The writer is founder and chief executive of Algebris Investments
“Shoot first, ask questions later” has been an apt description of the US and European bank space in recent weeks. With calm returning, should investors be buying UK and European banks? The perhaps surprising answer is yes. Let me explain.
Nerves have been frayed after the shuttering of three banks in the US by regulators. One of those banks, Silicon Valley Bank, made a massive losing bet on interest rates, and the other two had dived into crypto mania. All three were supervised under light-touch regulation.
Of course, the UK and Europe learned the lesson of under-regulation in the global financial crisis and addressed it in the decade that followed. We will shortly see a similar reversal from the US regulator. But the key point is that the rate bet that SVB put on would not even have been permissible in Europe, as regulations restrict banks from rate mismatches through stress tests and additional capital requirements. European banks prudently operate well below these thresholds; SVB was miles above.
Nonetheless, the Swiss have not escaped the recent turmoil. Credit Suisse had been in trouble for several years, making significant losses, and even saw its own deposit run last year, losing 40 per cent of its deposits.
When the deposit outflows reaccelerated following the SVB crisis, the bank’s regulator, Finma, pushed it to sell itself to UBS. In our view, this could well end up being the deal of the decade for UBS. UBS’s tangible book value increased 74 per cent on the transaction, it picked up jewel assets in Credit Suisse’s wealth management and Swiss banking units, and it has material buffers embedded in the deal to pay for the cost-cutting and restructuring over the coming years.
But Credit Suisse was a huge outlier among European banks in that it was unprofitable and was funded largely by an unstable, flighty deposit base. This is an undesirable combination but importantly not typical in the rest of Europe, where banks have large proportions of sticky household deposits and high and rising levels of profitability. The sector’s liquidity coverage ratio — a measure of the level of easy-to-sell assets held by banks to meet short-term needs — in the US is 120 per cent. In Europe it is 160 per cent. The numbers speak for themselves.
The bulk of the sector is making its highest profits in the past 15 years. Take NatWest, which has seen its return on tangible equity double, from around 9 per cent a year ago to closer to 20 per cent. It is not hard to see why. One consequence of low/negative interest rates over the past decade has been that banks have not been able to earn returns from half their balance sheets (the deposits). With rates now higher, both sides of the balance sheet are contributing to profits, and for the first time in over a decade, banks can earn their cost of equity.
On top of this, capital return has become a hugely attractive component of the investment case for European banks. After years of building up capital ratios from extremely low levels, banks sit on mountains of excess capital and regulators are waving through significant returns of capital to shareholders.
For the first time in two decades, share counts are going down at European banks. Very low market caps and significant capital return policies combine for payout yields (including dividends and share buybacks) in some cases near 20 per cent for national champion banks such as BNP, NatWest, ING, and UniCredit. Quite clearly, the market is stuck looking in the rear-view mirror of the past decade.
Of course, it has generally been correct not to own UK and European bank equity from just before the global financial crisis of 2007-08 until the end of 2020. The European bank index performed dreadfully over this period, due to the twin problems of capital inadequacy and negative interest rates.
But just as it was right to avoid the sector when rates were at their lows and banks needed massive restructuring, investors should now note how things have been transformed. Capital ratios are demonstrably higher than before the financial crisis, and meaningfully above those of US peers as well. European banks have the strongest liquidity in recent years and are buying back record amounts of shares.
The banks offer dividend yields of around 7 per cent with buybacks on top. Yet the shares are trading at their lowest levels relative to broader markets over the last 15 years. Banks now look to be well positioned to outperform, just as some in the market have deemed them — simplistically — to be uninvestable.
Algebris is an investor in financial securities