viernes, 6 de junio de 2014

viernes, junio 06, 2014

June 3, 2014 7:12 pm

European banks: Still unstable

The search for yield has helped fund institutions on the eurozone periphery but concerns remain
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©Reuters
Starry eyed: the European Central Bank’s decisions this week could further boost flows to financial institutions

Anthimos Thomopoulos arrives 30 minutes late for his lunch because of the traffic caused by a teachers’ demonstration. It brings back memories of the riots he dodged on his daily commute through Athens at the height of the eurozone crisis, when he struggled to cope as depositors withdrew their funds.

But the chief executive of Piraeus, Greece’s biggest bank, is not in his own country. Instead, he is tucking into taramasalata in London as he celebrates the successful issue of the bank’s first bond in five years and a €1.75bn share offering to shore up its balance sheet.

“In 48 hours we had around €3bn of orders from US and UK institutions. There is no need for me to go [to continental Europe],” he says, after cancelling a long-planned investor roadshow. “I have never seen demand like this in my corporate life. It is a turning point for Piraeus and Greece.”

The reversal in fortunes for the Greek bank reflects a broader economic recovery that has seen billions of dollars in foreign investment flood back into the parts of the eurozone hit hardest by the debt crisis. Nowhere has the rebound been greater than in the banks in the periphery region, which covers Spain, Italy, Greece, Ireland and Portugal.

Yet many bankers question whether the investment rush is justified by the anaemic economic recovery, or is merely storing up future problems. This week the European Central Bank is expected to take the unprecedented step of making an already wafer-thin key policy interest rate negative in effect charging banks to keep their money at the ECB. It is also set to launch policy tools designed to encourage lending to European businesses in the periphery.

Both measures risk even further inflating investment flows into the peripheral banks, which could prove destabilising if the market turns.

Policy makers are racing against the clock to boost competitiveness and strengthen the banking system before the next recession hits,” says Alberto Gallo, head of credit strategy at RBS. “By then there will be less dry powder to help banks or weak countries.”

Piraeus was one of 20 big banks in the periphery that have received about €186bn in state-aid allocation since mid-2009, excluding a share of more than €1tn in cheap loans the ECB pumped into the banking sector between 2011-12 to avert collapse.

Lenders such as Ireland’s Allied Irish, Spain’s Bankia and Portugal’s Millennium BCP were once regarded as having little chance of long-term survival. But today international investors are prepared not just to lend them billions of euros – they are doing so without collateral.

One reason such crisis-hit banks have returned to favour is that investment funds have taken on more risk in the hunt for better yielding assets. On the assumption that the eurozone crisis is over, the higher rates offered by banks such as Piraeus, whose landmark bond boasted a 5 per cent coupon, look attractive. “Right now everyone is a yield hog,” says a senior London-based debt banker. “Institutions don’t care what they’re buying, they need that yield.”

The turning point of Europe’s banking crisis can be isolated to a single moment: July 26 2012, when Mario Draghi, president of the ECB, promised to dowhatever it takes” to save the euro. If necessary, this meant buying the bonds of eurozone countries.

The ECB has yet to spend a cent. But after his speech, sovereign bond yields and banks’ borrowing costs fell. “It was a confidence boost,” says Anthony Doyle, investment director of fixed income at M&G Investments. “No one knows what itis, but the market believed him and a lot of appetite has returned to the periphery and that has relieved the pressure.”




At first only large “national champion” banks in the eurozone periphery, such as Italy’s UniCredit and Spain’s Santander, could access capital markets with senior unsecured bonds that rank above other creditors, a staple of most banks’ funding.

As the eurozone crisis abated, global investors decided Europe looked cheap especially compared with the US stock market, which was heading towards record highs. Last year investorsmany from the USpoured $66bn into European bonds and equities, says EPFR, the data provider. Another $70bn has flowed into the region since the beginning of 2014, the highest year-to-date inflows on record.

As funds returned, borrowing costs for Europe’s financial institutions fell by three-quarters from their November 2011 peak, according to the iTraxx senior financials index, which measures the cost of insuring bank debt.

Mid-sized peripheral banks began taking advantage of the investors’ yield hunt too. As a result, peripheral bond issuance has touched €39.3bn in the year to date, the highest figure since the onset of the crisis and up 72 per cent on the same period last year, according to Dealogic.

“We haven’t seen this level of sustained investment in credit markets since before the financial crisis, which is helping push yields to new lows,” says Chris Tuffey, head of debt syndicate at Credit Suisse.

The fall in yields has accompanied a modest improvement in economic prospects. The eurozone has been growing since the second quarter of last year. Moreover, banks have been implementing reforms to make them safer and building capital buffers in the event of another economic downturn. Morgan Stanley estimates that €45bn in capital has been raised since July 2013 in preparation for European regulators’ bank stress tests.




Nevertheless some of the metrics that determine the likelihood of debt defaults – which in theory should determine yields – have worsened. “It feels like we’re in the eye of the storm,” says Mr Doyle. “We’ve seen some initial rebalancing by the periphery banks on the back of better economic data but not enough to explain the fall in funding costs relative to a risk-free asset like German government bonds.”

One reason investors lost confidence in the region three years ago was large national debts and a fear that governments would not be able to afford a banking sector bailout. Since 2011 gross debt relative to the size of national economies has increased in every periphery country. Joblessness has also increased in all except Ireland.

The number of defaulted or “non-performing loans” (NPLs) reflect lagging indicators in the real economy. NPLs as a proportion of total bank loans have grown across the periphery since the crisis, according to local bank reports. They represent 32 per cent of all Greek loans, 27.8 per cent of all Irish loans, 12.6 per cent of those in Spain and 16.9 per cent in Italy.

