Why are investors dumping bank stocks, again?
- Bank investors abandon their holdings
- The industry in search of direction
The mood music around the banking sector was broadly positive year-to-date, with stock prices recovering on rising interest rate expectations and a post-pandemic recovery allowing the release of important capital which had been reserved to cover possible bad debts.
With balance sheets once again bloated with cash, shareholders should have settled in to enjoy a comfortable summer. However, the start of the war in Ukraine, which appears to be tipping the global economy into a major supply-side shock, as well as nervousness over a property price correction, have led investors to sell stakes in banks despite their historically low valuations. . Yet the key to understanding the situation is to distinguish between the usual problems facing banks and the truly exceptional ones.
Hardened bank investors are understandably the cautious type after being badly burned during the financial crisis and enduring years of stock price underperformance over the past 15 years. However, the sector was still surprised that Capital Group, a US fund manager with $2.7bn (£2.1bn) in assets, launched a sell-off of its bank stakes Europeans earlier in April.
The sale, according to a FinancialTimes investigation, was the result of the actions of a fund manager, meaning Capital sold nearly €7bn (£6.2bn) of its total bank holdings. Sales included Barclays (BARC) with a £900 million, 3.6% and 5% stake in Deutsche Bank (DE:DBK) and Commerzbank (DE:CBK), with a respective value of 1.27 billion euros and 475 million euros. Other stakes sold included most of the other major European banks, including France Societe Generale (FR:GLE)Dutch ING (ING) and Italian Unicredit (UCG) all affected by Capital’s actions.
A calculated or reckless action?
The question is whether the shares of Capital are emblematic of the fragility of the general sentiment of investors towards the banking sector? By themselves, Capital shares can’t really be justified on valuation grounds – the MSCI Europe Banks Index has a forward price-to-earnings ratio of just 7.75x, compared to 13 for the broader index. . It should also be noted that the net return for banks since December 1998 was only -0.45, and just 4% for the broader index.
While this is perhaps a mildly damning indication of how little investment banks are investing, it is broader economic issues that are affecting sentiment towards banks. The European Central Bank (ECB) recently released its stress tests in the sector which reflected the exercise conducted at the height of the pandemic in 2021. The results were not encouraging. In the best-case scenario, a recession in the euro zone this year could cause banks’ basic equity to fall by around 2%, and reach 7% if the difficult economic conditions persist over the next two years.
Furthermore, the ECB believes that house prices are at an inflection point in many countries at a time when rising interest rates are expected to affect low-income households the most, with obvious implications. for bank credit quality.
The silver lining in all this pessimism is that the banks are much better capitalized than at any equivalent time in their history; average Common Equity Tier 1 (CET1) ratios are over 14% for Europeans and some hold as much as 18% of balance sheet value in reserve capital. There is also a clear split between investment-focused banks like Barclays and Deutsche Bank, versus high street lenders like Natwest (NWG). Investors have clearly understood that investment operations are a black box waiting for the next bad surprise, while large operations are easy to understand.
The American exception
The situation is somewhat reversed in the United States, where bank profits have traditionally been supported by a combination of higher investment banking fees and large spreads available on domestic transactions. Even here, however, the nervousness seems to have set in. The S&P 500 Banking Index has posted a negative total return of -12% over the past year, showing that banking investors can suffer as much as anyone else.
The situation has been further aggravated by news that Berkshire Hathaway (US: BRK.A) finally sold the last part of its stake in Wells Fargo (US: WFC) in a token gesture for an action that was once Berkshire’s largest holding. Surprisingly, the Sage of Omaha didn’t entirely call time on bank stocks and traded Wells Fargo for a $3 billion stake in Citigroup (US: C) – a diametrically opposed business, with large foreign (and accident-prone) operations and many opaque investment banking divisions. The purchase raised a few eyebrows, to say the least.
However, this may be symptomatic of a wider malaise within the sector, which appears to be struggling for both direction and confidence now that the equity boom is well and truly over and a host of issues loom. on the horizon. It could also be that valuations need to fall further before investors again dare to leapfrog into bank stocks as a true value proposition.