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Emerging markets become a trap for US banks

Citigroup Inc, Goldman Sachs and other US banks had hoped emerging markets would take some of the sting out of the credit crisis, but in stead they seem to be worsening the pain.


Emerging markets have been battered along with other financial markets, leaving the main index of emerging markets stocks. MSCIEF down about 59% so far this year while sovereign debt has weakened to 2002 levels. That means banks that touted their emerging markets strength in the second quarter will likely be writing down loans and recording credit losses in the fourth. “The data shows that exposures ... are big enough to bring further pain to these big US banks and brokers,” Fox-Pitt analysts wrote in a research note last week.

Citigroup, which gets one third of its revenue from emerging regions, has been setting aside hundreds of millions of dollars to cover spiking credit losses in Brazil and Mexico. Its revenue from Latin America dropped 23% in the Q3. Goldman Sachs bought a stake in Industrial and Commercial Bank of China (ICBC) in 2006 that was valued at $7.1 billion at the end of August. ICBC’s shares in local currency terms have fallen by about 40% since then.

For about a year, it looked as if the financial crisis would mainly slam the United States and parts of Europe while emerging markets enjoyed a steady flow of dollars from record-high commodities prices led by oil, gold and copper. But even with windfalls from commodities, the strength in markets like Brazil, Russia, India and China seemed unusual given that when developed markets weaken, emerging markets generally become weaker still.

Many investors and banks, however, thought emerging markets had come far enough along to be able to “decouple” from the United States, so banks rushed to increase business in emerging markets and bragged about their growing exposure. “We’re long the world, and heavily overweight in emerging markets as a company,” Citigroup CEO Vikram Pandit said at an investor presentation in May. In June, Merrill Lynch CEO John Thain said: "Our ability to grow our business over the next few years is going to be particularly focused on the emerging markets in the growing parts of the world," noting that Brazil, Russia, India, and China offered real opportunities.



That thinking now looks to have been misguided as the world labors under a financial crisis, the breadth of which has not been seen since the Great Depression of the 1930s. Since August, currencies like the Brazilian real and Mexican peso have plummeted against the US dollar while stock markets in Russia and China were pummeled to multiyear lows. “The thought that emerging markets are decoupled from the rest of the world is just not the case,” said Sean Bogda, a portfolio manager at Global Currents Investment Management.

“We’ve only just started to see some hedge funds blow up in emerging markets. We’re going to see more of those in the near future, which means the deleveraging may continue,” said David Spegel, global head of emerging markets strategy at ING. “We’ve only just seen two months and, historically, crises in emerging markets last a lot longer.”

Emerging markets companies that issued debt will likely have trouble refinancing when their bonds mature, which is apt to be exacerbated by the strengthening US dollar. These companies face debt maturities of $450 billion in notes, bonds and loans next year, and another $487 billion in 2010, according to Dealogic. Market conditions have made credit scarce and refinancing difficult. Any corporate defaults will hurt banks that loaned money to companies in emerging markets.

“Rising loan loss reserve requirements due to economic slowdown in the emerging markets region would be most obvious with the large money center banks in the US,” said Keith Wirtz, president of Fifth Third Asset Management. It all adds up to a gloomy outlook, Wirtz said. “They’re going to see their business fall down. Capital markets activities, particularly those related to investment banking, mergers and acquisitions, everyone should expect that there is going to be a slowdown,” Wirtz said. (Reuters)