“At business school,” said the seasoned banker, “they teach you a simple lesson — if a company is trading for a sustained period below the value of its net assets then it should be closed down or broken up.”
A study by Boston Consulting Group, due to be published next month but foreshadowed at the FT’s Global Banking Summit last week, shows an extraordinary 73 per cent of Europe’s banks are trading below their book value. The vast majority of them have been doing so for more than a decade. Welcome to the realm of Europe’s zombie banks.
These are no ordinary zombies. Unlike standard undead companies, sustained by years of ultra-low interest rates but now struggling with normalised funding costs, the opposite should be true of banks: margins on lending have been boosted by interest rates that haven’t been this high for 15 to 20 years.
Many European lenders have indeed been delivering healthy profits. Shareholder payouts relative to the banks’ stubbornly low share price are running at more than 15 per cent, according to Mediobanca analysts, once you factor in share buybacks as well as dividends.
And yet investors are unmoved, seeing banks’ current returns as unsustainable. Even among the few banks that have enjoyed substantial share price recoveries (UniCredit stock has doubled this year), valuations remain well below book value (UniCredit’s price-to-book ratio is 73 per cent).
The break-up rationale, then, should still apply. And yet it doesn’t. There have of course been involuntary government-mandated break-ups — the UK’s Northern Rock and Belgo-Dutch Fortis back in 2008, for example. There have even been some attempts at break-up by investors, particularly in the UK: HSBC was targeted by Knight Vinke more than 15 years ago and more recently by minority shareholder Ping An, the Chinese insurer. And later, Barclays was attacked by Edward Bramson’s Sherborne. But nothing has come close to following the business-school textbooks.
This isn’t a wholly European problem — BCG’s study shows the low valuation problem afflicts more than a third of American banks and nearly all banks in parts of Asia. But there is a particularly toxic cocktail of causes across the EU and UK.
The first weakness is the region’s anaemic economic growth. Second the region’s quixotic policymaking. Bank supertaxes have been imposed in several countries, either as prolonged punishment for the damage they wreaked in 2008 (as in the UK), or as a more recent response to higher profit margins (as in Spain). Italy’s plan to impose a tax was revised to allow banks to boost reserves instead, but is still blamed for spooking investors.
A third issue is breadth of operations. Their home European market is far more fractured as the result of the failure to create a proper EU single market. The EU’s “banking union” remains only half-delivered and a proposed “capital markets union” is largely just a blueprint. This has ensured that even the most ambitious European group only has a significant presence in two or three EU countries.
A fourth differentiating drawback — relatively weak investment capacity — flows from the other three, but as the need to overhaul business models with artificial intelligence tools and other technology infrastructure intensifies, US banks are dwarfing their European rivals in terms of tech investment. All of this renders the bear case for Europe’s banks easy to make, especially as loan defaults rise at this stage in the economic cycle.
Among the reasons for optimism is the apparently solid state of European bank capital, liquidity and supervision that prevails at UK and ECB-regulated banks — the springtime regional banks crisis in the US and the collapse of Credit Suisse did not infect the UK or eurozone.
Certainly some opportunistic investors, such as Toscafund, the London-based hedge fund, have made decent money on selective European bank picks. “It doesn’t matter that they’re still below book value,” says one bullish investor. “If they go from 35 per cent of book value to 70 per cent of book, you still double your money.” If, over time, investors steadily see that bank balance sheets are solid, the policy environment remains stable and memories of past disappointments fade, Europe’s banks may one day make it back to book value — finally exorcising the zombie phenomenon for good.