Europe’s debt disease threatens contagion

Philip Salter
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THE Eurozone’s banks look perilously weak. Regulatory uncertainty and the Greek debt disaster present a bleak outlook. While the UK’s banks are much stronger, with less direct exposure to Greece, they too would be affected by a larger Eurozone implosion. Yet even if things go bad, there are opportunities for traders in Contracts for Difference (CFD).

Michael Hewson of CMC Markets suggests traders keep an eye on Lloyds, RBS and Barclays. He notes that last week’s Financial Stability Review – which showed that 10 per cent of UK mortgages could be close to default – concludes that Lloyds is at the greatest risk. 28 per cent of its domestic debt has a loan-value-ratio of over 90 per cent. The context is a housing market looking at stagnation at best. On RBS, Hewson states that its exposure to Irish debt “has been a key factor dragging on the share price along with last week’s ill-conceived intervention from the Deputy Prime Minister about the allocation of the shares to the public.”

“Barclays shares had until recently been significant out performers since the lows of 47p in 2009, hitting a high of 395p in 2010. However, progress since then hasn’t been great due to a number of factors, including the banks’ exposure to Spanish and Portuguese debt,” says Hewson. He adds: “Since those highs in May last year, the trend has been inexorably lower and last week’s break of support around the 250p area could well precipitate further weakness towards the 220p.” David Jones of IG Markets agrees: “With Barclays at its lowest level for a couple of years, I wouldn’t be in any hurry to buy just yet and the risk could be for further weakness.”

Angus Campbell of London Capital Group says: “Regulation is also playing its part in changing the way banks work with greater capital requirements and the splitting of investment and retail banking arms. With uncertainty about exactly how this will work, this too is depressing bank stocks.” Over the weekend, regulators agreed that banks thought to be too big to fail will have to hold 9.5 per cent capital requirements. Jean-Claude Trichet, the European Central Bank (ECB) president, argues: “The agreements reached will help address the negative externalities and moral hazard posed by global systemically important banks.” However, in picking banks that they think are too big to fail, Trichet and his colleagues are more likely to further embed moral hazard into the system, making explicit the still implicit public subsidy of the industry.

Jones thinks “the main opportunity lies around whether the trader thinks the weakness we have seen this year for the banks has been overdone, those who think the market is being too pessimistic about the European debt situation and a global slowing of the recovery.” But he cautions: “It is difficult to build a bullish case at the moment with consumer sentiment still weak, the housing market dead and the worries about Greek debt.”

Greece is the Trojan horse in the room. Ian O’Sullivan of Spread Co fears a default could destabilise the Eurozone’s banking sector. O’Sullivan says: “This potential chaos has started to worry investors, with Italian bank shares being suspended on Friday after dropping more than the 10 per cent limit allowed.”

CFD traders can profit even in a falling market. Campbell notes that since February traders could have profited from the 20 per cent fall in banking stocks. He adds that banks “are nowhere near the lows they hit back in 2009, so for any bearish investors out there who think they’ve got further to decline, they could profit from more weakness going forward.”