Europe is close to cleaning up its last cohort of problem banks. And after 15 years of almost constant crisis – GFC, eurozone sovereign debt, pandemic – no-one appears to be of the view that today’s economic uncertainties, monetary cycle or cost-of-living crunch will necessarily create a new vintage of bombed-out banks.
Of course, disorderly markets, cyberattacks, Black Swan events, stupidity, fraud and other types of criminal activity always present latent risks. But as things stand today, the European banking sector has been more or less sanitized. That includes banks in the eurozone periphery, formerly plagued by massive loan delinquencies and beset in some cases by dreadful mismanagement or worse, and banks elsewhere in Europe that fell into distress for a whole host of factors.
It’s not yet a case of job done. Supervisors are keeping a close eye on consumer and real-estate lending and leveraged finance; in particular there’s a lot of market and media focus on exposure to falling commercial real estate and residential house prices. But analysts seem comfortable that fortress balance sheets including strong capital underpinnings will prove sufficient to prevent a return to systemic endangerment. Improving profitability on the back of rising interest rates only sweetens the narrative.
The non-performing loan ratio of Greek banks was 4.9% at Q3 2022, European Banking Authority data show. Five years before that, it was 43.4%! Italian banks also achieved a huge reduction over the same period, albeit from a much less distressed 9.4% to 2.6%. European banks have dealt with hundreds of billions of euros of bad and under-performing loans in recent years through workouts, portfolio sales and securitization. There has been no shortage of US and European private equity firms and asset managers lining up to bid for assets.
There is a consensus that loan-loss provisions will go up in 2023 as asset quality weakens because of the murky economic environment and as banks exercise caution. But in his 2023 Outlook, Marco Troiano, head of financial institutions at Scope Ratings, referred to European banks as “strong ships in turbulent waters”. That seems to be the prevailing view.
Doesn’t the outlook make European bank equity, still trading at massive discounts to book value, a screaming buy?
Formerly troubled banks are on the road to recovery. The UK’s Co-Operative Bank, owned by a syndicate of private equity firms and hedge funds following a 2020 rescue, posted a 14% adjusted ROE at Q3 2022 (the most recent available). Sky News reported in recent days that the bank is at the front of the queue to acquire a £650 million (US$783 million) mortgage portfolio from Sainsbury’s Bank, the financial services unit of the UK supermarket group. That infers Co-Op is rising from the bottom. Hamburg Commercial Bank, the former HSH Nordbank, looks to be thriving five years after its acquisition, also by private equity and hedge funds, posting an ROE of 20.8% in 2022.
In Ireland, Permanent TSB is in aggressive expansion mode: in late 2022 it increased its mortgage book by 40% after acquiring €6.2 billion (US$6.57 billion) of performing non-tracker residential mortgages from NatWest’s Ulster Bank subsidiary (which is quitting Ireland). PTSB is also acquiring Ulster Bank’s SME and asset finance businesses.
Step forward Monte dei Paschi di Siena
As for the remaining problem cases in Italy, troubled Banca Carige was acquired in 2022 by BPER Banca, the country’s fourth largest lender by assets, from the country’s Interbank Deposit Protection Fund (FITD) for a symbolic €5 million (the FITD injected €530 million of capital to get the deal over the line).
Banca Popolare di Bari, the formerly insolvent lender, was shoved into state-owned bank Mediocredito Centrale (MCC) following a €860 million capital injection from the FITD to cover a capital shortfall (alongside something like €430 million from MCC). Its clean-up is continuing.
Even Italy’s biggest remaining banking headache, Monte dei Paschi di Siena, the country’s fifth largest lender and the world’s oldest bank, looks to be moving slowly down the road to recovery, although there’s a long way to go. Monte posted a 26% year-on-year increase in net interest income in 2022 and 31% in Q4 quarter-on-quarter thanks to rising interest rates.
The €156 million Q4 net profit led management to declare the bank’s capability to generate sustainable profitability. That’s a potentially big call. And there’s still a tonne of legal claims against the bank that will need to be resolved. A key stage in the bank’s rehabilitation will have been reached when the state is able to offload its 64.23% stake. The government took up its full rights allotment in the €2.5 billion capital increase in late 2022 but is under EU orders to divest.
In recent days, investors gave a thumbs-up to Monte’s first public bond market outing in three years, with orders of €1.5 billion for the €750 million bond. Bankers working on the deal hailed it a significant step but it’s important not to get over-excited. First of all, the primary bond market is hardly the best yardstick by which to judge progress since investors are driven by price and momentum as much if not more than by fundamental credit metrics.
And let’s be honest, it was a three-year senior preferred bond with a call at two years paying a chunky yield of 6.75%. Hard to describe that as a major achievement but it was definitely a staging post from which Monte will look to improve as it fills its 2023 capital requirements.
Showing there is still some sensitivity, though, Monte opted not to call its 5.375% €750 million subordinated Tier 2 bond on January 18th as a new issue would have likely demanded a significant premium over the existing bond’s reset. The coupon has now reset to 7.677% (500.5bp over five-year mid-swaps), payable until maturity in 2028. As of February 27th, the bond was marked at a price of 92.25, equivalent to a 9.73% yield, although it’s fair to point out that the bond price has risen sharply in recent months.
And finally …
With Deutsche Bank long having left the group of European banks described as “troubled”, that leaves just Credit Suisse. It would be foolhardy to predict the outcome of moves to achieve the targets of CS’s new-new strategy so I’m not going to. But the game is definitely afoot. Report card to-date: 4 billion Swiss franc capital increase? Tick. Sale of the securitized products group to Apollo? Tick. Acquisition of Michael Klein’s advisory boutique and installation of Klein as CEO of banking, the Americas and the CS First Boston capital markets and advisory unit? Tick.
That just leaves:
- Transform into the new Credit Suisse (centred around wealth management and the Swiss bank complemented by strong asset management and markets capabilities);
- Carve out an independent CS First Boston;
- Accelerate deleveraging and de-risking actions in the non-core unit;
- Simplify the organization and exit non-core businesses to improve efficiency and reduce costs;
- Strengthen business momentum in 2023 and beyond.
What could possibly go wrong?
