During the 2008-09 Financial Crisis, the ETNs issued by Lehman
Brothers got clobbered and eventually became worthless.
Today, the $15 billion market for ETNs in the U.S. is much larger
than it was three years ago, which means one thing: This time
around, the same ETN blowup that's on the verge of occurring will
much larger in scale and much uglier.
Four of the five top ETN issuers are European banks. Is history
ETNs are not ETFs
While ETNs and exchange-traded funds (ETFs) are sometimes grouped
together, or worse, confused as the same thing, they are not.
Unlike traditional ETFs, exchange-traded notes are debt
obligations backed by the financial or banking institution that
issues them. ETNs pay a return linked to the performance of a
single security or index. Who pays the return? The financial issuer
backing the note.
ETNs can track a variety of assets from commodities (NYSEArca:
DJP), to the VIX Index (NYSEArca: VXX) and Indian stocks (NYSEArca:
INP). ETNs are also used as day trading instruments for those that
want leveraged long exposure (NYSEArca: DGP) or leveraged short
(NYSEArca: DZZ) to gold or other assets.
Investors that choose to keep their ETN to maturity receive a
cash payment calculated from the beginning trade date to the ending
period, or maturity date. The annual fees deducted reduce the value
of the payment. Maturity periods can vary and may be as long as 30
years. ETN investors that don't want to hold their note to maturity
can sell it prior to maturity on the exchange where they
Europe's financial crisis (NYSEArca: VGK) has major domestic
implications because the U.S. ETN marketplace is heavily composed
of products issued by European banks. Here's what ETFguide told its
'From the very beginning of Europe's crisis, its leading voices
(from Europe's Central Bank to its heads of state) have been
consistent in one regard: They've continually underestimated the
severity of the crisis each step of the way. They were wrong about
Greece, Ireland and Portugal not needing bailouts - and they were
badly wrong on the actual size of the bailout required. Is there
any reason to believe they'll be wrong (again) about the alleged
soundness of Europe's banking system?'
Which of Europe's banks are illiquid, overleveraged or on the
verge of bankruptcy? Is it Britain's Barclays (
)? Is it Germany's Deutsche Bank (
)? Is it Switzerland's UBS (
)? Or is it someone else?
How large are the liabilities and what would a Greece default mean
for Europe's banking system?
The top three banks in France (BNP, Societe Generale and Credit
Agricole) hold almost $57 billion in Greek sovereign and private
debt. The largest German banks hold roughly $34 billion while
British banks hold around $15 billion. While banks from these
countries could probably absorb losses tied to a Greek default,
would they be able to survive any other major losses beyond
Other Threats to Europe's Banking System
Exposure to rotten sovereign debt isn't the only problem for
European financial institutions. The entire banking sector faces a
wave of bureaucratic oversight along with the possibility of
For U.K.-based banks, higher capital requirements and invasive
regulation are serious threat.
The Independent Commission on Banking (ICB), a nongovernmental
panel, just recommended that U.K. banks hold at least 10% core
equity against their assets as a financial buffer. Not only would
the new requirements be more restrictive compared to non-U.K. based
banks, but the estimated cost is a steep $11 billion annually for
the U.K. banking industry. According to some estimates, higher
capital requirements might cut bank earnings between 15% and 25%.
Will Britain's banking regulators implement the ICB's
recommendations? If so, it would be more bad news for Royal Bank of
Scotland Group (
), Barclays, and HSBC Holdings (
Don't be a Victim, Protect Your Money
WhichETNs are at the greatest risk of loss because of Europe's
financial crisis? The
Profit Strategy Newsletter
outlines who the top ETN providers are, which ones to avoid and a
protection strategy for navigating the storm.