Bonfire of European bank shares
In the 1980s film Brewster’s Millions the main character must find a way to burn through $30m in a month but have nothing to show for it at the end. If Brewster was set the same task today, putting the money into European bank shares would be a tempting option.
After a week where commotion surrounding Deutsche Bank has wiped yet more value from the share prices of Europe’s lenders, some may now be tempted to view their battered equity as cheap. They should not.
The refrain of the brave or foolhardy bank investor for several years has been that European lenders trade at large discounts to the accounting value of their assets. You can buy Deutsche Bank today at less than a third of its tangible book value. Driven by this logic, investors have poured magnificent sums into recapitalising the continent’s banks since 2009, subscribing to more than €200bn in fresh equity.
But the total market capitalisation of the Euro Stoxx Banks index today sits around €350bn, having been €450bn in 2009 — meaning, just like Brewster would have wanted, much of that fresh capital has been set on fire.
These numbers pale in comparison with the real problem — bad loans still festering from the crisis. There were €1.9 trillion of non-core bank assets still held by Europe’s banks last year, according to PwC, including €850bn that are non-performing.
At the same time European lenders are unable to earn their way out of this hole. The average return on equity for the sector has fallen from above 15 per cent before the crisis to not much better than 5 per cent today, according to Bloomberg data, while their average cost of equity has risen.
The cheap multiples of book value at which many European bank stocks trade reflect the near certainty that there will be many more rounds of dilutive equity issuance to come. Shareholders will be the losers. The winners will be distressed debt investors able to snap up bad loans and other non-core assets in what is clearly a buyers’ market. There is money to be made with European banks today, but anyone trying to express this view by buying up bank equity is looking in the wrong place.