Intense funding pressures, weaker credit markets and less supportive policy response make it too early for investors to buy the European banks sector, argues Huw van Steenis, head of banks and financials research at Morgan Stanley, tells the FT’s View of the Day column.
“The cost of senior bank funding has risen again for European banks in recent weeks, despite interest rate expectations edging lower,” he says. “More troubling, it’s now more expensive for banks to borrow in the wholesale markets than strong corporates – and the last time this happened in 1989 it led to sharp credit contraction and the early ’90s recession. ”
Credit indices have also taken a turn for the worse – at current prices, van Steenis believes global banks would have to write off an incremental $20bn-$30bn on hung leveraged loans. In addition he sees additional markdowns on commercial mortgage-backed securities, Alt-A mortgages, US consumer credit and other securitized products.
“If funding costs remain higher for longer, the outlook is weak for mid-cap mortgage banks with wholesale bias in Spain and the UK, as well as central and eastern European and Icelandic banks where loan growth has been well ahead of deposits. Also, as banks start a war for deposits, we expect large mutual fund outflows, hitting many asset managers.”
While much bad news is already priced in, van Steenis is concerned that European banks as a sector could be stuck in a value trap until we see much steeper European yield curves, greater transparency on losses, the start of balance sheet repair and a tightening of funding costs.
With these greater funding issues in mind, he recommends going long free, cash flow-generative, deposit-rich banks and financials – and selling short highly levered banks and those exposed to the credit black spots such as UBS, Kaupthing, or Erste.