As regulators attempt to place more controls on short positions, analysis shows interest in UK banks is on the wane
Analysis by DataExplorers into UK banks’ shares being borrowed by short-sellers since November 26 shows long/short funds have largely mis-timed short positions.
This comes as US regulators last month curbed the practice, and the Committee of European Securities Regulators last week recommended mandatory public disclosure of sizeable short positions.
But as John Paulson, the most successful manager publicly to report shorts in UK banks during the crunch, found out when he faced headlines saying he reaped about $1.2bn, short-selling hacks the public off. Especially when it is directed at UK banks.
During the crunch, it united unionists, politicians, church leaders and Joe Public in their opprobrium of speculators.
In the lead-up to banks’ latest reporting season last month, however, the public need not have worried.
Speculators borrow shares to sell into the market. If prices fall, they can repurchase them for less, return them to the lender and pocket the difference.
DataExplorers’ research relates to shorting using physical shares – not Ucits long/short funds using derivatives – but evidence does not suggest Ucits funds took significantly different positions.
Managers more than halved shorts in Lloyds Banking Group to 1.4% of its shares in late November, at the same time the bank’s share price dropped by 34%.
Funds then cut their shorts further to about 0.3% by January 22, as Lloyds shares hovered between 58p and 48p.
Between late November and mid-January, speculators increased shorts in Barclays from about 3.7% of its shares to 6.7%. Over the period, Barclays shares rose from 291p to 318p.
Then, in mid-February, short-sellers cut back from 7.2% to 1.4%. Barclays shares were flat.
Luke Newman, co-manager of Gartmore’s UK Absolute fund, says: “The problem with UK banks is the prospects for share prices still appear to be binary, depending on your macro
outlook.
“You can construct quite a positive scenario where we see a continuation in the grass shoots of recovery in the UK economy, and we continue to see declining bad debt provisions and fewer loan defaults – which would have a positive read across to valuations for banks.
“But, if we see a double-dip from a corporate or a household point of view, the downside is very difficult to quantify in terms of impairment charges rising.”
In the absence of greater clarity, he says, active trading of UK banks around their book values is here to stay, at least until a number of matters are clarified.
UK banks comprise a small proportion of the trading portion of the long/short fund Newman co-manages with Ben Wallace.
When clarity reigns, he says, investors can take a longer-term approach once more to banks.
“Firstly, we need better disclosure of the composition of their balance sheets generally and in terms of the carrying value of the assets [they hold] both in the listed and unlisted markets.”
Newman says banks might fear marking some positions to market, given the light this could throw on valuations of other assets they hold.
“If the assets’ market price is less than the carrying price on the balance sheet, there is a disincentive to sell the assets, if it means a markdown on the remaining assets.”
He cites a lack of visibility concerning Lloyds’ 59% stake in wealth manager St James’s Place and the holding in retirement home builder McCarthy and Stone, both inherited through the acquisition of HBOS.
Secondly, he says investors need confidence the worst of the bad debt cycle is over.
And finally he believes clarity on the effect of regulation is important.
According to Morgan Stanley research, Basel 3 capital adequacy requirements could force Europe’s banks to raise e83bn by 2012.
Newman says management is waiting for resolution of what are currently “a series of recommendations for the new Basel 3 requirements.
“It is incredibly difficult to quantify as an investor, but in the worst case scenario we could see capital requirements for banks increasing, which means pressure on their own financial position. You could not rule out highly dilutive equity raisings in that scenario, which limits the ability for banks to recommence lending because their capital is required elsewhere.”
