LONDON (Reuters) - A hasty scramble to ditch European banks after Cyprus took a contentious sovereign bailout drove some stocks lower than the credit market suggests they should be, potentially leaving them ripe for a rebound.
The rush for the exit after policymakers proposed forcing bank deposit holders to help pay for the bailout hit banks across the euro zone.
But, analysts say, it has left value in stocks such as Santander (Madrid: SAN.MC - news) that have been punished too severely relative to the market's pricing of their default risk.
"In some... the credit default swap is not that wide, and it's not widening in proportion to falls we're seeing in the equity, and that provides opportunities," Chris Parkinson, head of credit-equity research at Christopher Street Capital, said.
Well capitalised euro zone banks with low-risk balance sheets should therefore join leading non-euro zone banks in the Nordic region and the UK as Europe's outperformers, he said.
Since the deposit raid was mooted in late March, demand to sell short shares in STOXX Europe 600 Banks index constituents has risen nearly 40 percent - three times faster than in the broader index, Markit data showed - to its highest since May.
Investors who sell short borrow the stock from its long-term holder and sell it on with an expectation the price will fall so they can buy it back at a profit. That degree of so-called short interest in banks has not been seen since before European Central Bank President Mario Draghi's pledge to do "whatever it takes" to save the euro last July, which in turn prompted a multi-month rally in the banks.
Having risen 75 percent to a mid-January peak on Draghi's promise, euro zone banks are down 2 percent this year, and have not made up a 13 percent loss since the deposit levy was proposed. Some of the most shorted banks in Europe are in Spain, where the Cyprus bailout talks brought the sector's balance sheets into focus.
However, Parkinson cited Santander, down 7 percent since the first Cyprus bailout proposal, as an example of a bank whose share price overreacted to the implications of the bailout. Having initially widened, the cost of insuring Santander debt against default via five-year credit default swaps is back to a pre-crisis 260 basis points.
Santander CDS fell just 2 basis points on Thursday after disappointing first-quarter results that knocked nearly 4 percent off the share price. Equity prices are usually minor leading indicators for the CDS market, Parkinson said, as CDS traders use equity prices in their models more than equity dealers look at CDS prices.
However, he added that when this pattern breaks down over time, CDS traders override their models, believing that the share price is overstating the company's risks. "In this situation, the credit market is twice as likely to be correct...
The equity will eventually correct to reflect the credit market's view rather than vice versa," he said. Parkinson also sees positive indicators when comparing credit with equity for Deutsche Bank (Xetra: 514000 - news) , Societe Generale (Paris: FR0000130809 - news) and BNP Paribas (Milan: BNP.MI - news) , as well as Spain's BBVA (Madrid: BBVA.MC - news) .
For some Spanish banks, however, the stock market selloff is backed up by the credit market pricing. Banco Popular Espanol CDS spiked 100 basis points to above 500 bps after the Cyprus bailout, and has remained high. In the same period, the shares, which rallied along with other Spanish banks after Draghi's pledge, lost 18 percent.
"(After Cyprus) you'd now have to have different views of two banks in the same country depending on specific risks around balance sheets," Johan Jooste, chief market strategist for Merrill Lynch Wealth Management EMEA, said.
This is not just true of the periphery. In Germany, Deutsche Bank and Commerzbank (Xetra: CBK100 - news) have very different outlooks, according to their CDS prices. Commerzbank has undergone significant restructuring as the government seeks to reduce its stake, and is still in the midst of an effort to strengthen its capital base.
"In terms of both momentum and on an absolute basis, there's been a greater improvement in the CDS of Deutsche than in Commerzbank," Parkinson said. "So while both have been sold off, there's more upside in Deutsche Bank than in Commerzbank."
DIFFERENT PROSPECTS
The differing prospects of euro zone banks makes investing in them through funds that target the whole sector a less safe bet than during the post-Draghi rally, meaning non-euro zone lenders again look attractive.
"The havens in European banking are those stocks that are furthest from the crisis, such as Nordic banks... but the relative attraction of the stronger capital bases at these names was undermined by the Draghi put," Simon Maughan, financial sector strategist at Olivetree Securities, said.
Swedish banks are up 16.8 percent on the year compared with a 6.5 percent fall in euro zone banks, but, despite this, do not look too expensive, Parkinson said.
