Interactive Investor

Financials bloodied in February crash

10th February 2016 14:37

Lee Wild from interactive investor

It's like 2008 all over again. Banks are in the news for the wrong reasons, and talk of another financial collapse is back in vogue. Deutsche Bank shares have hit an all-time low and now Credit Suisse chief Tidjane Thiam feels it necessary to tell the FT his bank is safe.

Massive fines and a laboured restructuring have nobbled Deutsche, while the impact of tougher regulation contributed to record losses. Some of its largest investors have "lost faith" in the business, reports Reuters, and Citigroup warns of a capital shortfall of up to €7 billion (£4.8 billion).

Whether or not Deutsche is the new Lehman Brothers - unlikely if co-chief executive John Cryan's claim to be "absolutely rock-solid" is correct - current thinking is that this is not another financial crisis on the scale of 2008.

Of course, many investors now take the promise of a banker with a pinch of salt despite a radical overhaul of the industry. And Deutsche's share price has halved in value since October and had fallen by 42% in 2016, until this morning.

Buyers flocked back to Deutsche Bank shares Wednesday, chasing them up as much as 16% on talk that it may buy back billion of euros of its senior debt, using its €220 billion of liquidity reserves.

"Whilst the profitability outlook for European financials remains highly uncertain, a personal view is that the credit risk has been exaggerated in recent days," reckons Deutsche Bank strategist Jim Reid.

"The ECB still has numerous facilities that banks can use to prevent liquidity concerns. Having said this, even if the market is wrong on this, a mistaken sell-off can lead to self-fulfilling problems in a sector like financials. Banks are often a confidence play and there isn't much of it around at the moment."

Balance sheet strength

Balance sheets are far stronger now than eight years ago, however. UK banks passed the Bank of England's (BoE) second annual stress test, although Standard Chartered and Royal Bank of Scotland were waved through because of action taken since the test period end.

As we reported at the time, the BoE tested a five-year scenario out to 2019, in which global growth plunges by almost 7%, China expands by just 1.7%, oil prices sink to $38 a barrel, and the eurozone suffers three years of deflation.

A surge in volatility was factored in, and a soaring dollar was to depreciate emerging market currencies by a quarter. Another slug of misconduct costs also wiped out around £40 billion of banks' pre-tax profits for the purposes of the test.

However, even if the sector avoids another crash, it does remain exposed to a sharp downturn in business. There's a real fear that central bank action is no longer enough to stabilise, let alone trigger heavy buying of risk assets, including equities.

Since the Bank of Japan's shock decision to adopt negative interest rates last month, the domestic Nikkei index has plunged by as much as 1,600 points, or 9.5%! It fell almost 1,000 points on Tuesday and another 656 points mid-week.

As bank stocks have been beneficiaries of quantitative easing, it figures that the anticipated failure of future monetary stimulus will hit them disproportionately. And that's borne out by the performance of financials in February.

As you can see, eight out of the ten worst-performing FTSE 100 stocks in February are financials. Coincidentally, it's Thiam's old company that's top of the list, plunging 18% this month. It's down 22% in 2016 so far.

Reports earlier this month that China might place restrictions on the buying of overseas insurance did serious damage to the Far East-focused insurer.

And Legal & General has done so badly it published yesterday "a provisional, unaudited analysis of our annuity bond portfolio as at 31 December 2015". With results only a month away, this surprise move was a response to fears among analysts and investors about L&G's £39 billion bond portfolio.

Elsewhere, Schroders, HSBC and Lloyds Banking make February's list of Top 20 losers, down 13%, 12% and 11% respectively. Lloyds, however, has significantly de-risked its balance sheet in recent years and enjoys a strong capital position. Rising dividends still make it a favourite among income investors with an appetite for risk.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.