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Friday, 26 September 2008

Buy Buy Banks

Yesterday, Thursday, the FTSE 100 closed up 1.9% after falling 4.1% in the previous three sessions (& index is down 20% this year) and this morning fell 1.8% at the off. Gyrating up or down 2% is a normal day's shake 'n shiver, but there are interesting indicators below this. It is like watching racehorses at Aintree at the starting line of a steeplechase snorting steam in the cold air, jittery, spinning back and forth, riders adjusting checking all, thinking race strategy.
U.S. lawmakers neared agreement on TARP (with more protections for taxpayers or some kicking and ring scratches on the bankers)until McCain threw a spanner, as new data added to public concerns (WAMU, R-R-Recession, GE, Fortis and gosh, HSBC announces sacking 0.3% of staff?! And some chief portfolio strategist says, "It's an important watershed that the administration and Congress get this sorted, but it's not the key catalyst for buying the banks the next day".
OH BUT, NO BUT, YES BUT, it certainly is the 'key catalyst'- it's the flag about to drop or the starting gun cocked. Once financial stocks rebound significantly we will hear the complaints again that they're having it too easy; too much generosity gifted to these wastrels. It took 18 months after the introduction of the Resolution Trust Corp (RTC) to rescue the U.S. S&Ls in 1989 before U.S. banks started to outperform and many analysts compare the current plan to the RTC. But note the date. The banks started outperforming other stocks in the middle of recession! Starting from where they are now, chastened and pared down, outperformance is built in like a compressed spring.
Yesterday, jockeying at the start-line, Royal Bank of Scotland, HSBC, HBOS , Lloyds TSB and Barclays were up 1.8 to 7.1 percent. Insurers rallied too despite capacity in the insurance market falling, as capacity has fallen in banking too by about 30%, and so pricing is rising and dominant players like AXA can grow market. RSA Insurance soared 11.1%, Aviva 9.9%, Prudential 8.5%, Old Mutual 12.6% and Admiral Group 5.5%. These are very substantial moves but only the pre-start jockeying, and show the importance of TARP to the monolines and reinsurers and the whole insurance market, not just the banks.
3-month USD LIBOR-OIS spread jumped to record 199bp. 3-mo EUR LIBOR-OIS at 86bp (record was 93bp in Nov 2007). TED spread (3 month LIBOR/T-bill) at 316bp after whavering around 350-400bp. LIBOR rates at near record highs in USD, EUR, GBP. So, right now, there is no real term funding markets except for central banks windows and guess what, the Bank of England closed its SLS a few days back - the very event that probably triggered HBoS's rush into the arms of Lloyds. For now Libor is meaningless. It's for unsecured lending but there is no unsecured lending and all unsecured lending risk gradings of banks are awaiting downgrades. The measure of risk aversion and tightness in short-term bank funding by widening to almost 500bp, is the highest margin since the early '80s.
And what about the effect of banning short selling? Naked Shorting Continues in CDS Market (the onetime $62tn, now $54tn CDS unregulated dysfunctional market). Shortin has shifted to otpions and hedge funds can still bet against a bank in the unregulated OTT OTC CDS market without owning the underlying bonds in order to place a price fall bet. A bank bond short seller profits when the bond price drops further below face or goes into default.
Europe's banks (and Enhanced Money Market Funds) may now be more vulnerable than those in the US and more dependent on TARP going through. The leverage ratio (assets / equity) - of the average European bank is 35 (due to large in-house proprietary trading books), compared with less than 20 for large U.S. banks. This means small writedowns on assets have big impact on capital ratios. EU banks have become too big for any one European state to save while - too big to fail and too big to be saved; one reason the whit collar crime police have not been called in more often. Total liabilities of Deutsche Bank (leverage ratio 50+) are €2tn+ (one third more than Fannie + Freddie) or 80% ratio to German GDP. It may be well managed, but serious questions are being asked about other EU countries' banking champions.
So, of course, inevitably, this morning, Friday, the firing spring is coiled down again with banks down 0.9 - 4.3% (B&B down 14%) and insurers and listed hedge funds down 2.3 -5.6%. But other sectors and Europe and Japan are also sagging, hammocking.
Everyone is simply waiting for the folks on Capital Hill to ring the bell.

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