Bankers call it the “announcement effect”. As one European bank raises capital, the focus shifts to rivals with weaker balance sheets and the pressure increases on them to bolster their capital positions.
“The pressure is out there, which is why you are seeing people raising capital” says Gerald Podobnik, head of capital solutions at Deutsche Bank. “Irrespective of the Basel III phase-in schedule, the market is demanding everything now, faster than originally thought.”
Enthusiastic investor appetite for bank equity has allowed euro area lenders to embark on a dash for funds to tidy up balance sheets ahead of the comprehensive assessment by the European Central Bank, which encompasses an asset quality review (AQR) and stress test.
But regulators warn the sector is continuing to suffer from squeezed profits and deteriorating loan quality, which may leave some investors disappointed.
Eurozone banks raised €45bn of common equity tier one capital – the main measure of financial strength – between July of last year and May 2014, including deals announced but not completed, according to figures published last week by the European Banking Authority.
More recent examples include the €2.25bn rights issue launched last week by Millennium BCP, Portugal’s second-largest lender, and the €5bn rights issue completed this month by Monte dei Paschi di Siena, Italy’s third-largest bank.
Deutsche Bank, which is raising €8bn of fresh capital, estimates that European banks have raised almost €35bn of alternative tier one capital – a form of contingent convertible capital or “coco” that can be switched into equity in a crisis – since last October.
“The ECB’s asset quality review and the EBA’s stress test are driving activity already and a number of institutions are anticipating the effect and raising capital, particularly in southern Europe,” says Stephen Carter, Credit Suisse’s co-head of financial institutions group for Europe, Middle East and Africa.
Mr Carter says European banks have five main options to raise capital levels: deleveraging by selling portfolios of assets; selling businesses; publicly listing subsidiaries; doing a rights issue; or issuing non-dilutive instruments such as cocos.
Banks are expected to sell a record €80bn of non-core loans in 2014, up from €64bn last year, the EBA added in a Risk Assessment published last week. Lenders are also selling subsidiaries, such as UniCredit’s flotation this month of Fineco, Italy’s leading online bank, with a valuation of €2.2bn.
Given the extent of the balance sheet strengthening, some investors are no longer expecting a significant swath of failures to emerge when the results of the AQR and stress tests are released this autumn.
Philippe Bodereau of Pimco, the investment manager, says the ECB exercise could turn out to be a “bit of a damp squib”.
The banks that had been most at risk of failing were Italian, German and Portuguese lenders, and many are now raising equity, he says, adding that of nine Italian lenders subject to the AQR and stress test five were raising capital or had done so.
“The markets have been willing to give banks capital this year – the appetite has been huge – so if you get to November and end up failing the stress test it would be an unacceptable failure by the board and management,” he says.
Nonetheless, analysts and bankers say the lenders that may yet find themselves under pressure from the stress tests and AQR include German Landesbanken, such as NordLB and HSH Nordbank, Austrian lenders with high exposure to central and eastern Europe such as Erste Bank, and Spanish midsized institutions, such as Banco Sabadell.
Equally, they point out that some banks risk looking like their capital is low compared with rivals that have recently raised equity. Lenders with common equity tier one ratios of less than 10 per cent under the fully loaded Basel III rules, such as Germany’s Commerzbank, Spain’s Santander and the UK’s Barclays, may decide to raise more capital even if they expect to pass the stress tests and AQR comfortably.
“If you have a benign equity market then you might have some voluntary equity raisers who decide to take advantage of that, independent of AQR or stress test pressure,” says one senior banker who advises financial institutions.
Banks that have recently paid big fines, such as BNP Paribas and Credit Suisse, could also feel the need to top up their capital levels, says the senior banker.
Analysts at Berenberg estimate that European banks still face a €300bn capital shortfall – down from €400bn last year – saying they “continue to believe that absolute levels of equity capital remain too low relative to both history and potential future requirements”.
The EBA estimates that the common equity tier one ratio of the largest European banks stood at about 11.6 per cent in December – broadly equivalent to US banks – as institutions strengthen their finances.
However, the pan-EU regulator cited a number of trends that are set to hold back the sector’s fortunes throughout this year. The quality of some banks’ loan portfolios continued to decline into 2014, for example, and rising regulatory fines are set to compress profits throughout the year.
Banks with a return on equity of less than 4 per cent constituted nearly two-fifths of the total assets in a sample of 57 leading European lenders, the EBA found in a risk assessment report, published on Wednesday of last week.
The majority of bankers and analysts questioned by the EBA believed a return on equity value of 10-12 per cent was the right target for the “long-term viability” of their businesses.
This, the EBA said, is “a worrying situation, which combined with the new regulatory environment and modest growth outlook, will continue to present a challenge for management in terms of sustainability of some banks’ business models.” It added that a “smooth exit” of the weakest and least profitable banks would contribute to the efficiency of the sector.