Download European banks: Are we back to 2008?

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European banks: Are we back to 2008?
February 2016
David Moss
Head of European Equities
The performance of the banking sector, and in fact the whole
financial sector, since the start of 2016 would suggest that if we
are not quite back to 2008, then at the very least risk is on the rise
again. But is this really the case?
Institutional business:
Chart 1: European banking stocks performance year-to-date
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STOXX Europe 600 Banks Price (EUR)
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We believe not. The banking sector in Europe is fundamentally better positioned than
in the dark days of the “Global Financial Crisis”. European banks have raised over €800
billion of new capital since 2007 1 and this doesn’t include retained earnings (yes, the
majority of banks have made profits!).
Source: Bloomberg, as at 22 February 2016
This has been driven in part by the banks’ own desire to be more secure but primarily
by the regulators, determined to make the inter-connected global financial system
safer. They want to make sure that never again are they called to account for the
near failure of many major banks. To this end, in addition to new equity, they have
restricted dividends to shareholders, hugely increased risk weightings (the amount of
capital banks have to hold against each loan), introduced new hybrid capital (the now
infamous ‘CoCo’s’ or AT12) and forced the introduction of ‘bail-in’, a process by which
debt-holders share in bank failures, as evidenced in Portugal with Novo Banco.
Strengthened balance sheets
As well as the above-mentioned initiatives, banks have cleaned up the assets on
their balance sheets and no longer own the multitude of leveraged, mis-understood
alphabet soup of pre-crisis products, e.g. CDO’s, CDO squared, CLO, synthetic CLO’s,
RMBS, and so on3. Last of all, the real problem for the banking sector in 2007-9 was
not capital or the amount of bad assets on the balance sheet, it was liquidity and the
Goldman Sachs - Equity Research note “Europe: Banks”, 9 February 2016. 2 ‘CoCo’s’: Contingent convertible capital
instruments, AT1: Additional Tier 1. 3 CDO: Collateralized Debt Obligation, CLO: Collateralized Loan Obligation,
RMBS: Residential Mortgage-Backed Security.
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Continued
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inability to fund themselves as depositors became nervous
(remember the queues outside Northern Rock?) and funding
markets closed. Lacking capital and liquidity, banks became
forced sellers of assets at the worst time. Bear in mind that the
National Asset Management Agency (NAMA), the Irish body
that took all the really bad loans off the balance sheets of the
Irish banks, looks set to report a substantial profit once its role
is finally finished. Today this is no longer an issue, tightened
regulation means that banks cannot fund themselves with
short-term funding alone as new regulations mean that banks
must have a higher amount of long-term funding and substantial
liquidity in case of market stress.
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6. The rise of the AT1. AT1 is an alternate type of capital, a
bond that converts to equity in the event of a bank’s capital
ratios falling below certain levels. These were created
by regulators, are new and untested in stressed market
conditions but were readily bought by investors hungry for
Chart 2: European banking stocks performance in 2011
03/07/11
5. Uncertainties on Italian NPL’s (non-performing loans) and
the slow creation of the Italian bad bank has hurt sentiment
and again raised fears on the quality of banks’ assets despite
the ECB’s own asset quality review in 2014 addressing this.
We have been here before. Here is the performance of the
banking sector in 2011:
03/06/11
4. The bail-in of debt holders of the Portuguese bank Novo
Banco made the bond market aware that this threat is real in
poorly capitalised, badly run banks.
One more thing….
03/05/11
3. Regulation - despite comments from Carney and Draghi to
the contrary, there remain fears of ever-higher capital needs
depressing returns. The one area where banks have surprised
positively in this reporting season though is in the payment
of dividends. This would be unlikely, we would suggest, if
regulators were still concerned about capital levels.
03/04/11
2. There is a fear of slowing global growth, whether in the US,
China or Europe.
03/03/11
1. L ow interest rates - the banks have an earnings issue. Low
interest rates are bad news for banks who make money from
lending out the money we all keep in current and short-term
deposit accounts. Ever lower rates have been a consistent
driver of downgrades in the sector’s profits.
We do not advocate, however, indiscriminate buying of the
sector. At BMO Global Asset Management, our investment
process leads us to buy good quality businesses with durable
competitive advantages, and we do believe that such businesses
exist in the financial sector. The wholesale selling of the sector
gives us the chance to buy these higher quality businesses at
better prices giving us a bigger margin of safety. Examples of
such companies include well run retail and commercial banks
such as ING, Handelsbanken and DNB, as well as asset gatherers
such as Azimut in Italy or the world’s largest private bank, UBS.
31/01/11
Well, it’s clear that there are a number of issues which at the
very least have dampened sentiment, which in itself can have
a significant impact on an economically sensitive sector such as
the banks. The issues being:
So, there are lots of issues and the confluence of them has
significantly hurt sentiment. However, we believe that these
issues are manageable in an environment where banks have
strong capital ratios, regulators are on the ball and central banks
are willing and able to provide adequate liquidity. Despite the
underlying positives in fundamentals, adverse sentiment has
pushed valuations down, in some cases to lows not seen since
the financial crisis.
31/12/10
So what has been the cause of the sector’s recent very
poor performance?
7. Oil & Gas - banks are big lenders to the oil & gas sector and
this again has raised fears about increased losses. These
types of fears will clearly arise in times of overt market
downturns but so far the banks have provided detailed
disclosure of their exposures and have, in the main, stress
tested portfolios for the current low oil prices with the result
that losses do increase but not to unmanageable levels.
STOXX Europe 600 Banks Price (EUR)
A final point to consider: central banks weren’t ready last time.
There were no co-ordinated European Central Bank (ECB) liquidity
facilities - no LTRO, TLTRO etc4. Central banks now are very clear
on where they stand: ready to provide whatever liquidity the
sector needs.
the extra yield they offered. As the recent, partly technical,
issue of whether Deutsche Bank could pay the coupon caused
concern it became clear that this was a market with close
to zero liquidity in times of stress with knock-on impacts on
conventional bonds, credit default swap (CDS) spreads and
equities.
Source: Bloomberg, as at 22 February 2016
LTRO: Longer-Term Refinancing Operations, TLTRO: Targeted Longer-Term Refinancing Operations.
Continued
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The issues were different but the sector also had significantly
less capital. Here is what happened in the following 18 months:
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STOXX Europe 600 Banks Price (EUR)
Chart 3: European banking stocks performance Jan 2012
to Jun 2013
Source: Bloomberg, as at 22 February 2016
Will history repeat?
Probably not. Mario Draghi cannot stand up again and say “we
will do whatever it takes” and interest rates are already low (see
point 1 above) but it might rhyme.
Views and opinions expressed by individual authors do not
necessarily represent those of BMO Global Asset Management.
© 2016 BMO Global Asset Management. All rights reserved. BMO Global Asset Management is a trading name of F&C Management Limited, which is authorised and regulated by the
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