The sell-off in European banks is terrifying and baffling, all at the same time. GlobalCapital would be first to admit there are still issues — poor growth, weak balance sheets, non-performing loans, defered tax assets, complex forms of untested capital cooked up in regulatory labs – but the continent’s biggest banks aren’t going anywhere. For one thing, they are still too big to fail.
Europe has a shiny new set of bank failure tools. All countries except Poland have now transposed the Bank Resolution and Recovery Directive into national law, while eurozone countries now have big bank resolution handled by the Single Resolution Mechanism. The last eight years have been leading up to this point.
Not a moment too soon, to judge by the market. European bank shares have collapsed, some to multi-decade lows. UniCredit, reporting results on Tuesday, was off 7.9%, before lurching up on Wednesday and back down on Thursday. Credit Suisse, reporting last week, is off more than 8%. Deutsche’s shares are less than half the price they were the weekend Lehman collapsed (the three rights issues might not have helped there).
CDS is a similar story, not only for the vulnerable subordinated bonds, but even senior has blown out — in the case of Deutsche, by around 150% since the market began the current freakout.
But all of this is surely overdone. If Deutsche (or anyone else) misses an additional tier one coupon… so what? The market doesn’t die. It won’t be supportive for refinancings, but it will forgive whichever bank stops payment. It’s in the contract — fundamental to AT1’s treatment as proper capital.
Deutsche was, of course, the first bank to do an economic non-call on tier two, during the crisis. Investors still remember it — but still showed up in droves for new hybrid capital issued by the bank. One can argue that’s because they were drowning in excess central bank liquidity, but that’s not going away any time soon.
The bear case for the banks is simple: banks are a leveraged play on economic growth, where has the economic growth gone? But this is hardly news for banks focused on Europe. There hasn’t been growth in Europe for the best part of a decade, and there’s certainly nothing that has happened in the last two days to collapse the market.
But the case for staying invested, at least in the debt, is equally simple — what’s the endgame?
Resolution authorities do have an impressive new toolset, but one suspects they won’t be keen to test it out on banks of the size and systemic importance of Deutsche or UniCredit. Putting the new system through its paces by dismembering a G-SIFI over the weekend is in nobody’s best interest.
Regulators are also mindful of their ability to spook the market. Investors can’t absolutely rule out another debacle like the Novo Banco-BES situation, but Europe’s top regulators hated that — which was why it was pushed through before Christmas.
In short, the endgame has to be the continued existence of Europe’s big banks. If they need to do another round of rights issues, it will be painful, but it will happen, which protects the debt. If they don’t, wait another quarter, and banks may well cross over into slim profits. A quarter without fines, writedowns, provisions and exceptional items should be reassuring — not because it will show that Europe’s banks are money-making machines, but because it will show that they’re sticking around.