European Banks – a brief summary after the banking crisis

• Banking crisis brought about fears and questions about the banking system.
  
  
• European banks mostly still see profits and an unaffected liquidity position.
  
  
• The loan books of the European banks look decent for the time being.
  
  
• Banks are still well-capitalised, but CS AT1 was written-down due to a discretionary trigger, instead of a contingency trigger.
  
  
• For investors looking into European banks, Tier 2 subordinated bonds might look better in the current environment.

Barely halfway into 2023, we have probably experienced the highlight of the year – an extended banking crisis taking down 2 regional US banks and a global Swiss bank. The back-to-back incidents raised fears about the strength of the banking system and brought to the surface several questions on the monetary policy decisions. Across the same quarter, we saw numerous doubts as the crisis developed – and we hope to clear up some of these doubts about the European banks, using the financial results released in the first quarter of 2023 (“1Q23”), or of the respective fiscal years. The European banks covered in this article are mainly SGD issuers of subordinated Tier 2 and Additional Tier 1 bonds.

European banks’ profitability and liquidity

Table 1
Banks’ normalized RoTE, change in deposits and HQLA

Looking into the profitability of the European banks, most banks saw a high single-digit or low double-digit RoTE. Using RoTE to examine the profitability of the banks provides for a more complete picture as compared to using the growth in net interest income. With interest rates soaring in 2022, net interest income paints too rosy of a picture for most banks while failing to take into account other aspects of operations – especially with most banks seeing a drop in fees and commissions through their wealth management operations.

Most banks continue to see a growing trend in 2022, otherwise sustaining a relatively high RoTE. Societe Generale SA appears to be an exception from the trend, which it has had difficulties growing its net interest income and had to write down its Russian assets. Beyond that, Credit Suisse’s situation really appears to be isolated, where confidence in Credit Suisse was undercut by the contrasting losses it was making, while other banks remain profitable.

During the banking crisis as it happened, there were fears about whether a bank run had happened to the other banks – where customers were just withdrawing their savings as the banking system appears to be failing the citizens. From the quarterly results in 1Q23, the fears appear to be mostly unwarranted.

While Deutsche Bank and UBS saw a considerable fall in customer deposits, neither was to the extent of Credit Suisse which saw over 30% drop in deposits in 4Q22 alone. For BNP Paribas, it was reported to have a net inflow into customer funds over its outflow from deposits – suggesting most customers might have considered a transfer of deposits into alternatives such as money market funds, rather than out of the bank.

The minimal changes to the banks’ high-quality, liquid assets (“HQLA”) or liquid reserves (where HQLA information might be unavailable or inadequate) further supports the notion of stable deposits across the European banks. With the exception of Deutsche Bank which saw both a decrease in deposits and HQLA, overall impact on the banks’ liquidity appears to be mostly limited for now.

European banks’ loan profile

Table 2
Various ratios and changes on the banks’ loan books

A critical area of interest that dictates the forward viability of the banks would be the management of their loans. Across all the European banks, the average loans-to-deposits ratio (“LDR”) is estimated at 96.9%. A higher LDR would suggest the possibility of experiencing difficulties in the banks’ liquidity upon large deposit withdrawals. Most of the values fall within the European banks’ average, with HSBC and Standard Chartered having one of the lowest across the board. While Credit Agricole inclusive of its regional banks reflect a considerably high LDR at an estimated 110%, Credit Agricole itself reflects a much lower LDR at approximately 60%.

The loan loss provisions reflect the bank’s expectations on loan losses, which we had previously observed relatively high provisions allocated to loan losses in FY22 – likely due to the aggressive rate hikes across the globe. However, it appears that the banks have previously over-provisioned for loan losses, and as a result in 1Q23, they have been reducing their existing provisions. The banks are likely considering for the economic outlook to be better than initially expected in 2022, and therefore the revision in the total provisions allowed for loan losses. The NPL ratios and the respective changes similarly suggest that the loan books of the banks continue to remain strong for the time being.

European banks’ CET1 ratio and litigation cases

Table 3
CET1 ratio and their respective buffer

Coming to the CET1 ratio, we continue to see the European banks being well-capitalised, in which the CET1 buffers over the regulatory requirements remain substantial. On this note, we would like to remind investors on the writing down of Credit Suisse AT1 issuances, it was due to the discretionary trigger by the decision of the Swiss Financial Market Supervisory Authority (“FINMA”) instead of a contingency trigger where the CET1 ratio falls below a certain level.

As such, despite CET1 ratios being well above the necessary regulatory levels, the risk of a discretionary trigger dictated by the regulator still exists. Investors looking to purchase any subordinated bonds should carefully consider the loss absorption clauses it may have, and the circumstances that a loss absorption may occur.

Lastly, litigation may also affect the banks’ performances – due to the need to pay a settlement fee or for compensation purposes. Below we highlight several major outstanding litigation events, that are likely yet to be unaccounted for in the banks’ financial statements

• Banks operating in France, mainly Societe Generale, BNP Paribas and HSBC are involved in a cum-cum tax fraud case where the French authorities are currently seeking to recover EUR 2.5b in back taxes
• On a USD-LIBOR fixing lawsuit, Societe Generale and UBS are still pending potential settlements while defending their cases in trial. HSBC and Barclays had previously settled for more than USD 100m in fines, and Deutsche Bank had paid more than USD 200m.
• Deutsche Bank had recently come to a settlement for Epstein-related claims, for an estimated amount of USD 75m.

On the issue of litigation, while the settlement amount rarely reaches a level that incapacitates the bank, negative investor sentiments are generally associated with such cases. This is especially so for Credit Suisse, which was plagued by both poor results and multiple litigation cases putting it in a negative spotlight. Investors ought to remain abreast of the individual bank’s litigation cases.

Overall, we strongly believe the situation for Credit Suisse as a global bank, is truly idiosyncratic – and that the situation did not spill over to other European banks of interest. Despite that, the operational and business risks continue to be a concern for European banks in 2023. With net interest margin likely to hit a peak, alongside unfavourable headwind economic conditions across Europe, investors have a responsibility to closely keep track of the banks’ development in 2023.

For investors looking to invest in the European banks, T2 subordinated bonds may look more attractive than the AT1 bonds for the time being, given the higher risk of loss absorption on the lower-ranked AT1 bonds. In addition, AT1 bonds may experience higher non-call risks due to the current higher cost of new issuances and refinancing. On the other hand, issuers are incentivized to redeem their T2 bonds due to the need to amortize the capital on their balance sheet past the first call date. As such, greater certainty on the bond’s maturity period seen in T2 bonds would likely be more optimal for investors as well.  

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a position in BACR 8.300% Perpetual Corp (SGD), CMZB 4.200% 18Sep2028 Corp (SGD), CMZB 5.700% 03May2033 Corp (SGD), HSBC 6.500% 20May2024 Corp (GBP), HSBC 5.300% 14Mar2033 Corp (SGD), HSBC 4.375% 23Nov2026 Corp (USD), STANLN 4.300% 19Feb2027 Corp (USD), UBS 5.875% Perpetual Corp (SGD) and the analyst who produced this report holds a NIL position in the abovementioned securities.

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