Declining margins, rising leverage, above-trend asset growth and stalled earnings momentum are reasons why Citi’s research team has downgraded the sector to neutral. There are worries that trading income has peaked, non-performing loans have bottomed and that deteriorating free cash flows will lead to further cash calls. ABN AMRO, Barclays and Crédit Agricole have found their way onto Citi’s top 10 to avoid while Credit Suisse, RBS, Société Générale and UniCredit are on the buy list.
One particular concern is the quality of acquisitions. Citigroup European banks strategist Yann Goffinet says: “2006 may prove to be a very poor vintage for acquisitions. Banks are making more acquisitions, paying more and taking more risks in countries such as Russia and Ukraine. We are in a late part of the credit cycle. Earnings momentum is weakening and the leverage trick has already been played.”
In an earlier report, CreditSights pointed out that the switch to international financial reporting standards means that goodwill in acquisitions no longer has to be amortised. This has encouraged more mergers and acquisitions deals at high multiples, especially in emerging markets, but it stores up the risk of impairment charges in the future.
