News


19/09/2016


Flagstone Bank Credit Update 19 September 2016

Weekly Headlines:

• Although MPC members were unanimous in their decision last week to keep Bank Rate at its new record low of 0.25%, the MPC is still expected to cut interest rates to 0.10% later this year.

• The UK inflation rate unexpectedly held steady at 0.6% in August despite a big rise of 7.6% in the cost of fuel and imported raw materials.

• The UK labour market showed little sign of having been affected by the Brexit vote as the unemployment rate held steady at 4.9% and job creation rose in the three months to July.

• UK retail sales fell by only 0.2% in August after an upwardly revised 1.9% in July which was the strongest July performance in 14 years.

• The US DoJ has asked Deutsche Bank to pay $14.0bn (£10.6bn) to settle claims it mis-sold mortgage-backed securities which far exceeds market expectations for a figure of up to €3.0bn (£2.6bn).

• Shares in the Royal Bank of Scotland (RBS) fell by over 10% during the week as a result of the higher-than-expected claim against Deutsche Bank while shares in Barclays fell by 6% on the news.

Monthly Headlines:

• Although three months have passed since the historic Brexit decision was taken to leave the EU, financial markets continue to mark time while they await the activation of Article 50 early next year.

• The ITRAXX Europe Senior Financials 5-year CDS Index had again slightly improved to 83bps over the last month but rose to 96bps on Friday in reaction to the $14.0 billion DoJ claim against Deutsche Bank.

• Major banks remain under pressure to behave more like utilities from the indirect effect of financial regulators seeking to force them to hold so much capital that they are unlikely to fail.

• Some analysts are concerned that the ECB negative interest rate monetary policy is squeezing the margins of European banks, making their shares unattractive to investors and distorting market prices.

• Many analysts still question the creditworthiness of some major European banks despite the July announcement of the results of the EBA recent stress tests on 51 major banks within the EU.

General Commentary
Weekly Update:

Although the 9 members of the Monetary Policy Committee (MPC) were unanimous in their decision last week to keep Bank Rate at its new record low of 0.25%, the MPC is still expected to cut interest rates to 0.10% later this year, even though it expects the Brexit impact on the UK economy to be less severe than it expected only last month. The Bank of England (BoE) estimate that the economy will grow by 0.3% in the July-September period which is better than their previous forecast of just 0.1% made in August. However growth of 0.3% represents a halving from the second quarter’s level and the B0E has reiterated that it may well cut its benchmark rate again soon.

The UK inflation rate unexpectedly held steady in August despite a big rise in the cost of imported raw materials underpinning the prospect of another Bank Rate cut. Consumer price inflation (CPI) was unchanged at 0.6% which was in sharp contrast to fuel and material costs for factories which rose at their fastest rate in nearly five years, up 7.6% on a year earlier. Economists said inflation was unlikely to resist for much longer pressure from the fall in the value of sterling against the US dollar.

The UK labour market showed little sign of having been affected by the Brexit vote as the unemployment rate held steady and job creation rose in the three months to July. However analysts caution that a slowdown in wage growth may signal tougher times ahead for consumers as they face the prospect of higher inflation as a consequence of the fall in the value of sterling. The jobless rate remained at 4.9% which is its lowest level since 2005 while the employment rate rose to a new record high of 74.5%.

UK retail sales fell only slightly in August, after a bumper July, suggesting that consumer activity remains largely unaffected by the Brexit decision despite consumer sentiment initially suffering its sharpest monthly fall in a generation. Monthly retail sales volumes were down by 0.2% in August after an upwardly revised 1.9% in July, the strongest July performance in 14 years. Compared with a year earlier sales volumes were up by 6.2%.

The US Department of Justice (DoJ) has asked Deutsche Bank to pay $14.0 billion (£10.6 billion) to settle claims it mis-sold mortgage-backed securities. This would be among the biggest penalties levied by the DoJ as part of its investigation into the toxic debt scandal.The bank intends to contest the shock demand that some analysts believe raises questions about the future of Germany’s largest lender. The claim far exceeds market expectations that the DoJ would be looking for a figure of only up to €3 billion (£2.6 billion). Shares in Deutsche Bank fell sharply on the news, dropping by over 12% over the week. The bank only narrowly exceeded the European Banking Authority (EBA) stress test benchmark in July and has warned it may need deeper cost cuts to turn itself around after revenue fell sharply in the second quarter due to challenging markets and low interest rates. Even if the bank negotiates a significantly lower figure, analysts believe the bank may need to raise fresh funds from investors and/or sell assets to shore up its capital adequacy ratios.

Shares in the Royal Bank of Scotland (RBS) fell by over 10% during the week as a result of the higher-than-expected claim against Deutsche Bank while shares in Barclays fell by 6% on the news which has fuelled concerns that other European banks will be ordered to pay vast sums by the DoJ. Analysts believe that RBS faces a bill of between £4.0 billion and £9.0 billion for outstanding fines and litigation.  RBS and Deutsche have about the same financial exposure after selling similar amounts of toxic mortgage bonds while Barclays sold about a third of the amount and so is expected to pay less. RBS is waiting for a separate court action to start in a case brought against it by America’s Federal Housing Finance Agency. The bank has provisioned $5.6 billion towards a settlement. It is not allowed to make a provision for the DoJ case because it has not yet entered talks.

