21 September 2009

Time to short the banking sector?

After being hit hard (and for a reason), the banking sector posted fantastic gains:

High Low Close H to L C to L C to H

S&P 500 Banks 414.75 46.72 131.45 -89% 181% -68%

Feb-07 Mar-09 18-Sep-09

FTSE 350 banks 11696.3 1877.1 5308.74 -84% 183% -55%

Feb-07 Mar-09 18-Sep-09

DJ Euro Banks 491.78 84.61 231.75 -83% 174% -53%

May-07 Mar-09 18-Sep-09

DJ Stoxx Asia Pacific banks 96.93 32.97 56.96 -66% 73% -41%

May-06 Mar-09 18-Sep-09

Topix Bank Index 508.18 125.65 150.72 -75% 20% -70%

Apr-06 Mar-09 18-Sep-09

Hang Seng Financial 4932.55 1718.91 3573.2 -65% 108% -28%

Nov-07 Mar-09 18-Sep-09

Are these sustainable (at least in the developed world)?
  • Banks profitability is driven by the endless open check book provided by central banks around the world at 0% or near 0% financing cost whilst investing in US treasuries or equivalent and getting around +/- 3% for 5-10 years maturities. Despite the rhetoric, central banks are more interested in banks increasing their shareholders funds than increasing lending to consumers and companies. The decrease in lending accelerated in July to an annual rate 10.4% (7.4% the previous month) according to data from the FED.

  • Whilst having improved, balance sheets are still weak despite deleveraging, capital increases seen for the past 12 months and write-downs. According to today's FT:
    There is mounting concern among industry professionals about how to restructure or refinance the $2,100bn of European commercial property loans, in particular the $200bn in CMBS. [Commercial Mortgage Backed-Securities]

    A report from the UK industry group that met with the Bank highlighted that the UK commercial property sector could be in negative equity until 2017 and undercapitalised by up to £120bn ($195bn) based on current conservative banking refinancing terms.

    Close to £43bn of loans to the commercial property sector are due for repayment this year alone, according to De Montfort University research.

    Half of the outstanding European CMBS market needs to be repaid in 2011 and 2012, and CMBS in default have already proved difficult to restructure.

  • In the US, the situation is not much rosier. Since the beginning of the crisis, the FDIC (Federal Deposit Insurance Company - the body that insure deposits) has spent approximately $50 billions and is now underfunded (see graph below). Write-off on US commercial real estate loans could amount up to $400 billion. Add increased delinquency for credit cards and you get the picture.

  • Banks are again mulling calls to their shareholders to raise new equity, Royal Bank of Scotland being the last one to queue. With banks showing profits again during H1 2009, investors would have thought that they should not need to come to the markets again so soon. This lead me to be suspicious about the solidity of banks' balance sheets, and I am not convinced by the argument where new equity is needed to get freer from Governments: they need to raise capital because their loan losses are high and rising. The latest release from Institutional Risk Analytics shows that bank stress in Q2 2009 was at the highest level ever.


Between being short or being long, I would choose the former since too many uncertainties are lingering at this juncture of the crisis in the banking industry which benefited from the central bank largess. And I do not expect anything great from the G20 meeting in the US if I refer to the previous meeting in London where tax havens were wrongly targeted and now traders' bonuses seems to be the next scapegoat. I however still scratch my head with leading indicators having improved for 5 months in a row...


Financial Times
European property groups face debt time-bomb

Federal reserve Statistical Release
Consumer Credit

John Mauldin
Thoughts from the Frontline Weekly Newsletter
The Hole in FDIC

Institutional Risk Analytics
Q2 2009 Bank Stress Index Ratings

Northern Trust
Loan Delinquency and Charge-Off Rates at Troughs of Business Cycles