As measured by the Stoxx Europe 600 Banks index (SX7P), European banking stocks have now fallen by nearly 20% in just over three months.
Is this a buying opportunity or are further troubles ahead?
Hedge fund manager Crispin Odey is in the former camp, according to a report earlier today on Citywire. Odey believes that bank stocks and other financials are oversold and that many names in the sector – the report names Barclays, HSBC, insurers RSA and Allianz as his picks – offer good long-term earnings potential.
The bearish view, well articulated by Pedro Noronha on this site in August, is that banks have not owned up to the extent of their bad loans, are engaged in a game of “extend and pretend”, and have derived a lot of their apparent improvement in profits over the last year simply by reversing some earlier provisions for bad loans.
Banks are also not run for the primary benefit of shareholders. This week’s controversial decision by the UK government to shelve plans to enforce better disclosure of banks’ pay and bonus policies is a reminder of the lobbying power of those benefiting from high financial sector pay. The BBC’s Robert Peston argued yesterday in a blog entry "that the balance between rewards for bank employees and rewards for the owners have been skewed too far in favour of the employees”.
I should declare a personal interest at this point – I find arguments like those of Noronha and Peston compelling, and have owned some of db x-trackers’ Stoxx 600 Banks Short ETF (which benefits from falling share prices) in my pension plan since earlier this month.
But to me there’s now a far bigger threat to the rally in bank share prices since last March’s equity market bottom. The worsening debt crisis in the Eurozone threatens to remove the implicit government guarantee that financial institutions have been relying on.
Germany is pressing on with plans to force bank bondholders, including those owning senior debt, to share the burden of restructuring financial institutions. In Ireland, owners of bank senior debt, who were previously considered untouchable, are now in the sights of the visiting IMF-EU mission, according to Tracy Alloway in this morning’s FT Alphaville.
With talk of bondholder losses becoming louder, the existing share capital of banks suddenly looks a whole lot riskier. The possibility of severe dilution or even a wipe-out under a debt-for-equity swap is one I’d suggest not many current bank shareholders have factored in. And if those shareholders now start to balk at such a prospect, they would have more of a moral argument had they required the boards of the companies they own to retain most of the last 18 months’ profits instead of paying a lot of it out in bonuses and pay rises.
There are still many moving parts in the regulatory discussions, and of course there’s a chance that another market downdraft could force politicians and regulators to panic and reconsider the current tough talk of burden-sharing.
But with public disquiet mounting at the cost of never-ending financial sector bailouts, I sense a wintry chill descending on the prospects for banks' shareholders.