Monthly Summary:

Although three months have passed since the historic Brexit decision was taken to leave the EU, financial markets continue to mark time while they await the activation of Article 50 early next year and appear somewhat ‘disappointed’ that the dire warnings of economic catastrophe have not yet come to pass. As a consequence, in common with other key indicators the ITRAXX Europe Senior Financials 5-year CDS Index had again slightly improved to 83bps over the last month but has since risen to 96bps last Friday after the shock announcement of the $14.0 billion claim against Deutsche Bank for the mis-selling of mortgage-backed securities and its potential implications for some other banks.

After the shock findings of the early sentiment surveys that pointed to a significant deterioration in UK economic activity, the latest plethora of economic data has been consistently better than predicted by most economists and appears to confirm the apparent resilience of the UK economy since the Brexit decision. This has resulted in many economists predicting that the UK may be able to avoid a recession this year. In particular, the UK’s services industry rebounded strongly in August according to the latest Markit/CIPS purchasing managers’ index (PMI). The index showed activity in UK services recorded the biggest month-on-month rise in the survey’s history. The index rose from 47.4 in July to 52.9 in August (with a score above 50 indicates growth) and effectively takes services back to pre-Brexit levels.

However major banks remain under pressure to behave more like utilities from the indirect effect of financial regulators seeking to force them to hold so much capital to guard against default risk that they are unlikely to fail. The downside of this approach is that the major banks may be reluctant, or capital constrained, to take significant credit risk onto their books which will result in a tendency towards them concentrating on low risk transaction activities which in turn will significantly reduce profit generating opportunities.

Analysts also point to the unhelpful current European Central Bank (ECB) negative interest rate monetary policy which is squeezing the margins of European banks, making their shares unattractive to investors and distorting market prices. Critics argue that it is unacceptable that financial regulators on one hand demand that banks increase their capital adequacy ratios while on the other hand they impose punitive interest rates on the additional reserves that this policy creates.

The creditworthiness of some major European banks under stress conditions continues to be questioned by many analysts despite the July announcement of the results of the European Banking Authority (EBA) recent stress tests on 51 major banks within the EU. Critics have expressed concerns that the results were inconclusive and open to subjective interpretation as there were no passes or failures but instead the results were presented as a league table based on estimated Tier One capital and a series of economic shocks.

See below for 5-year CDS spread and share price movements for the last month.
5-YEAR CDS SPREADS AND SHARE PRICES 
Monthly Movements
Date: 19th September 2016
5-Year CDS Spreads (bps) Equity Share Prices (LCL)
Financial Institutions 16-Sep-16 12-Aug-16 Chg 16-Sep-16 12-Aug-16 Chg
ABN Amro Bank N.V.
ABN AMRO Groep N.V. n/a n/a n/a 18.20 18.89 -3.7%
Parent: Aldermore Group plc
Aldermore Bank plc n/a n/a n/a 1.70 1.41 +20.6%
Irish Sovereign
Allied Irish Banks 56 61 -8.2% 6.05 6.80 -11.0%
Parent: Arbuthnot Banking Group plc
Arbuthnot Latham & Co. n/a n/a n/a 15.50 16.18 -4.2%
Aust and NZ Banking Group Ltd 65 69 -5.8% 26.36 26.56 -0.8%
Banco Bilbao Vizcaya Argentaria S.A. 117 120 -2.5% 5.23 5.27 -0.8%
Parent: Barclays plc
Barclays Bank plc 87 93 -6.5% 1.65 1.63 +1.2%
BNP Paribas SA 70 71 -1.4% 44.64 44.68 -0.1%
Parent: Close Brothers Group plc
Close Brothers Limited n/a n/a n/a 13.96 13.42 +4.0%
Credit Agricole SA 68 70 -2.9% 8.64 8.25 +4.7%
Parent: Credit Suisse Group AG
Credit Suisse AG 121 128 -5.5% 20.45 21.58 -5.2%
Deutsche Bank AG 195 197 -1.0% 11.99 12.75 -6.0%
Parent: HSBC Holdings plc
HSBC Bank plc 65 71 -8.5% 5.67 5.45 +4.0%
Parent: ING Groep N.V.
ING Bank N.V. 58 61 -4.9% 10.68 10.58 +0.9%
Intesa Sanpaolo S.p.A. 133 122 +9.0% 2.01 1.98 +1.5%
Parent: Investec plc
Investec Bank plc n/a n/a n/a 4.60 4.96 -7.3%
Parent: Lloyds Banking Group plc
Lloyds Bank plc 77 82 -6.1% 0.57 0.55 +2.7%
 
Metro Bank plc n/a n/a n/a 27.32 22.99 +18.8%
 
Nationwide Building Society 80 88 -9.1% n/a n/a n/a
Nordea Bank AB 62 65 -4.6% 84 79 +6.3%
Parent: RBS Group plc
Royal Bank of Scotland plc 104 112 -7.1% 1.86 1.96 -5.1%
Ult. Parent: Banco Santander S.A.
Santander UK plc 80 83 -3.6% 3.88 3.84 +1.0%
Shawbrook Group plc
Shawbrook Bank Limited n/a n/a n/a 2.43 1.98 +22.7%
Societe Generale 70 71 -1.4% 31.13 32.05 -2.9%
Parent: Standard Chartered plc
Standard Chartered Bank 103 113 -8.8% 6.07 6.57 -7.6%
Svenska Handelsbanken AB 56 61 -8.2% 114 108 +5.6%
Unicredit  S.p.A. 176 167 +5.4% 1.97 2.12 -7.1%
 
FTSE 350 BANK INDEX n/a n/a n/a 3535 3468 +1.9%
 
SNR FIN ITRAX CDS 5-YEARS 96 87 +10.3% n/a n/a n/a

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