What started as a crude oil driven selloff in the equity markets has quickly evolved into fears around the global banking sector. Why? Here are some trends that help explain the situation.
1. Bank jitters started with Portugal’s bank called Novo Banco which was restructured forcing haircuts on senior bondholders (including Blackrock and Pimco). As analysts had suspected for some time, European senior bank bonds are not really “senior” and are in fact subordinated to depositors. The Novo Banco event brought this issue to light. Moreover not all senior bonds were treated the same. Only bonds carrying a minimum denomination of €100,000 (institutionally held) were hit. After such an event, why would any institution ever buy a senior European bank bond?
2. Bad loan balances at some European banks continued to rise. Italian banks looked especially shaky and starting in 2016 Italian bank selloff accelerated.
Source: @MarkTOByrne
3. Sovereign wealth funds of many oil producers hold significant amounts of financials shares. With fiscal situations strained, dumping public shares is a quick way to release some of those petrodollars. This is one of the links back to oil.
Source: ?@Schuldensuehner
4. As bank shares sold off, some became concerned about capitalization. The focus shifted to the so-called CoCos (contingent convertibles) which became a popular way in Europe to raise tier-1 capital. The securities are treated like bonds and therefore don’t dilute existing shareholders. In an adverse event a regulator can force CoCos to be converted to equity – providing additional capital cushion. Now that some have raised questions about capitalization, investors became concerned about CoCos shutting off coupons in order to preserve capital. In such a situation investors are effectively short a put on the bank but are not collecting any premium (coupon). So they headed for the exists.
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