Weeks have passed since the heads of euro area governments, meeting in Brussels, laid out intentions to help European banks past the closure of term-funding markets with a new system of sovereign guarantees.
The heads of state announced that such guarantees were an essential part of their strategy to limit banks’ deleveraging, that a coordinated EU-level approach on entry criteria, pricing and conditions was needed, and that the European Commission should urgently work up the details in consultation with the EBA, EIB and ECB.
In identifying the importance of finding a way to restore banks’ access to term funding, the euro heads hit the nail squarely on the head: this is far more important for banks than raising capital. "Funding is the key issue," says John-Paul Crutchley, analyst at UBS. "There is no term unsecured funding and without that, fundamentally, banks can’t operate."
However, since the announcement in Brussels on October 26, while the wholesale funding markets have continued to shrink, banks have heard nothing more about these sovereign guarantees. "We’ve had meetings with the ECB and with other banking regulators in the weeks since October 26 and none of them know how to make these sovereign guarantees work," one banker tells Euromoney.
| “I’m inclined to use 12%, for want of a better number, but I’m not going to die in a ditch over it” |
The absence of guarantees to improve the availability and cost of funding makes it inevitable that banks will restore their capital ratios by shedding assets rather than by raising equity. With term funding scarce and punitively expensive, banks’ business models long ago stopped making sense to equity investors who won’t fund them. Banks cannot present a growth story to equity investors, as they are forced to withdraw from the most promising growth markets in the emerging world for lack of deposits. Compelled by regulators to retain earnings rather than pay out dividends, they can’t present themselves as value stocks either. That puts bank stocks in a third category: distressed.
Under weight
"Normally, when you see equity investors this far underweight such a big sector as banks, they are nervous they might miss out on a big rally," says Crutchley. "But investors aren’t worrying about that at all. Investors have disengaged to a degree." It’s not hard to see why. When RBS announced its third quarter results last month, one questioner asked chief executive Stephen Hester what he calculated to be the bank’s cost of equity. "Well, I don’t get too hung up on it, to tell you the truth," came the insouciant reply. "I’m inclined to use 12%, for want of a better number, but I’m not going to die in a ditch over it."
It’s no wonder that a chief doesn’t want to get hung up on it when his bank is on track to earn a return on adjusted equity of closer to 2% this year and maybe 6% next if it’s lucky. Of the UK banks, only HSBC and Standard Chartered are anywhere near to making a 12% return on adjusted equity and they are emerging market banks that just happen to be headquartered inside the EU.
