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Monday, 9 May 2016

These Are The 8 Triggers For A New Financial Crisis

The Independent

There are a number of potential triggers to a new crisis.

The first potential trigger may be equity prices.
The US stock market runs into trouble. A stronger dollar affects US exports and foreign earnings. Emerging market weakness affects businesses in the technology, aerospace, automobile, consumer products and luxury product industries. Currency devaluations combined with excess capacity, driven by debt fuelled over-investment in China, maintain deflationary pressures reducing pricing power. Lower oil prices reduce earnings, cash flow and asset values of energy producers. Overinflated technology and bio-tech stocks disappoint.

Earnings and liquidity pressures reduce merger activity and stock buybacks which have supported equity values. US equity weakness flows into global equity markets.

The second potential trigger may be debt markets. Heavily indebted energy companies and emerging market borrowers face increased risk of financial distress.
According to the Bank of International Settlements, total borrowing by the global oil and gas industry reached US$2.5 trillion in 2014, up 250 percent from US$1 trillion in 2008.

The initial stress will be focused in the US shale oil and gas industry which is highly levered with borrowings that are over three times gross operating profits. Many firms were cash flow negative even when prices were high, needing to constantly raise capital to sink new wells to maintain production. If the firms have difficulty meeting existing commitments, then decreased available funding and higher costs will create a toxic negative spiral.

A number of large emerging market borrowers, such as Brazil’s Petrobras, Mexico’s Pemex and Russia’s Gazprom and Rosneft, are also vulnerable. These companies increased leverage in recent years, in part due to low interest rates to finance significant operational expansion on the assumption of high oil prices.

These borrowers have, in recent years, used capital markets rather than bank loans to raise funds, cashing in on demand from yield hungry investors. Since 2009, Petrobras, Pemex and Gazprom (along with its eponymous bank) have issued US$140 billion in debt. Petrobras alone has US$170 billion in outstanding debt. Russian companies such as Gazprom, Rosneft and major banks have sold US$244 billion of bonds. The risk of contagion is high as institutional and retail bond investors worldwide are exposed.

A third possible trigger may be problems in the banking system fed by falling asset prices and non-performing loans. European banks have around €1.2 trillion in troubled loans. Chinese and Indian bank problem loans are also high.

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