After nearly a year of comparative stability in Euroland, a touch of chaos has returned after the publication of the coalition agreement between the Five Star Movement (M5S) and Lega, followed by a seeming constitutional crisis as President Mattarella refused to allow the two parties to nominate an 81-year old professor with a Eurosceptic past to the post of Finance Minister. The Italian bond yield has gone sharply up and bank share prices sharply down, while the European Commission and Eurogroup are already making hostile statements. It’s not exactly the same as the Greek crisis, but anyone who remembers 2015 can be forgiven a sense of déjà vu. So what does this mean for the banking industry?
All deals are off. Starting with a piece of good news; if you were worrying that your job might be put at risk by a merger this year, you should most likely be worrying a bit less. It’s true that European bank CEOs all feel like consolidation is both inevitable and desirable, and it seems that they have the more or less explicit support from the regulators to get bigger and more efficient and to create a continental financial system that won’t have so many local difficulties. Long term, the logic is hard to fault. But in the near term, a climate of political and macro uncertainty is likely to take up all the mental bandwidth that might have been used to seek for merger partners. And in an environment in which nobody’s completely sure what anybody else’s exposure is to currently safe assets which might suddenly turn bad, even banks that have been cautiously approaching each other are likely to see it as prudent to wait a while.
But, all deals are off. The bad news is that capital markets deal-flow, which had just begun to get off the floor, is likely to be knocked right back again by the uncertainty associated with a sovereign crisis. Corporate borrowers will be reluctant to issue debt at higher spreads than they consider to be fair and investors also tend to sit on their hands and try to cluster in a small number of perceived safe havens. Equity issuance is highly and negatively correlated with market volatility, and as for CoCo, AT1 and innovative bank capital instruments, the historical experience is that we can forget it until the crisis is resolved.
Margins will be called and funds will blow up. Episodes like the eurocrisis tend to be associated with some macro investors making reputations, others destroying them and some funds blowing up entirely. They also tend to attract plenty of “tourists” from other investment disciplines, attracted by the perception of an opportunity to make money out of other people’s trouble. The clear lesson from the last Eurocrisis is to watch your leverage and your position sizing. The path of Euroland policy is almost never in a straight line, and it’s quite common for even a basically correct trade to end up being closed out at a loss because it went too far in the wrong direction. (Remember those “Greece Opportunities” fund launches?). There’s also significantly less liquidity than there used to be, and counterparty risk managers may be even more trigger-happy with their margin calls.
Basically, it looks like being a worse year in the markets than we might have expected a few weeks ago. One day the crisis will be over and perhaps Euroland will have a more functional set of economic institutions – it might even make progress toward a genuine continental Banking Union. But we can all wish that the means of getting there wasn’t so awkward.
Dan Davies, is a senior research advisor at Frontline Analysts and a former banking analyst at Cazenove, Credit Suisse and BNP Paribas.
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