Last year I wrote a blog post on how U.S. hedge funds were shorting Canadian banks based on their loan exposure to the oil patch. If you eliminate the drop in value of the Canadian dollar, the actual stock prices have dropped marginally. Plus when you short a stock, you have to pay the quarterly dividend until you repurchase it. The short trade has been a poor bet so far if you add back the cost of having to pay the bank dividends.
However, it seems that hedge funds have turned their attention to shorting European banks. Everyone seems to think there is some kind of crisis. The stock prices of European banks seem to be telling us something is wrong! As of the closing prices of Feb 8th, the Year to date prices are: Deutsche Bank down 35.6%, Credit Suisse down 33.4%, BNP Paribas down 25.3% and UBS down 22.8%, yikes!
Here are some concerns about European banks:
- Ongoing restructuring and litigation charges.
- Flattening yield curve/negative rates.
- Slower European growth.
- Asset management slowdown. Asset management has suffered because wealthier clients aren’t investing.
- Book value issues: European banks did not take the big write-downs that U.S. banks took; there’s concern there may be more asset write-downs that would cause book values to decline.
- Capital positions: While the U.S. banks were out raising capital and selling new shares in 2008-2009, the European banks didn’t. The result: U.S. banks don’t need to raise capital, but European banks probably do.
I understand why there is concern in Europe but investor anxiety regarding banks has spread to U.S. banks causing a selloff. Part of the downdraft has been caused by the debate on future interest rates hikes by the Fed. Raising interest rates are actually good for bank profits from their loans. International exposure is another headwind for many U.S. multinational banks. Finally, many banks are trading below book value because investors believe that some of those assets contain oil loans that will be written off.
I have no doubt that short sellers are also pushing these stocks as far as they can go, into irrational territory. What is happening now is that guys who were long these stocks are being forced to sell simply to reduce exposure. Bank of America is down 27.1%, Citigroup is down 26.7%, Wells Fargo is down 14.5% and Goldman Sachs is down 17.2%.
The chart below is three financial indexes, XFN is Canadian, XLF is U.S. and EUFN is Europe.
According to Hedge Fund manager Kyle Bass, more pain in the banking sector
Bass is best known for making a winning bet on the subprime mortgage crisis and later profiting from his call that the Japanese yen would fall in tandem with a projected round of monetary stimulus by the Bank of Japan.
Kyle Bass has been ringing the alarm bells about China’s banking system and the yuan for months. The premise of Bass’ bet goes like this: China’s banking system has grown to $34.5 trillion, equal to more than three times the country’s GDP. The country is due for a loss cycle as cracks begin to show in its economy.
When that happens, central bankers will have to dip into China’s $3.3 trillion of foreign exchange reserves to recapitalize the banks, causing a significant depreciation in the value of the yuan. He said China’s export-import industry requires China to maintain $2.7 trillion in foreign exchange reserves to continue operating smoothly, citing an International Monetary Fund assessment.
Bass confirmed Wednesday he is devoting much of his fund to his bet the yuan will depreciate. He characterized shorts against the currency, including his, as totaling “billions.”
The market will ultimately come to view a 10 percent yuan devaluation as “a pipe dream,” he said. “When you look at the size of the imbalance and the size of their economy, it’s going to go 30 or 40 percent in the end, and it’s going to be the reset for the world.”
China’s controlled devaluation of the yuan this year has sparked growth concerns that shook the equity markets around the world and contributed to the worst January for the Dow and S&P 500 since 2009. If Kyle Bass is right on China’s banking problem, than stock market declines around the world will get even worse.
I have been slightly bearish on stocks since mid-December and most of my January posts have contained more negative than positive views. However, North American banks are in much better shape than during the great recession. Canadian banks have been on my buy list for quite awhile. I am now adding some U.S. banks to the list. I am patiently waiting for a bottom in oil prices and more information on future loan loss provisions.
Are you ready for a great near term buying opportunity in North American bank stocks or is there another banking crisis coming?