This is my last Lex column after 18 months of writing about banks in Europe. When I applied for the job towards the end of 2015, my prospective boss asked for my outlook on the sector. Back then the Euro Stoxx 600 banks index had been on a roll pretty much since 2012. There were good reasons to believe the rally would continue: better economic data, balance sheet clean-ups and the prospect of rising interest rates.
If I have learned anything, it is that investors’ quest to find the merest hint of rising rates increasingly resembles Captain Ahab’s monomaniacal hunt for the White Whale. Like Moby-Dick, lending rates can stay submerged for much longer than anyone expected — or expects. The most benign credit conditions in human history are great for borrowers; less so for bank shareholders.
By 2016, investors were fast losing their mojo. The Euro Stoxx banks index shed a third of its value last year as it became clear that balance-sheet problems had not gone away, equity raisings maybe hadn’t gone far enough and rising rates in Europe — with which banks are highly geared — was nonsense.
After more multibillion-euro rights issues from Deutsche Bank, Credit Suisse and UniCredit the sector has broadly recovered to where prices were when I joined. The battle cry from banking bulls echoes again. Balance sheets are stronger! Rates can only go up!
Any European bank investor must begin with an acknowledgment that, over the long term, lenders create very little shareholder value. Since the introduction of the euro, European banks have collectively produced annual average total returns of 0.2 per cent. If you exclude dividends returns are negative.
Regulators want banks to be like utilities. But utilities don’t carry leverage equivalent to 30 times their equity. As a levered punt on gross domestic product, this is banks’ special sauce. In good economic times they can make a lot of money very quickly. But leverage works both ways.
The fact remains that eurozone bank balance sheets are still roughly three times regional GDP, bigger than any other place on earth. Perhaps instead of politicians’ perennial cry that banks should lend more, we should consider the possibility that there is too much lending, or at least not enough that makes an economic return over the cycle.
As is a Lex tradition for departing writers, let’s see where I screwed up. Uppermost, I didn’t foresee the impressive recovery in share prices, especially for riskier lenders such as Deutsche Bank, which occurred last autumn. I also thought UK bank earnings were going to get hammered in the wake of the Brexit vote. They haven’t (yet). And I was overly bullish on banks’ subordinated debt given recent bail-ins. Buying risky debt, it turns out, really does involve risk.
Some big calls I got right: Deutsche Bank was never going bust. Banco Popular probably was. Lex has been less bearish on Italian banks than peers elsewhere. And when done credibly bank restructurings — ripping out costs and/or mending the balance sheet — have offered one of the few levers for boosting earnings in a negative interest rate environment.
A big future question is what proportion of banks’ so-called “surplus capital” — that is, capital in excess of the regulatory minimum — will flow to shareholders rather than regulators. A tug of war between the two will continue because big lenders still benefit from an implicit state guarantee. As my distinguished colleague Martin Wolf told me, this is equivalent to a call option on a government bailout. The value of that option goes down the more equity banks raise (as governments and regulators would like). But since the option is essentially free, lenders are incentivised to maximise its value by raising as little equity as possible.
A primary rule at Lex is producing an opinion strong enough that someone can disagree with it. Reader feedback, especially the criticism, is always insightful. I would probably go so far to say that the quality of comments on Lex is the best of any financial news outlet.
Finally, I am leaving to take on a new columnist job and finishing a book proposal aimed at millennials — basically why they could be the first western generation since the end of the second world war to die poorer than their parents. At 34, it is a subject on which I am quickly gaining first-hand experience. All thoughts on that are invited to get in touch via Twitter — @CGAThompson.
No hard feelings. Inter-generational injustice can wait. It is Friday after all.
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