Goldman has just started selling European bank stocks to its clients, whom it is telling to buy European bank stocks. Said otherwise, the stolpering of clients gullible enough to do what Goldman says and not does, has recommenced. Our advice, as always, do what Goldman's flow desk is doing as it begins to unload inventory of bank stocks. Translation: run from European bank exposure.
Raising banks from underweight to neutral
We are shifting our recommendation on banks from underweight to neutral. We shifted to an underweight position recently. This was based on our view that the economic environment was deteriorating. The combination of weaker growth and the need to shore up balance sheets was, we felt, likely to be a significant headwind and reduce demand for corporate loans while also increasing NPL’s. Furthermore, the sector is becoming more domestic as banks sell assets outside their main markets.
While all of these concerns remain, the new funding arrangements agreed by the ECB and other central banks should significantly help the banks offset the pressures of the economic downturn in our view. The coordinated action by central banks last week has brought a reduction both in the rate (down to OIS+50 bp; previously OIS+100 bp) and margin (down to 12%, previously 20%) while giving commercial banks access to US$ through this channel. In a further positive surprise, the ECB is also now offering banks 3-year liquidity (full allotment, fixed rate), on an expanded collateral pool (which now includes loans) and a lower reserve ratio. According to our banks analysts (see “Capital story is ending, funding receives a large ECB boost” December 9, 2011) the scope and structure of this facility directly addresses the banks’ key funding concerns.
The 3-year duration will address mismatching issues while an expanded collateral pool and lower reserve ratio increase the scope for banks to get access to liquidity. The interest rate structure meanwhile allows banks to detach their funding cost from that of sovereigns, which has been one of the key factors that has kept the risk premium on banks so elevated. As a result, our banks analysts expect a positive impact on margins, deposit pricing and loan availability resulting in a high take up of the facility. While these facilities help to reduce the risk premium to some degree they should be seen against the ongoing deterioration in fundamentals so that, on balance, we feel a neutral in the sector is appropriate.