Banking turmoil: A rout for rationality
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As Deutsche Bank executives watched a frenzied sell-off in its shares and debt on Monday, Marcus Schenck found a way to take the sting out. The bank’s chief financial officer had received an email from its accountants, who had reviewed the books and expressed confidence in Deutsche’s ability to comfortably pay back its debt. Making this information public could end the bloodletting.
Hours later, Deutsche issued the good news. Yet for the next 24 hours, headlines worldwide screamed with clangers like “Deutsche insists it can pay all its debts”. Executives were horrified.
On Tuesday, officials tried again to bolster confidence by tweeting a staff memo from John Cryan, the co-chief executive, stating that Deutsche was “rock solid” — but this only seemed to worry investors more. German finance minister Wolfgang Schäuble’s comment that he was “not worried” about Deutsche did not help either. The shares kept falling, losing another 5 per cent on Tuesday to hit a 30-year low.
Deutsche was not the only bank searching for ways to staunch this week’s sell-off, which had echoes of the 2008-09 financial crisis. Credit Suisse, Standard Chartered, Bank of America Merrill Lynch and Morgan Stanley were among the other banks suffering steep falls. The broad European FTSE 350 banks index fell nearly 7 per cent, while in the US the S&P 500 bank stocks index dropped 3.3 per cent between Monday and Tuesday.
As the sell-off gained pace, the list of explanations for why it was happening grew longer. It was China’s stagnation. It was poor global economic growth. It was low oil prices. It was interest rates turning negative. It was fears about banks’ capital. It was looming loan losses. It was a herd mentality spiralling out of control. It was schizophrenia.
“Rational people suspend rationality in fast moving markets,” says a senior banker. “There’s no single cause you can point to. It’s pick your poison.”
After huge swings in markets — steep falls on Monday and Tuesday, a rebound on Wednesday, a collapse again on Thursday — momentum changed again. Jamie Dimon, chief executive of JPMorgan, set the tone when he disclosed that he had bought $26m worth of shares in his bank on the open market.
Chris Mutascio, banks analyst at Keefe, Bruyette & Woods, says: “It’s one of the most respected, powerful bankers in the world saying, ‘I’m putting my money where my mouth is’. It allays a fear out there that we’re going into something much more sinister than it really is — that this is a balance sheet-type, 2008 recession.”
Yesterday, Deutsche said it would start buying back its own bonds, lifting its shares 10 per cent.
For all the drama of the past five days, the banking stocks blowout has been building for some time.
On January 22, analysts at Berenberg produced a report titled “Free Falling”, noting that European banks were trading at “all-time lows” relative to the broad market index. Low interest rates and the poor economic outlook were identified as the key factors that led Berenberg to conclude “European banks are turning Japanese”. In the US, banks have been underperforming the broader stock market since the turn of the year.
Not long ago the narrative was different. As the US Federal Reserve signalled last year that it would begin to raise interest rates, many thought the industry’s long post-crisis slump would begin to fade. Now, though, interest rates are expected to stay lower for longer, crushing banks’ margins. The slowdown in the Chinese economy is having a global ripple effect, as are potential losses from lending to the oil and gas sector.
The pain in the world of investment banking continues as regulations make it harder for banks to find sweet spots where they can make money. Investors, too, are still adjusting to a world where banks’ return on equity has been hobbled by the sheer amount of capital they have to hold.
Yet while the post-crisis regulatory regime has been frustrating for banks, they should be better prepared for a slowdown and better able to withstand losses. They have their highest levels of capital in decades — the top US banks have improved their ratios by more than half, while European banks have raised more than €400bn since 2007.
The banks are also involved in fewer risky activities: they no longer trade on their own account because of rules limiting proprietary trading, nor can they hold big positions. Even the inventories they hold for “market making” have shrunk as regulation made it less attractive.
Despite the headwinds, analysts are not forecasting disaster. Europe’s biggest banks are expected to make almost as much money in 2016 as they did last year, while the top five American banks are expected to post a drop in adjusted net income of less than 7 per cent.
Most big US banks beat earnings expectations in the fourth quarter. Halfway through the European earnings season, banks reported almost the same number of earnings beats as misses.
For those reasons, European bankers, analysts and investors argue that the dramatic movements in bank share prices are being driven by sentiment, not fact.
“There is no explanation in the company fundamentals that are visible to us, that would justify anything like this scale of sell-off,” said Jeremy Sigee, banks analyst at Barclays in London. “The market is pricing in fears of a large global macro/credit shock that we cannot yet see or fully describe.”
Tidjane Thiam, chief executive of Credit Suisse, told the Financial Times on Tuesday that the market was pricing in a “major world recession” and that the share price movements were “not justified”. His bank’s shares had fallen 8 per cent that day and 20 per cent in the previous week.
In the US, there is a wider spread of opinions on why banks are falling so much. The arguments for a fundamental cause are stronger: US banks have a bigger exposure to oil than Europeans and had high hopes for interest rates this year.
Janet Yellen, chair of the Federal Reserve, on Thursday suggested she was in no hurry to raise rates. She said the Fed was carefully watching the financial and economic maelstrom, telling lawmakers that, even if she did not expect it to become necessary, she was not ruling out a reversal of the Fed’s December rate increase.
Ms Yellen also refused to rule out negative interest rates — a step taken this week by the Riksbank in Sweden, joining the Bank of Japan and the European Central Bank — if the US economy splutters.
Negative rates would be very bad news for US banks. As well as the administrative nightmare, they would have to pay for the deposits they hold unless they could persuade savers and companies to pay to put their money with a bank.
Still, Jim Cowles, head of Europe, Middle East and Africa at Citi, says the market is undervaluing his bank. “What’s happening is that the drop in oil has been so fast and so dramatic that you’re seeing the negative impact but not seeing the positive impact yet,” he says. He added that just when households and businesses will start to benefit from low oil prices is “the big unknown”.
Citi has lost 28 per cent of its value since the start of the year but Mr Cowles says the bank has not seen “any sort of unease” from its clients. “They can look at . . . what our capital base is, what our liquidity reserves are, all the different regulations that have come into play, and say the banks are in a very much stronger position than 2007-08,” he says.
Market sources say this feels different to the chaotic markets after Lehman’s collapse. Stocks are seeing outsized rises as well as falls — ING, for example, jumped as much as 9.5 per cent on decent but not amazing results on February 4, the same day that Credit Suisse fell 13 per cent on bad ones.
Even so, confidence is fragile. Jeff Harte, analyst at Sandler O’Neill in New York, says banks might be on a firmer footing than during the crisis but confidence will remain weak until the economic outlook improves.
“You can say the banks have a lot of capital and liquidity, you can do that analysis and feel OK . . . but you’ve still got that psychological fear that maybe you’re wrong,” Mr Harte said. “To say this is over, we need fundamental relief on something like growth in gross domestic product, energy prices or interest rates, some positive fundamentals for people to sink their teeth in to.”
Additional reporting by Ralph Atkins in Zurich, James Shotter in Frankfurt, Sam Fleming in Washington and Patrick Jenkins in London
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