Pedro de Noronha, managing partner of Noster Capital, has been in the headlines for the last couple of days with his hedge fund taking short positions in five large European banks. IndexUniverse.eu editor Paul Amery spoke to him yesterday to discover the reasoning behind his views on banks, why he’s bullish on oil, and how his fund makes use of ETFs.
IU.eu: Pedro, your fund has recently taken a short position in a basket of five European banks: Barclays, UBS, Intesa San Paolo, UBI and BBVA. Why now? Isn’t the outlook for financials improving?
Noronha: There is a consensus view that the banking sector is on the road to recovery. But this is the result of massaging the numbers. Regulators have suspended mark-to-market accounting and almost every bank in the world is playing “extend and pretend”. If you marked the legacy loan books of most European and US banks to their real market value you’d be talking about a 30-50% writedown.
The stress tests we’ve recently seen were simply a public relations exercise and central banks are doing everything they can to keep banks alive, even though this is creating massive moral hazard. The capitalist system doesn’t work if bad firms are not allowed to go bust.
And how can one invest in banks on the basis that they’re trading at a discount to book value when the book value isn’t sound? Worse, even the people running the banks can’t value their own loan books. John Thain, as CEO of Merrill Lynch, came back to the market for funding five times in a few months, each time proclaiming that this was the last time he needed to raise money. All banks’ CEOs know is that they need to keep extending and pretending and hoping things get better.
IU.eu: But why should banks face reality as long as governments are propping them up? Do we have to wait for a crisis in government finances first?
Noronha: Yes, you need to see governments stopping what they are currently doing, propping up the real estate market and so on. But in the last few months there’s been real talk of public sector austerity for the first time in years. Second, I don’t buy the Keynesian argument that you can spend your way out of recession. That maybe worked when you had debt-to-GDP ratios of 30%, not when they are nearing 100%.
I should also point out that up to half of the decent earnings reported by banks for the last quarter resulted from the reversal of provisions taken earlier for bad loans. There’s a limit to how much more profit can be generated in future from reversing provisions and in fact I’d expect that, as the assets behind banks’ loans fail to generate sufficient cash flow to service them, we’ll see pressure to raise provisions again.
IU.eu: Why have you chosen those five particular banks to short?
Noronha: In the UK, Barclays has a very aggressive investment banking arm that’s been doing well, but we expect the bank’s loan book to suffer as the British real estate market deteriorates. Our BBVA short is also motivated by a negative view on Spain’s property market. In the case of Italy’s Intesa San Paolo and UBI, we’re concerned about exposure to overvalued Eastern European real estate. The growth engine for UBS has been private banking and we think that big banks’ private client business is under real pressure from boutiques and niche players.
IU.eu: What do your views on the banking sector imply for the broader market indices?
Noronha: It will depend on China, which has the reserves to keep the world’s resource industries busy without needing the banks. But, ignoring China for a minute, credit conditions are quite tight for everyone and we think this will have knock-on effects for the broader economy.
Going forward, we expect the second wave of Option-ARM and Alt-A mortgage resets in the US, which is just starting now, to affect credit conditions there and in Europe in due course. We’re expecting a second leg down in the US real estate market, which will cause the banks to take a hit and should bring the broader averages down as well.