Due to national differences in how bad loans are classified, many analysts believe the true number could be significantly higher. Banks outside Spain have yet to deal in a more comprehensive manner with their NPLs,” says Nikhil Srinivasan, chief investment officer at Generali, the insurer. “NPLs are not only a drag on profitability but, in a sense more worrying, they are a distraction for bank managements. A bank with 20 per cent NPLs is hardly able to focus on growing its loan book.”

This matters in particular for periphery banks because they are tied to their national economies through large-scale investment in domestic government debt – a trend regulators call the “bank-sovereign nexus”.

Since the crisis, eurozone banks’ holdings of their domestic governments debt have increased in all periphery countries except Greece. These account for more than a 10th of all Italian banks’ assets and 9.7 per cent in Spain, for example.

As a result, the fate of national banks is even more intertwined with national governments than three years ago. Added to that is the combined size of European banks’ balance sheets €30.7tn – which remains the biggest in the world relative to gross domestic product.

Mr Gallo says: “It is unlikely in the event of another crisis that governments could afford to bail out banks againwhich is precisely the opposite of what regulators want to achieve. The problem of too-big-to-fail banks in Europe has not gone away and, in some cases, has become worse.” He estimates banks need to cut an additional €1tn in assets by 2018.

The burden is greatest on smaller banks. This is stoking fears that lending to the region’s small and medium size enterprises, which has fallen in spite of lower bank-funding costs, will decline even more sharply as a result.

Optimists point towards the EU’s banking union system to police the eurozone and cover the costs of bank failure through a common resolution fund. If a bank struggles to raise funding, EU state aid rules require that it first imposes losses on investors and then taps its home member state. Only then can it call on the eurozone’s €500bn bailout fund, the European Stability Mechanism, which provides loans with strict conditions.



Critics contend that the funds available would be a fraction of the amounts required if a big banking crisis were to hit. But faced with the prospect of negative interest rates being set by the ECB, investors’ risk appetite shows no signs of diminishing in their hunt for yield. The question many bankers are asking is how much further can yields fall?

“In light of banks’ improving capital situation and lower rates in general accompanied by close to zero inflation in southern Europe, the massive reduction in yields has a basis,” argues Mr Srinivasan. Have they gone too far? Perhaps. I don’t expect much [yield] compression here out but demand should remain.”

Over the past four months there has been an explosion in an as yet untested type of complex debt instrument called a “contingent convertible”, or coco, bond. These high-risk, high-yield assets combine features of debt and equity that allow banks to raise capital more cheaply than simply issuing shares. They offer investors bond-like fixed interest payments while providing equity-like risks on the principal in the event of default.

Banks’ coco issuance is predicted to reach €50bn this year, up from about €11.5bn last year, in spite of warnings by the Bank of England and Standard & Poor’s that investors are throwing caution to the wind

Investors have been yield hunting. This means taking more risk to get that extra return,” says Tim Skeet, managing director at RBS. “But the question remains to what extent a fundamental analysis underpins the investment decision. Is risk being correctly priced? This is far from certain.”

In Athens, following Piraeus’s announcement of its own capital raising, three more bailed-out Greek banks followed suit. In less than three months institutions once viewed as national basket cases raised €8.3bn in equity between them. With the ink barely dry on the Piraeus deals, Mr Thomopoulos says investors have inquired about the possibility of the bank’s first coco.

Risks aren’t being priced in and the consequences will come to the fore sooner or later,” warns Richard McGuire, head of rates strategy at Rabobank. “There is certainly an argument to be made that the eurozone crisis isn’t over it’s sleeping.”


Regulatory scrutiny: Stress test raises grumbles but prompts clean-up


The launch of the European Central Bank’scomprehensive assessment” of the region’s banking system last autumn provoked grumbling among bank executives about a lack of clarity and the potential for protracted uncertainty, writes Sam Fleming.

Yet analysts say the financial health check has prompted a positive reaction, as banks seek to get ahead of the authorities by cleaning up their balance sheets rather than receive marching orders later this year.

Eurozone banks have strengthened their balance sheets by raising €45bn before the Asset Quality Review and Stress Test (AQR) being conducted by the authorities, including fundraisings of €8bn by Deutsche Bank alone, according to estimates from Morgan Stanley. Analysts there expect the AQR to have a “catharticeffect and help unclog lending channels.

The AQR is by some estimates the most ambitious in regulatory history, covering €3.7tn in assets held by 128 of the biggest lenders in the eurozone. Some 58 per cent of their risk-weighted portfolios will be put under the microscopemore than the 50 per cent originally signalled by euro area regulators.

The review has involved armies of auditors working with regulators scouring banks’ asset portfolios, in a process that could cost tens of millions of euros. Examiners will look at samples of assets to determine if they are being classified correctly – for example whether they are non-performing or subject to forbearance – and whether they have been accurately provisioned for.

It will test how banks would cope with a significant downturn. It requires institutions to maintain common equity tier one capital of at least 5.5 per cent under an “adverse scenario”.

Mario Draghi, the ECB president, has warned that some banks will fail the exercise. It would be pure guesswork” to estimate the outcome, says Alberto Gallo, head of European credit research at RBS.

The pace at which eurozone banks are shrinking their balance sheets has slowed to near zero, from €400bn to €500bn a month last year, according to ECB data. Yet many euro area banks remain undercapitalised, and for taxpayers to be insulated from future banking crises balance sheets may need to be strengthened by more than €400bn, RBS figures suggest.


Copyright The Financial Times Limited 2014.

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