It is another “risk off” day in the jargon for stock markets in Europe.
Banking stocks, in particular, are falling out of bed.
Shares of Deutsche Bank and Commerzbank, Germany’s two largest lenders, have fallen at their worst by 13% and 8% respectively while BNP Paribas and Societe Generale, the first and third-largest banks in France, have each fallen by 7% or so.
Meanwhile UBS, which of course has been cajoled by the Swiss government into a shotgun marriage with its largest rival Credit Suisse, has fallen by 7.5%.
These reverses have been echoed to a slightly lesser extent by falls in banking stocks in London. Shares of Barclays, Standard Chartered, NatWest Group, HSBC and Lloyds Banking Group are all among the biggest percentage fallers in the FTSE 100 today.
Perhaps most disquieting is the fact that, not only have some European lenders seen big declines in their share price, the cost of insuring against the likelihood of these banks defaulting has risen.
For example, the price of a five-year credit default swap (or CDS, the instrument used to buy insurance) on Deutsche Bank has shot up from 89.625 basis points two weeks ago to as much as 211.655 basis points.
That is a stupendous increase that speaks to the levels of uncertainty in markets. The price of CDSs on other European lenders have also jumped.
So what’s going on?
Several things. The first thing to say is that there does not appear to be a particular single, overwhelming, catalyst for the sell-off. Rather it is a combination of factors.
One of these is the rescue of Credit Suisse which, while impressively executed by the Swiss authorities, has introduced an addition level of uncertainty for those who invest in bonds issued by banks in particular.
The rescue saw some $17bn (£14bn) worth of value in bonds known as ‘AT1’ bonds completely wiped out.
It has provoked fury among the holders of those bonds because, normally, shareholders rank below bondholders in the hierarchy of creditors – and, on this occasion, shareholders of Credit Suisse received at least a modest sum for their shares even as the AT1 bondholders were wiped out.
That is highly unusual and has probably made some owners of bonds issued by other lenders reappraise their appetite for risk – hence the surge in CDS prices.
Another reason is the fact that there is still a good deal of unease among investors in the mid-tier and regional lenders in the US following the collapse of Silicon Valley Bank.
Confidence in what was America’s 16th largest lender unravelled when it failed to raise extra capital from shareholders and when it was forced to sell a $21bn bond portfolio in order to meet demands from depositors for their money back.
SVB crystallised a $1.8bn loss in the process, due to falls in the value of the bonds in which it had invested, raising concerns in the minds of some bank investors as to how much the worth of bond portfolios owned by other lenders might also have fallen.
Attention has focused on other mid-tier lenders, most notably First Republic, a New York-based bank which, last Friday, received some $30bn in deposits from 11 other lenders – among them giants such as JP Morgan Chase, Citigroup and Wells Fargo – in an attempt to shore up confidence.
So there is concern there – and that has, to an extent, percolated to Europe.
An additional factor is the position of some of the individual banks. Attention focused on Credit Suisse because of its recent accident-prone history and its poor financial performance.
To an extent, Deutsche Bank is coming in for similar treatment for the same reasons.
The lender is no stranger to sudden sell-offs in its share price, most notably in 2016, but in more recent times it has appeared to be back on the straight and narrow. This reflects in no small way Deutsche Bank’s restructuring under Christian Sewing, its chief executive, which began in 2019.
Deutsche last month reported a net profit for 2022 of €5.7bn (£5bn), more than twice what it achieved in 2021, which represented its best outcome for 15 years. Yet Deutsche continues to be dogged by past legacy issues – the German financial regulator, BaFin, continues to be unhappy at its internal controls to identify and stop money laundering – and these may yet result in more misconduct penalties.
Legacy misconduct charges also potentially hang over UBS.
It and Credit Suisse are, reportedly, under investigation by the US Department of Justice over allegations that some employees may have helped Russian oligarchs evade sanctions following Russia’s invasion of Ukraine.
So, no one overriding factor, but lots of individual ones that, put together, create a cocktail of unease.
All of that, ahead of the weekend and as the end of the first quarter approaches, explains why some investors are squaring their books and avoiding excess exposure to banking stocks and bonds.
The reasons why some investors feel uneasy about banks were explained succinctly this week in an article for the Financial Times, entitled “Why I never invest in bank shares”, by the influential investor Terry Smith.
In the piece, he highlighted the sector’s poor returns to investors, the high levels of leverage in the sector, the disruption to traditional lenders by fintech firms and, above all, the systemic risks that still lurk in the banking sector.
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Mr Smith wrote: “Even if the bank you are invested in is well run, it can still be damaged or destroyed by a general panic in the sector… banks can be brought down by the actions of their peers.
“Look at what happened to some US regional banks in the wake of the SVB disaster. Lord Mervyn King, the former Bank of England governor, encapsulated this when he observed that it made no sense to start a run on a bank, but once one has started you should join in.”
His words sum up perfectly why, when sell-offs in banking shares occur, the selling can be sometimes indiscriminate.
When a butterfly flaps its wings in Zurich, it can lead to share price falls in New York, London and Frankfurt.