European bank stocks have been under pressure: This follows on from the European Bank Stress Test which covered 51 banks representing ~70% of the banking system but excluded banks from Greece and Portugal, where some of the weakest players reside. Under the stress scenario, which critics note was weaker than the stress tests carried out on the US banks in June, the results highlighted the banks with weak levels of loss-absorbing equity capital. Of the banks analysed under the scenario 49 out of 51 had CET1 capital above 6% in 2018: the weighted average CET1 capital level improved to 13.2 percent at the end of 2015 an increase of 200 basis points over 2014 levels.
As expected, the Italian bank Monte dei Paschi di Siena, which has already had 2 state bail-outs and an additional €8bn in capital over the past 2 years, saw all of its capital eroded under the stress scenario (-2.44% CET1 by end of 2018 under the adverse scenario). Fortunately, this announcement was met with a bad debt sale (of €9.2bn reflecting 33 percent of the loans’ face value of €27.7bn) and recapitalisation plan (rights issue) of €5bn and avoided the contentious issue of having to bail in bond shareholders as public funds were not used.
As we have outlined before the Italian banking sector faces sizeable difficulties: Estimates put Italian non-performing loans (NPLs) at €360bn or ~18% of total loans and ~22% of GDP although ‘sofferenze’ or the severely delinquent bad loans are closer to €200bn. Net of provisioning estimates put the figure closer to €85bn. One of the issues with the Italian banks has been the high levels of retail ownership. The IMF estimated that ~1/3rd of €600bn of bonds are owned by retail investors and ~1/2 of subordinated bank bonds are also owned by retail investors. Under the new EU rules subordinated debt must be converted into equity before state aid can be given and if banks are placed into resolution by the national central bank or the ECB then the senior bank bonds can also be subjected to losses. Following the Brexit result the Italian government has been pushing the EU for some leniency in the rules to help find a way to recapitalise its banks.
Recapitalisation concern and weak results from some of the banks have put share prices, such a Unicredit, under pressure as investors worry NPL write-downs similar to Monte dei Paschi di Siena will necessitate capital raisings: the Italian Press reported that Unicredit may be considering a €7-8bn capital raising. Capital raisings and the drag of a negative rate and low growth environment on bank profitability have particularly negative implications for the equity part of banks’ capital structure and bonds at risk of bail-in. But the pressure for improved capital ratios, liquidity buffers and balance sheet de-risking have been credit positives. Thus, EUR bank senior unsecured credit has generally outperformed equity over the past 12 months and bank EUR bond benchmark senior unsecured spreads have generally outperformed spreads on lower ranked AT1 (additional tier 1) tranches.