Big Trouble in Emerging Markets.

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

Banking stocks in Europe continue to benefit from the gravitational pull exerted by the so-called Trump effect. But the effects have not been felt universally. Monte dei Paschi di Siena, which is at the center of Italy’s banking crisis, has been reduced to a penny stock. The shares of Italy’s other large banks continue to trend downwards. And the problems in other national banking sectors have not gone away; they’ve just been consigned to the background. Such is the case in Spain, where the risks and challenges in the country’s banking system continue to bloom.

Spain’s Very Own Homegrown Monte dei Paschi.

The multiyear decline of Banco Popular, Spain’s sixth biggest bank, has been no less spectacular than Monte dei Paschi’s, having lost over 90% of its stock value in the last nine years. The shares are now worth just €0.85 (compared to over €15 in 2008) and continue to shed value. Over 7% of its shares are being shorted by London and Connecticut-based hedge funds.

The biggest cause of concern is Popular’s plan to spin off €6 billion of impaired property assets into a vehicle optimistically christened “Sunrise,” which might not go far enough given the bank is estimated to have €30 billion of toxic assets festering on its balance sheets. In its latest report, S&P declined to downgrade Popular’s rating, though its choice of words at times, including “moderate solvency” and “ambitious plan” (to describe Sunrise), hardly inspire confidence.

To make matters worse, a bitter power struggle is being waged between Popular’s long-serving president, Ángel Ron, who has occupied the top spot since 2006, just a year before the rot began to set in, and a cluster of board members led by Mexican billionaire Antonio del Valle who, together with his associates, owns 4.25% of Popular. Del Valle has already made a name for himself in the banking business by turning around Chicago-based Metropolitan Bank Group, after acquiring the business for a fraction of its book value. Now he appears to have his sights set on a much larger prize.

Big Trouble in Emerging Markets.

Since Trump’s election, Spain’s two biggest banks, Santander and BBVA, have seen their shares slide, by 3% and 11% respectively. The simple reason for this is their bloated exposure to emerging markets, whose assets are cascading in response to a strengthening dollar.

Santander’s biggest emerging market, accounting for 20% of its global profits, is Brazil, a country that has been mired in recession for over two years, its longest for decades. Earlier this year, President Dilma Rousseff was deposed and replaced by her vice president, Michel Temer, a backstage wheeler-dealer who hadn’t won an election of his own for over 10 years. He’s now facing calls for impeachment after revelations of corrupt business practices. And the economy continues to languish.

Santander’s second biggest emerging market is Mexico, a country that is bearing the brunt of the negative fallout from Trump’s election and which accounts for 6% of Santander’s global profits. For Santander’s rival, BBVA, the risk of exposure to Mexico is seven times greater.

Currency Woes

Mexico accounts for two-fifths of BBVA’s global profits. BBVA’s second biggest foreign market is Turkey, via its 40% ownership of the Turkish bank Garanti. Months ago, Turkey was the scene of a botched coup d’état and is now toiling under a prolonged state of emergency, a massive purge, and dark clouds of economic uncertainty.

Even in the tumultuous first quarter of 2016, BBVA received 21% of its operating income and 13% of its net profits from Garanti’s operations. The country also accounts for roughly 5% of the group’s loans. Under government pressure, Garanti has had to cut rates on loans to small companies and consumers twice since the coup attempt.

For the moment earnings are just about holding up in both countries but it’s in the currency markets where the real pain is showing, and that eventually is going to have an impact on the bank’s margins. The Turkish lira is the third worst-performer among emerging-market currencies this year, losing 11% against the euro. The European Parliament’s unanimous vote yesterday to freeze EU membership hardly helped matters, spurring a fresh round of losses.

But the dubious title of worst performing emerging market currency in 2016 goes to the Mexican peso, which took its biggest two-day tumble in more than 20 years following Trump’s victory. Year to date, the currency has lost just over 20% of its value against the dollar and 18% against the euro. As Reuters reports Trump’s presidential win has smashed Mexican assets, prompting analysts to lower their forecasts for Mexico’s economic performance.

None of this bodes well for BBVA’s most profitable global subsidiary. The bank is reportedly hedging 40% of next year’s expected net attributable profit from its Mexican unit, the lender said in a statement.

For Santander, the problems are not contained to emerging markets. Besides Spain, its two most profitable mature markets are the UK and the U.S., the two countries at the heart of the global populist backlash. The market risks for the bank — from the plunging pound to the stagnating automotive sector in the U.S., where Santander holds a sizable share of outstanding subprime auto loan securitizations, on which the losses are rising — are legion.

The irony in all this is that the one factor that helped insulate both Santander and BBVA from the worst effects of Spain’s property crash — their geographic diversification — has now left them acutely vulnerable to the political and economic shocks reverberating around the globe. As for Banco Popular, much like Monte dei Paschi, it needs a market miracle. By Don Quijones, Raging Bull-Shit.

Italy’s crisis is becoming ever larger and reaches far beyond the banks. Read…  Italy’s Crisis Turns into a Multi-Headed Hydra

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