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Risk of Bank Defaults Spreading to Europe, Man Group Fund Manager Says

(Bloomberg) -- The banking-sector jitters that are rocking the likes of New York Community Bancorp will not be confined to the US, with the potential for defaults spreading to Europe, according to a top-performing fund manager.

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“There are portions of the market that we think are in very deep trouble,” said Jonathan Golan, a portfolio manager at Man Group Plc in London, whose investment-grade bond fund beat 99% of peers last year in data compiled by Bloomberg. “You’ve got more banks that are coming under scrutiny, more banks falling casualty, and potentially some banks defaulting on both sides of the Atlantic.”

Investor concern over US commercial real estate is already rippling across global markets. Exposure has led to plunges in the shares of New York Community Bancorp, Germany’s Deutsche Pfandbriefbank AG and Japan’s Aozora Bank Ltd., with traders now scrutinizing who might be next.

“In Germany, Scandinavia, we are seeing commercial real estate exposure as percent of tangible equity in the 400, 500, 600, 700% range,” Golan said in an interview. “If each of these banks takes a 15 cents write down for every dollar they lend to commercial real estate — which I’m not saying is a base case, but is a completely reasonable scenario — not only are these banks not investment grade, they’re insolvent.”

There have been some early signs of potential wider contagion, with bonds issued by real estate-focused German lenders slumping this week after Morgan Stanley analysts recommended clients sell senior bonds issued by PBB. The German firm has increased provisions because of the “persistent weakness of the real estate markets.” Its shares still hit a record low Friday.

Read more: Commercial Real Estate’s Slow-Motion Crisis Explained: QuickTake

Bloomberg Intelligence thinks US commercial real estate loans, at 1% or less of assets, don’t significantly threaten major European banks such as Deutsche Bank AG, HSBC Holdings Plc and BNP Paribas SA, but pointed to risks at some lenders.

“Aareal Bank’s exposure at 16% and Pfandbriefbank at 10% are at more risk, with PBB’s just-raised 2023 loan-loss provision guidance showing how property market weakness isn’t fully reflected,” analysts including Tomasz Noetzel wrote in a note.

Read more: Europe Property Funds Hit as Investors Pull €1 Billion a Month

Golan said shorting securities is now appealing, though he declined to name any companies or comment on his fund’s performance. Man Group, founded in 1783, is the world’s biggest publicly listed hedge fund with $161 billion in assets.

“We’ve been focusing on identifying sectors and individual names that are trading substantially above their intrinsic value,” he said, adding that in recent years the opportunities were mostly from going long. “But now we’re at a very late stage in the valuation cycle and therefore we aim to play offense and defense at the same time.”

Despite the recent jitters, Golan sees value in other parts of the banking sector, particularly in smaller jurisdictions where the market is more oligopolistic and margins higher. He pointed to some central and eastern European lenders as well as specialist UK banks that don’t compete for the same business as the major players.

“There are several very strong institutions that have modest exposure to commercial real estate, differentiated business models, strong profitability, solvency and liquidity,” he said. “It is in these areas where we are finding attractive opportunities, but you need to be really selective.”

(Updates with PBB share price move in fifth paragraph.)

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