IFR Editor-at-large Keith Mullin
SO THERE I was getting bored rigid taking in the dull, suburban analysis (in my view) of the failed EU Summit and watching the markets trading up, down and sideways, unsure of what the signals were and how to read them; and it suddenly occurred to me that one way to escape the tedium would be to revisit a trade idea I’d put out in July after results of the mid-year stress tests were published.
Those of you who’ve been reading my column for a while will know that I’ve been stridently negative about stress tests all year. When those first results came out, I spent a bit of time looking at the banks that had failed and concluded that, taking into account the various actions they’d taken or had planned, and counting back things like provisions or mandatory converts that the EBA had excluded, they didn’t actually look that bad.
So I put out an idea that to some looked extremely counter-intuitive but was, as it turns out, a good shout: going long shares of the banks that failed or almost failed the stress tests and shorting the major European banks that passed those mid-year tests but would, I said, be hammered under any remotely realistic stress scenarios.
For the leading European banks I used eurozone G-SIFIs (global systemically important financial institutions) as a proxy, against the 16 listed banks of the 24 that failed the tests. Amazingly, my bias was spot on. The loss differential between the two groups would have pocketed me a small profit on the trade.
Using a simple comparison of share prices on the day I posted the blog (July 19) and December 15 when I closed out, the banks that failed the tests had seen their share price fall by an average of 37.68%. But share prices of the EZ G-SIFIs fell more than 42%.
MY SENSE AT the time was – and still is – that the banks deemed too big to fail have a lot more to lose, given their sovereign debt and other potentially explosive exposures (such as residential and commercial real estate), their inability to offload assets and businesses quickly enough to make deleveraging a realistic alternative to recapitalising by the June 2012 EBA deadline; the higher costs of regulation; and bearing in mind the negative economic prospects.
I think the trade has legs for a while longer. Think about it: the EZ SIFIs have been buffeted by ratings downgrades or reviews; have had intermittent access to wholesale funding over the past few months; are all attempting to ditch risk-weighted assets left, right and centre as they refocus and restructure; and still remain heavily exposed to peripheral sovereign debt.
Banks deemed too big to fail have a lot more to lose, given their sovereign debt and other potentially explosive exposures
There are eight eurozone G-SIFIs, including BNP Paribas, Societe Generale and Credit Agricole; Commerzbank, which by many accounts (but not its own) is going to be nationalised because it won’t be able to meet the latest €5.3bn EBA capital deficit; Dexia (need I say more?); and UniCredit, which is in the midst of a substantial refocusing and is discontinuing certain lines of business.
In the past couple of days, Credit Agricole said it would report a loss in 2011 owing to a €2.5bn write-down on investments; cut 2.350 jobs; exit 21 of the 53 countries in which it operates; and pay no dividend. The bank is closing entire businesses including equity derivatives and commodity trading and will heavily cut back commodity trade financing. On Friday, the bank said it had sold its private equity business to Coller Capital.
In Germany, the government is not reviving its bailout fund SoFFin for nothing; the fact that bank regulator BaFin now has the power to force TARP-like capital injections on banks is hardly a harbinger of good tidings.
BY CONTRAST, THE mid-year stress test failures are getting their act together. Spain’s bank restructuring agency FROB has engineered two mergers involving four of the Spanish banks that failed the tests, with no impact on the government budget. Banco Popular Espanol is acquiring Banco Pastor in a €1.35bn deal; while Banco Sabadell has taken over Caja de Ahorros del Mediterraneo.
FROB had injected €5.249bn of capital into deeply troubled CAM from the bank-financed deposit guarantee fund and transferred ownership to Sabadell for €1. The deposit guarantee fund will in addition bear 80% of losses from a pre-determined asset portfolio over 10 years, while FROB will assume certain contingent liabilities to ensure CAM has access to funding.
The reason I say my trade has legs only for a while longer is that I’m perturbed by impending distress in the Spanish banking sector caused by the new government’s drive to deal with the real estate disaster. Spanish banks have more than €300bn of real estate exposure on their books, of which €176bn is impaired. It’s a hell of a mess.
That last sentence, alas, could serve as a summary of much of the past year. I think 2012 is going to be challenging. This is my final column of 2011. I’m heading off to recharge the batteries ahead of what I suspect will be another action-packed year. I suggest you do the same. Best wishes to all for the festive period and let’s do it all again in the new year.