"They are trading at a valuation premium, but you could argue that this premium is justifiable given the risk there is in some of the alternatives."
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The rush for the exit after policymakers proposed forcing bank deposit holders to help pay for the bailout hit banks across the euro zone.
But, analysts say, it has left value in stocks such as Santander (Madrid: SAN.MC - news) that have been punished too severely relative to the market's pricing of their default risk.
"In some... the credit default swap is not that wide, and it's not widening in proportion to falls we're seeing in the equity, and that provides opportunities," Chris Parkinson, head of credit-equity research at Christopher Street Capital, said.
Well capitalised euro zone banks with low-risk balance sheets should therefore join leading non-euro zone banks in the Nordic region and the UK as Europe's outperformers, he said.
Since the deposit raid was mooted in late March, demand to sell short shares in STOXX Europe 600 Banks index constituents has risen nearly 40 percent - three times faster than in the broader index, Markit data showed - to its highest since May.
Investors who sell short borrow the stock from its long-term holder and sell it on with an expectation the price will fall so they can buy it back at a profit. That degree of so-called short interest in banks has not been seen since before European Central Bank President Mario Draghi's pledge to do "whatever it takes" to save the euro last July, which in turn prompted a multi-month rally in the banks.
Having risen 75 percent to a mid-January peak on Draghi's promise, euro zone banks are down 2 percent this year, and have not made up a 13 percent loss since the deposit levy was proposed. Some of the most shorted banks in Europe are in Spain, where the Cyprus bailout talks brought the sector's balance sheets into focus.
However, Parkinson cited Santander, down 7 percent since the first Cyprus bailout proposal, as an example of a bank whose share price overreacted to the implications of the bailout. Having initially widened, the cost of insuring Santander debt against default via five-year credit default swaps is back to a pre-crisis 260 basis points.
Santander CDS fell just 2 basis points on Thursday after disappointing first-quarter results that knocked nearly 4 percent off the share price. Equity prices are usually minor leading indicators for the CDS market, Parkinson said, as CDS traders use equity prices in their models more than equity dealers look at CDS prices.
However, he added that when this pattern breaks down over time, CDS traders override their models, believing that the share price is overstating the company's risks. "In this situation, the credit market is twice as likely to be correct...
The equity will eventually correct to reflect the credit market's view rather than vice versa," he said. Parkinson also sees positive indicators when comparing credit with equity for Deutsche Bank (Xetra: 514000 - news) , Societe Generale (Paris: FR0000130809 - news) and BNP Paribas (Milan: BNP.MI - news) , as well as Spain's BBVA (Madrid: BBVA.MC - news) .
For some Spanish banks, however, the stock market selloff is backed up by the credit market pricing. Banco Popular Espanol CDS spiked 100 basis points to above 500 bps after the Cyprus bailout, and has remained high. In the same period, the shares, which rallied along with other Spanish banks after Draghi's pledge, lost 18 percent.
"(After Cyprus) you'd now have to have different views of two banks in the same country depending on specific risks around balance sheets," Johan Jooste, chief market strategist for Merrill Lynch Wealth Management EMEA, said.
This is not just true of the periphery. In Germany, Deutsche Bank and Commerzbank (Xetra: CBK100 - news) have very different outlooks, according to their CDS prices. Commerzbank has undergone significant restructuring as the government seeks to reduce its stake, and is still in the midst of an effort to strengthen its capital base.
"In terms of both momentum and on an absolute basis, there's been a greater improvement in the CDS of Deutsche than in Commerzbank," Parkinson said. "So while both have been sold off, there's more upside in Deutsche Bank than in Commerzbank."
DIFFERENT PROSPECTS
The differing prospects of euro zone banks makes investing in them through funds that target the whole sector a less safe bet than during the post-Draghi rally, meaning non-euro zone lenders again look attractive.
"The havens in European banking are those stocks that are furthest from the crisis, such as Nordic banks... but the relative attraction of the stronger capital bases at these names was undermined by the Draghi put," Simon Maughan, financial sector strategist at Olivetree Securities, said.
Swedish banks are up 16.8 percent on the year compared with a 6.5 percent fall in euro zone banks, but, despite this, do not look too expensive, Parkinson said.
"They are trading at a valuation premium, but you could argue that this premium is justifiable given the risk there is in some of the alternatives."
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