Why European Bank Stocks May Have At Least 40% More Downside
Last week we noted how up to 90% of the European banking system's equity market capital (or ultimate risk buffer) would be wiped out if they were forced to transform (and price risk appropriately) their mis-marked asset base. The market itself has already started to adjust for this possibility (just look at Italian and Spanish bank stocks recently) but it is the similarity of Europe's bursting bubble of credit extension and current balance sheet recession that brings Japan to mind, and, as Barclays notes, if European banks follow the same trajectory as Japanese banks did from their peak in 1993 (as Europe has been since their peak in 2006), then Europe's banks market cap as a percentage of the total market is likely to drop from the current 11% to around 6% within the next year. Combine that with reality with Deutsche Bank's note that Spanish and Portuguese banks (and less so Italy for now) appear perilously short of ECB-eligible collateral, and is it any wonder things are shifting from bad to worse over there as bank recap plans are critical.
As Barclays notes:
Two banking systems separated by two decades are bound to be different... Compared to Japanese banks, then, today's European banks are more profitable, are more consolidated and have recognised losses much earlier.
...but disturbing similarities? For both systems, a private sector credit boom – followed by a bust – has seen loan books shrink and revenue growth stall. Europe's banks now closely track the Japanese experience on several metrics.
But perhaps the clearest evidence of Europe's 'Japan-isation' is the verdict of the stock market. Both banking systems reached ~20% of their respective stock markets, and six years from peak, both halved to ~10%. Worryingly, Japan's banks then went on to decline a further 40% over the next half decade.
And while Deutsche Bank notes that the ECB could further ease collateral requirements (which would seem a critical short-term step for Spain already) the following chart shows just why Europe is so encumbered already - as they note that the first and most critical step in Europe is a bank recap (which can only be dilutive for current shareholders) before any of the liquidity can flow into the real economy...
In the US, the ETF EUFN is the simplest way to play a position in European financial stocks but the ETF is small, illiquid, and has in the past been heavily shorted so buyer (or seller) beware.