Tags: ecb | bank

Investors Wary of European Banks' Reliance on ECB

Monday, 20 Feb 2012 01:48 PM

A wave of very cheap money from the European Central Bank may have averted a credit crunch, but it has sown confusion among Europe's bankers over how profitable their business really is.

Banks need a fundamental rethink of their business models for a future in which 489 billion euros that the European Central Bank (ECB) has pumped into the system are no longer available, in three years' time. The ECB is expected to repeat the offer of cheap money next week, possibly for the last time.

And investors will hold back until the picture is clearer.

Almost none of 188 fund managers surveyed by Aviva held more financial stocks than their benchmark recommends during the second half of December and early January and only 17 percent expected to increase allocations to the sector in 2012.

"We are not really addressing the fundamental problems, and we are not really discerning between the better managed banks and the poorly managed banks," said Jonathan Chia Croft, at boutique investment bank AdviCorp.

The ECB's action has stemmed last year's near-crisis, when concerns about a further spread of the euro zone's sovereign debt woes sparked worries that another bank might collapse after the October bail-out of Belgium's Dexia.

Funding markets have now re-opened, and banks have raised $87 billion from covered bonds and unsecured debt this year -- similar to the tally for all of the last five months of last year, Thomson Reuters data show.

In particular, the ECB move has helped national champions like Switzerland's UBS, ING and Britain's Barclays, as well as Spanish and Italian banks, Santander, BBVA and Intesa SanPaolo.

In a sign of increased market confidence, Intesa by Monday had attracted an order book of around 2 billion euros for its first unsecured long term borrowing since a worsening of the euro zone crisis last summer.

But one worry is that some of the smaller banks will use the cash as a quick fix, tempted by the opportunity of using cash borrowed cheaply from the ECB to buy high-yielding European government bonds, generating easy profits.

Banks are estimated by equity analysts to have spent up to 100 billion euros of December's cash on government debt, helping cut borrowing costs for Italy, Spain and others -- as intended by the ECB.

Smaller Spanish or Italian banks like Bankinter, UBI Banca or Monte dei Paschi may be tempted to lift their profits by taking this so-called carry trade.

The risk is that they will be caught on the wrong side of a bet if more economic headwinds send bond yields soaring again, inflicting further losses.

Their rationale for buying is that if the government bonds fall in value, these smaller banks are so exposed to their domestic economy anyway that they would have nothing to lose.

 

NO STIGMA

Some banks -- Deutsche Bank and UK-based Barclays are two examples -- have not used the ECB cash, enabling them to show they were strong enough to fund themselves privately and avoid political interference.

But so far, there has been no stigma attached to taking the cheap money.

"I don't think the banks that tap the second (ECB cash injection) will be tainted at all," said Kathleen Gaffney, co-manager of the $19.4 billion Loomis Sayles Bond Fund.

"It would be unforgiveable from an investor's perspective if they refused to borrow this time, and suffered fresh problems down the line," she said.

The focus is therefore firmly on how the sector as a whole will perform in the future, not on picking stocks.

"Banks will need to reinvent themselves... we are really curious to hear what they tell us at the end of 2012 or 2013 as to how they want to position themselves," said Uwe Zoellner, head of pan-European equity at Franklin Templeton.

Italian, Spanish and French banks were the biggest takers of the initial 489 billion euros which the ECB offered just before Christmas. The Italian banks took some 116 billion euros, and the Spanish and French banks each around 100 billion euros, according to analysts and sources.

They had been effectively locked out of the interbank market, amid concerns about contagion from the Greek debt crisis. Big French banks also used the facility.

Now, investors are asking what's next.

"The risk with the (ECB cash) is that it crystallises the fact that a lot of banks' funding models don't work," said Mike Harrison, analyst at Barclays Capital.

"If a bank is loaded to the gills with ECB money there is a risk that a bank's independence and ability to act in shareholders' interest gets impaired at some point."

The cheap central bank funding could offer a modest profit boost. A bank drawing 5 billion euros in funding to save 2 percent on its funding costs would get 75 million euros in extra profit, or about 1-3 percent of this year's profit for most big names, Deutsche Bank analysts estimated.

Such concerns have slowed a sharp rally in bank bonds and shares, which followed the ECB's offer.

To regain investor trust, banks will need a wholesale reshaping, to improve profitability and keep lowering the risk on their books to lessen the likelihood of further taxpayer bailouts -- set against a backdrop of recession.

"What we have learned in the (United) States is that the real pressure comes after you take the liquidity and what do you do with it," said Kathleen Gaffney, co-manager of the $19.4 billion Loomis Sayles Bond Fund.

"In the U.S. most of the banks held onto it, and didn't make the loans and as the markets rebounded strongly, they continued to pay high bonuses and there's been some pretty significant backlash on that as a result."

Estimates for the ECB's next offer range from 200 billion to more than 1 trillion. Banks are likely to draw 500 billion euros, according to a Reuters poll of 23 traders.

That will alleviate a total refinancing need for European banks this year of some 725 billion euros.

Opinion is divided on whether the market should cheer another massive take-up or rather demand more discipline from banks and tell them it is time to stand on their own feet.

"It's a bit like standing outside the doctors to see who goes in, and assuming those who do go in are the people who are sick," said Advicorp's Croft.

($1 = 0.7668 euros)

© 2017 Thomson/Reuters. All rights reserved.

 
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