The year when hits just kept coming for European banks
Poor profitability, outdated business models and negative rates have driven investors away en masse
When Deutsche Bank boss Christian Sewing hosted a call for his top managers in October to discuss yet another disappointing set of results he lost his cool, lashing out at their “bullshit” excuses for poor performance.
It is not hard to see why Mr Sewing and his fellow European bank chief executives feel under so much pressure these days.
The region’s lenders have had their worst year since the nadir of the eurozone crisis as a constellation of issues including anaemic profitability, outdated business models, negative rates and the seemingly perpetual farrago of Brexit have driven investors from the sector en masse.
European bank stocks have fallen on average 25 per cent — the most since 2011 when they dropped by a third — eliminating all gains made in the past six years and wiping out $380bn in shareholder value, according to analysts at Autonomous Research. Collectively they are on track to make a 2018 return on equity less than half the 16 per cent generated by their US rivals, Citigroup data show.
“Everyone hates European financials at the moment. There’s almost no discrimination in the sell off,” said Richard Buxton, chief executive of London’s Merian Global Investors. “People are concerned about profitability — rate rises look further and further out and many are convinced the next recession is around the corner.”
None of the 16 largest British, French, German, Italian or Swiss banks trade above book value. On average, they are valued at about 0.6 times their net assets, compared with ratios of 1.1 for the top six US banks and 1 for lenders on the MSCI Emerging Asia Banks Index.
At the bottom of the European pile is Mr Sewing’s Deutsche, which trades at a quarter of its book value after plunging 53 per cent during a tumultuous 2018. Germany’s biggest lender fired its CEO in the spring and last month was the subject of a two-day police raid linked to money laundering. It is struggling to retain its best staff as deferred stock bonuses have halved in value.
“When most banks are trading well below book value, many significantly below, there is clearly a major problem in Europe,” said Philipp Hildebrand, vice-chairman of BlackRock and former head of the Swiss central bank. “We have one of those really tough moments where business model issues, cyclical issues and external challenges like technology are coming together all at the same time.”
Regulators are well aware of the dangers of persistently low returns. The Bank of England and the European Central Bank have both said they are worried about lenders’ ability to earn enough to survive another prolonged economic downturn.
Mario Quagliariello, the senior European official leading the most recent round of stress tests, told the FT in November “profitability remains the key challenge”.
On the surface, things should be getting better. Analysts at Citigroup predict a 42 per cent growth in European banking profits this year on the back of an 86 per cent increase in 2017. Banks are safer, having more than doubled their capital buffers since the financial crisis and most have put their biggest misconduct fines behind them.
However, any improvements in performance have been overshadowed by geopolitical and macroeconomic worries, combined with an underlying concern banks have not altered their business models enough to reflect tougher capital standards and leverage restraints.
“The hits have just kept on coming for the European banks,” said Stuart Graham, chief executive of Autonomous Research. “2018 started as a sell-off on disappointing growth, gathered pace with the election of a new Italian government, was compounded by the ECB’s dovish rate guidance in mid-June and amplified by concerns over emerging markets, especially Turkey, and trade wars.”
Italy tops the list of worries, where a stand-off between the Eurosceptic populist government and the EU over the size of its budget deficit has led to speculation it might leave the single currency. Dire warnings also exist about possible contagion from a “doom loop” caused by the country’s weakened banks owning too much of its devaluing sovereign debt.
“It is difficult to find a marginal buyer of European banks right now and you can’t fight the tape,” Adam Gishen, chief adviser to Credit Suisse chief executive Tidjane Thiam, told the FT. “The macro is so negative that for a fund manager to make a big bet has become a very, very difficult thing to do.”
2019 looks even bleaker. The prognosis for the UK economy is highly uncertain, with the prospect of a chaotic Brexit and few economists expect European interest rates to climb out of negative territory soon. ECB president Mario Draghi said this month that eurozone risks are rising because of a number of concerns from geopolitical uncertainty to trade protectionism and market volatility.
The scale of the bank stock decline has also dented the hopes for cross-border EU M&A, which regulators say is needed to reduce competition on a continent that still has far too many lenders. For example, Deutsche boss Mr Sewing has ruled out a long-rumoured merger with Commerzbank while valuations are so low.
These days, 12-year-old Dutch online payments company Adyen is worth €13.4bn, more than Commerzbank at €8.2bn and not far off Deutsche at €15.7bn.
The lack of political progress on a pan-European capital markets union — which would allow capital and liquidity to move more freely across the bloc — and especially a common eurozone deposit insurance scheme are also major barriers to banking consolidation.
“We don’t invest in [the banking sector],” said the head of equities at one of Europe’s biggest fund management groups. “The whole bank business model is questionable.”
Much of Europe — from the UK and Germany to Spain and Italy — is beset with problems such as slim net interest margins, the prospect of asset price deflation and weak technology, they said. These make banks unattractive investments, even at current “screamingly cheap” share prices.
The equities boss at another big European asset manager said there were now no active bank investments in the company’s portfolio, pointing to low interest rates and resultant weak profitability as the key disincentive. “There is better risk-reward elsewhere,” the fund manager said.
Investors are particularly unconvinced by those Europeans still trying to compete with Wall Street in investment banking. Even though a resurgent Barclays has posted four consecutive quarters of market share growth in bond and equity trading, its stock has steadily fallen. A high-profile activist investor is trying to force it to exit large swathes of the business, arguing it absorbs too much capital for too little return.
The “migration into US-style investment banking for the most part has turned out to be a very bad adventure,” said BlackRock’s Mr Hildebrand. “We are at a point in Europe — and this has taken in my mind too long, I don’t quite understand why — where we have a recalibration” away from “something that basically hasn’t worked”.
Peter Richardson, an analyst at Berenberg in London, said: “There is definitely more scepticism about those with large investment banking operations remaining. Investors believe US franchises will continue to take a larger share of a smaller pie.”
European banks are now just 5 per cent away from hitting an all-time low relative to other sectors, analysis by Berenberg shows. Credit Suisse’s Mr Thiam — whose stock is down 35 per cent this year — said earlier this month that European banks are so cheap there is a great buying opportunity.
However, while they might seem good value trading as they are at about eight times their estimated earnings power, this is contingent on them increasing income at between 2.5 and 3 per cent a year.
“History has shown that investors have consistently overestimated banks’ ability to grow, with revenues exceeding expectations just once in the last seven years,” said Berenberg’s Eoin Mullany. “We expect the disappointment to continue. The sector remains a long-term value trap.”
Perhaps understandably, morale inside banks is low.
During an internal video recorded during the latest police raid on Deutsche, Mr Sewing faced a blunt question by a staffer: “Everyone is asking, when does this end?”
The chief executive replied: “I share the frustration . . . We’ve always said the years between 2015 and 2018 would be very busy cleaning up our issues, and we are very much at the end of this now, but still things are coming up.”