European Banks – a storm is brewing

In the shadow of the broadly discussed fall in oilprices and the implications for stocks around the world, the problems of the european banking sector have been almost overlooked so far by the broader audience. 

This is going to change soon. From Deutsche Bank to Credit Suisse, the shares of european banks are under immense pressure and there is no immediate cure in sight. 

Credit Suisse just reported its first full-year loss since 2008 after booking a big impairment charge at its investment banking business, while Deutsche Bank posted a record loss for 2015.

After losing a quarter of the market value since the start of the year, Deutsche Bank CEO John Cryan said in a memo to staff this week that the bank remained ‘absolutely rock-solid’ given its strong capital and risk position. But his comments only undermined investors’ confidence further and the stock tumbled once again.

What’s behind the meltdown? 

The visible and sad truth is, that seven years after the collapse of Lehman Brothers in 2008, that triggered the global financial crisis, many euro-banks are still a mess, while their US-competitors like JP Morgan, Goldman Sachs or Wells Fargo came out of this crisis stronger than ever. 

The market increasingly belongs to US banks that were restructured years ago, were faster to raise capital, raised more of it and strengthened balance sheets. 

The less visible issues of the european banks are for instance the problems with the non-performing loans, european banks still carry in their balance sheets. For almost 60% of these sour credits, the european banks didn’t bother to build up sufficient reserves so far.

And there s much more to come. European banks facing exposure in excess of 100 billion USD to energy-sector loans and may need to sell assets to bolster against future losses.

The four U.S. banks with the highest dollar amount of exposure to energy loans have a capital position 60 percent greater than Deutsche Bank, UBS, Credit Suisse or HSBC.

Possibly, some european bank may be forced to asset sales to generate provisional capital.

To calm the audience and in an unprecedented act, german finance minister Wolfgang Schäuble this week reasured investors – ‘No, I have no concerns about Deutsche Bank’, he said. If politics start to ‘reasure’ the public about a bank, you should be aware, there is seldom a smoke without a fire and you can assume that something is very bad within european banks. 

Two disturbing facts

Besides this and what’s really worrying many observers these days is the immense complexity. A decade or two ago the banks’ balance sheets were clearly structured and relativley easy to read. Today, trying to understand what’s on these large banks’ balance sheets is almost impossible, even for longtime banking professionals.

The other fact is, that in Europe, the banks are much more important for the credit mechanism in the economy  than it is in the U.S. There is a capital market where it’s easier to issue corporate bonds and get funding outside the commercial banking system. Europe doesn’t have that to the same extent. 

“The current environment for European banks is very, very bad. Over a full business cycle, I think it’s very questionable whether banks on average are able to cover their cost of equity. And as a result that makes it an unattractive investment for long-term investors.”

Peter Garnry, head of equity strategy at Saxo Bank.

‘Absolutley rock solid’? Deutsche Bank’s headoffice in Frankfurt.