Maybe we should call it euro-fatigue. Every day eurozone troubles make headline news. The story rumbles on and on… and on. I worry that too many investors have become desensitised to the gravity of the situation on the continent because they’re bored with it.
Last weekend a good friend of mine said he’s thinking about picking up some ‘cheap’ bank stocks – Mark was insistent: “many are trading at their half book value, Bengt!”
But there’s a very good reason for that. And frankly, these banks could be worth a whole lot less… I really don’t think the markets have a clue what lies ahead.
Your banks need you!
The president of the European Commission, Jose Manuel Barroso, says that Europe’s banks need fresh funds – in a big way!
As I’m sure you’re aware, banks hold a lot of money. In fact together, the balance sheets of our banks are many times the value of our country’s GDP. And because the regulators don’t want the banks to gamble away depositors’ cash, they insist that a certain amount of the bank’s balance sheet is held in ‘safe investments’.
Now, according to the authorities the safest investment you can get is a government bond. And banks have been loading up on those in the last year or so.
The trouble is that now the banks are full of government debt – much of it looking dodgier by the day. And the implosion of French/Belgian bank Dexia has forced the likes of Barroso to question the robustness of the banks.
Should we ‘ring fence’ the banks?
Tim Bennett examines if ‘ring fencing’ can stop banks going bust.
• Watch all of Tim’s videos here
The head of the IMF, Christine Lagarde, said it first; now the president of the European Commission is confirming it: The banks need fresh capital. Their core and most sacred savings could be junk.
There are three reasons why this is going to prove very costly for the banks. Especially the continentals that hold the most vulnerable bonds. This banking crisis has yet to reach its climax.
No dividends and no bonuses
Barroso wants to cut down on the banks outgoings. And that means shareholders can expect to get lower dividends and bankers will have to make do with lower pay.
I don’t suspect many readers will be too concerned about bankers taking a pay cut.
As for shareholders – haven’t they taken enough pain? Why would they continue to take on the high risk of the banking sector if they don’t even get paid to do so?
And this is the nub of the problem.
“Remember Lloyds?” I asked Mark. “The last time the market was taking chunks out of the bank sector in late ’08, you told me you wanted to buy Lloyds! You told me that they were yielding about 12% and presented a great opportunity. The shares were around £2 as I recall.”
That was late summer 2008 on a sun-drenched roof terrace in the south of France. I persuaded Mark to steer clear of Lloyds. And I was kind of happy to remind him of it last week as we met up in London and he revealed his latest plan to load up on some bank stocks.
Since 2008 Lloyds shareholders haven’t seen a dividend and they won’t see one this year either. As for next year, some optimistic analysts are pencilling in a dividend of less than a penny.
Meanwhile the shares languish around the thirty pence area.
As with Lloyds and RBS, a forced re-capitalisation drives the share price down.
Expect the begging bowl to come out
If the banks can’t make enough savings from cutting wages and cutting shareholder payouts, then they’re going to have to come cap in hand to the shareholders.
Barroso’s idea is that the first port of call is shareholders, ie rights issues, where shareholders pump in fresh money in proportion to their shareholdings.
But even if you can get a rights issue ‘away’ in these markets, it’s going to be devastating for the share price. And if shareholders don’t buy new shares as demanded by the bank, then their existing shareholding gets severely diluted.
Now, if the shareholders simply won’t go for it, then it’ll be up to the government (taxpayers!) to take a stake, a la Lloyds and RBS. And this time around I don’t think governments can afford to be as generous to shareholders as they were in the ’08 crunch.
But what if governments can’t afford a bail-out? Well, then the banks will have to pass the begging bowl round to the eurozone bail-out fund. And they’re going to be sure to drive a very hard bargain.
“Whatever way you look at it Mark, there could be a lot of pain to come for shareholders. If the EU can’t find a way of stabilising troublesome nations – then the banks’ core capital reserves will start to evaporate. They’ll have to be replenished with new cash. That’ll devastate the shares.”
Who will be the worst hit?
In this week’s cover story for MoneyWeek
, James Ferguson points out that “cumulatively, the five largest French and German banks today have core tier 1 capital amounting to just 2.4% of their assets.”
So if Europe’s leaders want to recapilise the region’s banks, “these five alone would require €115bn to satisfy the mininim leverage ratio of 4% required in America for a bank to be adequately capitalised”.
James picks apart the balance sheet of Dexia – pointing out that the bank, along with a host of other European and UK banks, has done very little to acknowledge the true extent of its bad debts.
It’s a fascinating read. James picks out the worst offenders in the banking sector. But he also points to a couple of banks that he would recommend buying now.
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