Since the beginning of October, as the eurozone debt crisis has moved from a slowly-smoldering sovereign debt crunch affecting the smaller and weaker economies of Europe to a full-blown crisis threatening to engulf the world, the share prices of major European banks have gone on a rollercoaster of up-and-down swings.
As if tracing the alternating feed of grim news and apparent breakthroughs, investors have poured money in or taken money away from equities of big banks like Germany's Deutsche Bank AG (XETRA:DBK) and Spain's Banco Santander (Madrid:SAN), causing the price of those bank's stocks to fluctuate wildly.
On the fixed equity side, however, the big money is decidedly heading for the exits.
Large institutional investors are running, not walking, to shelter themselves from any potential deterioration of the banks' balance sheets. Money managers have dramatically decreased their day-to-day lending to the banks while simultaneously, other sophisticated investors are rushing to buy insurance against the possibility of default. Perhaps most poignantly, the banks themselves are increasingly mistrustful of their peers, making those in need of short-term interbank loans pay through the nose in order to receive the dollar-denominated assets.
From the first day of trading in October until the close of the market Tuesday, shares of Spain's Banco Santander (Madrid:SAN) have gone from €6.03 ($8.14) to €5.51, down 8.65 percent on the Bolsa de Madrid. For the same period, German global investment bank Deutsche Bank AG (XETRA:DBK), whose shares trade on the Frankfurt-based XETRA electronic trading network, has gone from €24.95 to €27.95, up 12.02 percent. In the Bourse de Paris, banking group Crédit Agricole SA (Paris:ACA) went from €5.06 to €4.63, down 8.5 percent, while competitor BNP Paribas (Paris:BNP) is up 4.28 percent to €29.98, from €28.75 at the beginning of the month. Shares of Dutch bancassurer ING Groep N.V. (Amsterdam:INGA) went from €5.06 to €5.36 for the period, gaining 5.93 percent in value on the Euronext Amsterdam exchange.
These valuations, corresponding to the five biggest Continental banks when measured by assets, have moved roughly in tandem, going up or down as equity dealers have responded equally to rumors and concrete developments. The period between October 26 and November 1 was especially volatile, as traders, encouraged by the solutions announced at the end of a head-of-state summit in Brussels, bid up the shares of European financial companies. After massive gains of over 20 percent for some of the banks, more bearish sentiment on the actual details of the rescue plans caused a retrenchment to more sedate levels.
Hustling for the Paper
Yet over the same period that the stock market has bobbed up and down, those providing the companies' short-term financing have been fleeing en masse.
According to an analysis by Bloomberg News, the eight largest U.S. money market funds have precipitously choked off one of the main financing mechanisms European banks use to fund their day-to-day operations. As the situation has grown increasingly volatile, the funds have been buying up less and less of the banks' commercial paper, ultra-short-term bonds issued by the banks that are generally redeemable on a daily basis in exchange for a few basis points worth of interest.
The Bloomberg analysis revealed how these funds took away $8.1 billion in financing from Deutsche Bank during October. They also pulled away $2.6 billion, or two-thirds of the total financing formerly provided, from France's Credit Agricole S.A. Competitor BNP Paribas saw a more modest decline of 10 percent for the month.
The cash-flow tightening appears as the latest, if most severe, example of a year-long financing contraction on the part of the American money managers. The past twelve months have seen the big money funds pull 78 percent of their dollars from French banks, according to Bloomberg. German banks have fared slightly better. An unrelated report by Fitch Ratings stated German banks saw funds draw away 40 percent of the previously-provided short-term financing from May to September of the current year.
Covering Their Assets
Just as the money market funds have been cutting their exposure to European financial institutions, investors in longer-term debt were scrambling for cover, negotiating a flurry of insurance agreements to protect themselves in case the banks defaulted on their bonds.
According to data provided by the Depositary Trust and Clearing Corporation, a settlement clearinghouse for credit derivatives and other over-the-counter financial products, October saw investors negotiate $10.76 billion in gross notional protection against default on the debt of the five banks previously mentioned. While gross notional value is somewhat of an imperfect measure, it is useful to note that the amount represented 1.77 percent of the value of all risk transferred that month in the wider credit derivative market.
