funds (31%) and mutual funds (31%):
“Together (these three) hold an estimated total EUR16 trillion of assets, equating to more than 1.15 times the region’s GDP… Insurance companies are the most prominent debt investors, with EUR3.8trn invested, accounting for 57% of their total portfolios (or 75%, excluding unit-linked investments). They are closely followed by mutual funds (EUR2.4trn; 40% of total).
"Finally, pension funds, which have historically been more equity focused, now have bond investments totalling EUR1.5trn (45% of assets). Country analysis reveals that continental European investors are more debt focused while UK institutions retain a historical equity bias."
The fear, Fitch suggests, is that regulatory changes could make investors in these three core categories much less prone to buy European government debt of any sort. However, there were signs even in late June, just two days before the Greek Parliament was due to vote on the latest round of austerity measures proposed by the Greek government, that the European crisis is not yet having a noticeable impact on funding costs. The National Bank of Australia, for example, which owns the Clydesdale and Yorkshire banks in the UK, said on 28 June that its funding costs had not increased materially despite the European sovereign debt crisis. Australian banks are particularly sensitive to rises in term debt costs, since this is where they get nearly a quarter of their annual funding from. The fact that global volatility has not yet been perturbed to the point where Australian banks are feeling any fresh pain is a good thing.
A positive insight from DTZ
Even better news comes from property specialists DTZ. Although DTZ’s focus is narrower, concentrating on debt secured by commercial property as collateral, it pointed out in its May 5 DTZ Insight that the global debt funding gap is actually shrinking. There is now just $202 billion secured by commercial property that will not be able to get refinancing over the next three years, versus $245 billion in November 2010. Japan, the UK and Spain continue to have the largest absolute and relative gaps on the global league table. On the positive side, there is some $403 billion of equity available for investment over the next three years, up 7% on the figure reported by DTZ in its earlier estimate.Hans Vrensen, Global Head of Research at DTZ points out the fact that there is now twice as much equity available in total commercial property portfolios as the debt funding shortfall, and that this is very positive for the market. However, he points out that, though property transactions globally have picked up substantially, the overall picture is still very market specific. Asian markets are on the road to full recovery, while Hong Kong has already fully recovered. “Markets are at very different states of recovery around the world but even in the advanced economies we are seeing property deals coming back quite strongly. We worry, of course, about the potential impact of the sovereign debt crisis, but property transactions will go on even if Greece defaults. The important thing is that there are positive signs in the market now, and that is a lot better than where we were two years ago,” he concludes.
Tags: asset allocation strategies , austerity measures , Basel III , Clydesdale , credit rating agencies , DTZ , European debt , Fitch , Greece , Greek austerity , Hans Vrensen , National Australia Bank , National Bank of Australia , roll-over funding , sovereign debt , Spain , The European Debt Investor Landscape , Yorkshire bank