Billions in bank redemptions if the winter is mild


If you want to predict the fate of banks in the UK and Europe, the only thing you should watch is the price of petrol. If the winter is warm and the stored gas is not burned, unloved lenders in the area will look significantly undervalued.

The third quarter results highlighted that many are sitting on billions of pounds or euros of excess capital. In some cases, that money will be needed in part to meet higher capital demands from regulators, as the final parts of Basel’s global capital rules are fully implemented in Europe. Others will want to invest in loan growth or acquisitions.

But much of the cash should be returned to shareholders, especially if economies don’t suffer as much as some fear.

The reason to watch gas is simple: it will be one of the most important influences on the paths of inflation and interest rates – and therefore on the duration and depth of the seemingly inevitable recession to come. This is a major difference with the United States, where Russia’s invasion of Ukraine caused far fewer problems in terms of economics and energy costs.

Still, European banks, like their US counterparts, saw profits boosted by rising interest rates and strong trading on bond and currency desks, as well as some repayment problems among borrowers. However, everyone expects things to get worse, and the banks have all increased provisions for bad debts – but again, just like their US counterparts, these often look like a return to levels of before the pandemic rather than a sharp rise.

Even after these provisions, strong earnings helped banks raise capital for high-potential grants to investors. BNP Paribas SA leads the pack, mainly because it is expected to earn $16 billion from the sale of its US arm, Bank of the West. BNP will make a €4 billion ($3.97 billion) buyout as soon as the deal closes, likely at the end of this year. That alone equates to a one-time return of nearly 6.5% on BNP’s current market value. On top of that, it promised in a strategic plan unveiled earlier this year to pay out at least 50% of its profits as cash dividends every year.

Even then, BNP will be left with around €7 billion of excess capital that it wants to spend on transactions or technology to drive growth. If it can’t find the right complementary acquisitions or the right profitable assets to invest in, the pressure will increase to return that money to shareholders. And that would equate to an additional 11% return on its current market value.

Other banks might not receive monster sales proceeds, but several still have plenty of capital. ING Group NV has already bought back €2.1 billion of shares this year and announced a further buyout of €1.5 billion with its third quarter results in addition to its regular dividends. After that, the Dutch bank still has €6 billion more capital than it needs to meet its Tier 1 Tier 1 capital ratio target, which is the key measure of a company’s strength. bank. If he were to shell out all that excess capital, it would equate to a return of almost 15% on the market value of ING.

UBS Group AG will complete $5.5 billion in share buybacks by the end of this year – of which $4.3 billion has already been completed – and will still end up with more than $3 billion in capital at the moment. above its target ratio. UBS shares are already much more valuable than many of its European peers, so its surplus only equates to a return of around 5.5%. But again, that’s on top of dividends, which offer a recurring yield of around 3.5% next year.

Lloyds Banking Group Plc and UniCredit SpA also have excess capital for buyouts that can yield more than 10%. Meanwhile, Societe Generale SA and even Deutsche Bank AG have available capital worth around a percentage of their market value. For these two banks, however, the buyback potential could be limited by higher capital requirements from regulators or a need to invest for future growth.

There are growing tensions between banks and cautious regulators in the UK and Europe. European bankers are pushing back against what they see as brutal interference by the European Central Bank. Some fear that this could prevent banks from paying dividends if recessions start to deepen as they did during the Covid pandemic. UniCredit shares fell on Monday after a Financial Times report alluding to disagreements between the Italian bank and the regulator over its long-term payment plans and other issues.

Still, most European bank stocks are trading at deep discounts to their expected book values. This is partly justified because profitability is relatively low, generating returns on equity of less than 10%. But many are also trading below what their expected returns suggest they should be worth.

This additional discount is due to fears of recession. The more interest rates have to rise over the next two years, the longer and deeper the recession will be and the more painful it will be for borrowers and lenders. In Europe, gas prices are the main contributor to inflation and the most difficult to predict, and the ultimate peak in interest rates is therefore not yet clear, as the Bank of England said the last week.

But Europe has rebuilt its gas stocks, and if the winter is mild, European economies will look much healthier and many banks will be well stuffed with excess liquidity. If winter brings a big freeze, however, the impact on borrowers could be severe, and some of those banks won’t end up having as much extra capital.

More from Bloomberg Opinion:

• City of London bankers better check Rishi Sunak’s interference: Paul J. Davies

• BOE moving towards rate pivot sends signal to ECB: Marcus Ashworth

• The reasons are piling up for optimism on inflation: John Authers

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Paul J. Davies is a Bloomberg Opinion columnist covering banking and finance. Previously, he was a reporter for the Wall Street Journal and the Financial Times.

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