After a medium-sized German bank, comes a German asset manager. After that, comes a second German investor. So how much further will the game of subprime dominoes reach?
Analysts at Dresdner Kleinwort say they don’t expect another IKB. The rapid implosion of the German small-company lender has sent them scanning the European banks sector. The implications of the subprime crisis for the investment banks are profound, they conclude, with potentially lower revenues and higher provisions combined with previously unforeseen risks. Management teams are relaxed – though with instruments largely ‘marked to model’, changes to the underlying model will take time to filter through. However, writes Arturo De Frias at DK: “it is fair to say that in previous periods of market turbulence the ‘pros’ (the investment banks) have been very good at limiting risks.”
Other banks should have limited exposure – unlike IKB’s bet to the tune of 12 times its equity on CDOs. There will be charges, say DK, but these should be treated as one-offs.
While remaining underweight on the capital markets banks, DK believes the recent selling of European banking stocks has now reached the point of over-reaction. The sector’s earnings multiple relative to the market is now 0.82 times, close to the low of the past five years and in line with that other crisis involving Russian bonds and a notorious hedge fund.
There is a disaster scenario, where spillover across the financial landscape creates a global liquidity crunch and current valuations become meaningless. But, says DK, the probability of that in their view is marginal.
So all OK? Well no. The knock-on effects on capital markets revenue in the third quarter could be severe, say DK. They have also excluded the investment banks’ exposure from their numbers.
And who’d even heard of IKB a few weeks ago? The next victim could be lurking outside DK’s familiar list of banking names.
Lombard Street Research is more sceptical. After the IKB shock came Frankfurt Trust, which closed one of its funds despite the fact that it hadn’t invested in subprime mortgages directly. Next up is WestLB Mellon which has frozen the assets in a fund which invests in structured credit instruments.
Soothing words from banks and investors around Europe are all very well, says Lombard Street’s Gabriel Stein. But there’s a worrying tendency here in terms of when European investors choose to pile into US assets. Before the dot-com bubble went splat, foreign purchases of US equities surged in the last quarters before the market peaked.
And the latest data, though more volatile, shows an pattern of increased buying for foreign and eurozone investors over the past two years, according to Lombard Street.
Of course US shares have done well – so no reason for investors in Europe or elsewhere not to pile in for some of the bounty. But in leaving it too late to get involved, eurozone investors may have again managed to play the game in terms of buy high, sell low.
When it comes to derivatives, says Lombard Street, there is little reliable data. But is there any reason to think that investors will have proven more savvy when it comes to ABSs than they have shares?
A much more likely scenario is that there is still much left to come out in terms of Euroland holdings of US subprime mortgages and other ABSs.