Where are the European equity capital trades?

IFR 2095 8 August to 14 August 2015
6 min read
EMEA

THE STORY SO far: many of the world’s leading banks are in flagrant mid-strategy; the regulatory tidal wave is similarly in mid-rollout, with utility banking and curbs on risk-taking at its heart; return on equity is below the cost of equity in many cases; and many banks are sporting capital deficits – or will do when the roster of capital and resolution rules is finalised (think TLAC/MREL etc).

There’s a worrying amount of senior executive churn; litigation reserves to cover those well-documented sins of the past (and, alas, if what we read is true, of the present too) show scant signs of reducing; policymakers are pushing the cause of disintermediation at every step; and there’s been a step-shift in activity into the shadow banking sector. And bankers are still public enemy number one in the minds of many people.

So it’s no real surprise that a lot of bank stocks are trading below book value. And with the macroeconomic picture still decidedly mixed, you’d have thought prospects are less than hot. I was thinking about those factors and about how they could be reconciled with what seems to be prodigious buyside appetite for the bank equity and hybrid capital issuance we’ve seen this year.

IN THE CASE of the latter, appetite for Additional Tier 1 and other subordinated debt is pretty easy to explain: yield. In a zero interest-rate environment, it’s that simple. I suspect a lot of buyers don’t understand the complex features and triggers embedded in them but couldn’t care less so long as they can book spread pick-up.

On initial viewing, the numbers on the financials ECM side seem impressive: I took a look at activity year-to-date and was blown away to see that even in a year in which global ECM activity is up 10% year-on-year at US$615bn, financial ECM has out-gunned it, growing by over 23% to US$156bn and accounting for more than a quarter of total issuance. To put that into context, that’s well over twice the quantum of each of the M&A-crazed go-go healthcare and power sectors.

Chinese banks and brokers have cranked out a string of massive multi-billion IPOs and follow-ons. If you include those huge cuspy equity/debt onshore hybrid capital preferreds, the country accounts for some 40% of the total. Back to my reconciliation point, though, once you exclude China, the bank element to the financial ECM story runs out of steam.

In terms of the European bank ECM pipeline, the cupboard is bare

EUROPE IS A bust: the amount of capital actually going into banks’ coffers from stock sales is arrestingly insignificant. Region-wide, Europe accounts for around 30% of financial ECM activity but if you exclude insurance companies, non-bank financials, stock exchanges and non-financials dressed up as financials etc and include just banks, you’re left with half of that.

And if you then look at who’s been doing what, it’s generally not the banks getting the money. In the case of RBS, the US$3.2bn in proceeds went to the British government; Permanent TSB proceeds went to the Irish government; while cash from the Deutsche Pfandbriefbank stock sale went to the German government. Away from state sell-downs, it was the EBRD that cashed in on its stake in Poland’s BZ WBK, while Fairfax was the seller in that Bank of Ireland trade.

What does that leave us with? Precious little. Santander executed that chunky US$8.84bn drive-by at the start of the year; Monte dei Paschi di Siena did that make-or-break US$3.36bn rights; Commerzbank raised US$1.5bn; Banca Carige raised US$950m; Criteria raised US$632m from that Caixabank trade; and Portugal’s Millennium BCP raised a much-needed US$331m from off-loading its stake in Poland’s Millennium Bank. That’s it! (Banco Sabadell’s US$1.7bn stock sale wasn’t a capital accretion trade; it was to fund its acquisition of TSB.)

In terms of the European bank ECM pipeline, the cupboard is bare. Standard Chartered may do something, although it’s very vague. Credit Suisse likewise may do a capital-raise. CEO Tidjane Thiam isn’t ruling it out but is non-committal.

Contrast that with Australia, where ANZ, NAB and Westpac have raked it in. ANZ just raised A$3bn via a no-grow A$2.5bn fully underwritten institutional placement and a non-underwritten A$500m share purchase plan that pushed up its CET1 capital ratio by 78bp. That was in response to the Australian Prudential Regulation Authority’s July ruling to narrow the IRB/standardised differential by upping the average risk weight for domestic residential mortgage exposures by banks using the IRB method from 16% to at least 25% from July 1 2016.

That ruling had come just a week after the agency said its banks needed to increase their capital ratios by 200bp; the higher IRB risk weights for mortgage exposures will account for about 80bp of that.

In May, National Australia Bank executed a A$5.5bn capital boost via a fully underwritten accelerated 2-for-25 renounceable entitlement offer that included a A$2.7bn institutional tranche. (It’s worth noting that NAB also raised US$400m from the sell-down of its 28.5% stake in US bank Great Western Bancorp this past week, which added 34bp to its CET1 ratio. Next on the docket is the listing of its UK business Clydesdale Bank). Westpac, meanwhile, could raise up to A$2bn via its underwritten dividend re-investment plan.

We’re getting close to final term sheets on capital and resolution. European banks, like their counterparts everywhere else, are actively working on capital, resolution and funding plans to optimise the use of permissible buckets. From a competitive angle, certain banks will be targeting floors in excess of the statutory minimum and building additional buffers.

Might core equity, the form of capital most preferred by regulators, be the only child at the party without a prize?

Keith Mullin