Why Banking Stocks Are Taking A Bashing

The smell of fear hangs over banking stocks after a rout in the sector during the first five weeks of the year.

The Stoxx 600, an index of European banking stocks, is down by 24% since the beginning of 2016.

Within that, there have been some horrendous falls suffered by some of the sector’s biggest names, with Germany’s Deutsche Bank (Other OTC: DBAGF - news) and Commerzbank (Xetra: CBK100 - news) down by 37% and 29% respectively; Societe Generale (Swiss: 519928.SW - news) of France down by 29% and UBS (NYSEArca: FBGX - news) of Switzerland down by 24%.

In Britain, Barclays (LSE: BARC.L - news) has been the biggest faller, declining by 24% this year, with RBS (LSE: RBS.L - news) and Standard Chartered (BSE: 580001.BO - news) close behind on 23% and 22% respectively. Santander of Spain, meanwhile, is down by 18%.

The biggest carnage, though, has been in Italy and Greece. Shares (Berlin: DI6.BE - news) of Monte dei Paschi (Milan: BMPS.MI - news) , Italy’s third largest bank and the world’s oldest, have lost 58% of their value so far this year. UniCredit (EUREX: DE000A163206.EX - news) , Italy’s largest bank, is down by 41%. The Greek duo, Piraeus and National Bank (Other OTC: NBGWF - news) of Greece, are down by 66% and 57% respectively.

While Europe has seen the most eye-catching falls in banking shares, some of Wall Street’s biggest names have also taken a drubbing, with Morgan Stanley (Xetra: 885836 - news) down 29% and Citi and Bank of America Merrill Lynch down 27% apiece. Citi, it has been noted, is now trading on a price-earnings multiple not far from where it was trading during the Lehman crisis.

Aside from share prices, the credit default swaps – the cost of insuring against a default by a bond issuer – of banks have surged, another strong indicator of nervousness.

But what’s behind all this? Well, several factors. The first and most obvious is that a number of central banks are now deploying negative interest rates. The Bank of Japan has just done so, joining the European Central Bank, the Swiss National Bank (LSE: 0QKG.L - news) and the central banks of Sweden and Denmark.

Negative interest rates, quite apart from signalling concerns about economic growth, eat into the profits of commercial banks because they are required to lodge a certain amount of capital with their central banks for regulatory purposes – and so negative rates, where they are paying the central bank for making overnight deposits with it, cost them money.

Moreover, negative interest rates compress the ‘spread’ between the amount banks charge borrowers and pay savers, further putting the squeeze on profits. This, in turn, has led to fears that banks may have to tap their shareholders for more capital.

A second factor is that concerns over global growth have, accordingly, raised doubts about the quality of some lending by banks. Shares of Britain’s Standard Chartered, for example, have been hit by worries that its loan book is disproportionately skewed towards troubled players in the oil and gas sector.

This is particularly true of the Italian banks, which are generally reckoned to have the largest share of non-performing loans (NPLs) – in other words, loans that are near or in default – than anywhere else in Europe. Analysts at JP Morgan recently suggested that one in six loans made by Italian banks were in this state, compared with an average of just 5.6% elsewhere in Europe.

This remains a hangover from the financial crisis and is at odds with the situation in other formerly struggling Eurozone economies, such as Ireland (Other OTC: IRLD - news) and Spain, where the banks have cleared up their balance sheets. It is also why the likes of Spain and Ireland are now enjoying stronger economic growth than Italy. Belatedly, the Italian authorities are now discussing a ‘bad bank’ into which the banks could dump their non-performing loans, of the kind introduced during the crisis in Spain, Ireland and, indeed, the UK, where a government-backed body, UK Asset Resolution, continues to own parts of the former mortgage books of Northern Rock and Bradford & Bingley.

In addition, the Italian banking sector has many individual quirks that have heightened its plight: it is vastly fragmented, compared with other European banking markets, with many more, smaller, players, the majority of which are co-operatives of the kind that came unstuck elsewhere in Europe – notably in Spain - during the crisis. Italy also has more bank branches per person than anywhere in Europe. These are costly to maintain and is another reason why Italian banks are among Europe’s least profitable.

Then there are problems faced by specific banks. The one that has been most commented-on in recent days is Deutsche Bank, which has one of the weakest levels of capital of any major European bank. Fears on Monday grew to such an extent that it now costs owners of Deutsche’s bonds more to insure against a default than it did at the height of the crisis. In particular, questions have been raised about Deutsche’s ability to meet interest payments on instruments known as ‘contingent convertible’ or ‘CoCo’ bonds, to the extent that the bank issued a statement on Monday evening aimed at calming fears.

That such concerns have arisen are not entirely Deutsche Bank’s fault. Years of ultra-low interest rates have pushed investors into all kinds of instruments in a desperate hunt for yield and, in many cases, not all of these instruments are easily traded – in the jargon, they lack ‘liquidity’. One example would be Deutsche’s CoCo bonds – and so, when fears arise, any falls in asset prices are exaggerated.

There is one last factor – which is that there is an element of doom-mongering going on in financial markets by some people who should know better. It’s almost as if, having been made to look stupid by failing to spot the last financial crisis, some market commentators and economists are falling over themselves to ensure they don’t miss predicting the next one.