During the first week of November, a considerable spike in interest led to the transfer of $5.86 billion in gross notional protection against default on the debt of those five banks, which constituted an astonishing 4.04 percent of the total value of worldwide credit derivative protection bought or sold that week.
That first week of November also saw credit derivative swap spreads, essentially the price investors are willing to pay for a certain amount of protection against default, increased dramatically for those banks. The CDS rally has bled into the present. The spread on Deutsche's Bank 5-year bonds was 214 basis points Monday, meaning traders were demanding $214 to insure $10,000 worth of Deutsche Bank's medium-term debt against default. Crédit Agricole and BNP Paribas' spread are even higher, in a range of over 250 basis points. Banco Santander's CDS spread rose dramatically Tuesday (over 40 basis points) to a heady 360 basis points.
Trust or Bust
Perhaps the most damning assessment the smart money is making against the banks comes from the banks themselves, who have been steadily raising the price they charge peer institutions for short-term loans.
Since August, the 3-month London-Interbank Offered Rate (LIBOR), a publicly reported figure capturing the average interest rate banks claim they are being charged for dollar-denominated short-term loans, has been rising steadily. A rise of 7 basis points in August was followed by 4 more basis points in September and 6 additional ones in October. The official rate has risen 4 more basis points since the beginning of the month, nearly doubling the interest banks charged each other on three-month loans, from 0.25 percent in late summer to 0.46 percent at the present moment.
And that's if the banks are reporting their borrowing costs accurately, which some have suggested is not happening. A Wall Street Journal report suggested BNP Paribas and Crédit Agricole, as well as smaller rival Société Générale SA (Paris:GLE), were willing to pay between 0.57 and 0.62 percent for three-month dollar-denominated loans Tuesday, a significant premium over LIBOR.
According to the report, Banco Santander was even more desperate for dollars, offering to pay 1.41 percent interest on short-term loans provided by other banks (Santander does not participate in the survey used to determine LIBOR).
Hail the Almighty Dollar
While worrisome, these developments haven't escalated into a full-blown credit crisis, like the one that seized the U.S. markets following the collapse of Lehman Brothers in 2008. The banks always have the option of requesting liquidity from their central banks in euros. But they are finding it increasingly difficult to snap up the dollars they need to run certain operations.
Some banks are in more trouble than others, and have been for months. The French banks, in particular, rely on dollar-denominated commercial paper financing much more heavily than their German counterparts. When Crédit Agricole was downgraded by rating agency Moody's on September 14, excessive reliance on short-term funding was cited as one of the causes. Because the banks are also inextricably tied to the national fortunes of their respective sovereigns, Spain's Santander, for example, finds itself in more precarious standing than its Dutch or German peers.
It is still to be seen how the financing crunch develops into the future, when some of the banks will have to raise additional assets to comply with new rules set by the European Banking Authority (and the banks themselves prior to that) in order to satisfy capital requirements. Santander, for example, reportedly needs to plug a €6.5 billion shortfall. BNP Paribas' capital hole is €2.1 billion, while Deutsche Bank's is €1.2 billion.
Go Big or... Go Little?
One interesting possibility is that these behemoths, which have largely spent the last decade ignoring their retail and small commercial costumers to focus on their high-flying trading business, will go back to their roots.
BNP Paribas and Deutsche Bank, for example, have been engaged in a mad dash to trim their trading operations, with the stated intention of raising assets to cover their capital shortfalls organically. As the banks shed the riskier assets on their books, they are likely to focus their attention to more staid, traditional areas of money management.
Already, for example, Deutsche Bank has increased the proportion of day-to-day funding supported by its transaction banking business, an unglamorous corner of finance that deals with helping real-world corporations smooth payrolls and manage accounts receivables.
Santander, for its part, recently made heads turn when it introduced clients in the United Kingdom to what the bank called "Upfront Savings Bonds," a savings account wherein the bank matched £1 for every £10 the costumer deposited (a £10,000 minimum and a three-year commitment was part of the deal).
Unlikely as it would have seemed in the banking heyday now only a few years in the rear-view mirror, it seems these large banks, now turned away by the leviathans of money, might be seeking relief in the little people: those rather unremarkable folks that open savings account, entrust banks with managing payroll and, perhaps foolishly, bid up stock prices.