Bank scores weigh heavily on Europe

SINCE JUNE, INVESTORS have become bearish about the health of Europe’s banking system. The threat of a large-scale default on Greek government debt continues to hang over Europe’s banks. As Euromoney went to press, the latest recapitalization plan, hammered out in Brussels at the end of last month, was rumoured to require Europe’s banks to raise €106 billion ($150 billion) during the next six to nine months. Some estimate the shortfall they need to fill is at least twice that figure.

With Europe’s sovereign debt crisis intensifying, and with policymakers seemingly unable to find a solution, Europe’s banks remain trapped in a liquidity squeeze. All but the highest-quality names have been shut out of the primary funding market since June. Already, the liquidity trap has claimed a high-profile victim: Franco-Belgian lender Dexia, rescued by the Belgium government on October 10.

The Euromoney Country Risk data bring into sharp focus the declining stability of Europe’s banks. In the survey, in which economists rated 186 countries across 15 variables of country risk, average scores in the bank stability section for European countries declined for the fourth successive quarter in September. In all, the bank stability scores of 17 EU member states deteriorated in Q3 by an average of –0.1.

"The funding problem facing Europe’s banks is a symptom of the crisis, not its cause," says Nicholas Spiro, director of Spiro Sovereign Strategy. "The cause remains sovereign solvency. To relieve the pressure on banks, policymakers must first restore confidence in the debt of peripheral and European sovereigns."

Greece, France and Denmark fall hardest

European Bank Stability scores, Sept 2011 Biggest fallers Country Score change (June to Sept) Greece -0.9 France -0.6 Denmark -0.6 Czech Rep -0.3 Bulgaria -0.3 Germany -0.3 Malta -0.2 UK -0.2 Cyprus -0.2 Italy -0.2 Selected European countries, UK and US Country name Bank stability Sweden 8.3 Netherlands 7.7 Czech Republic 7.6 Slovak Republic 7.5 Denmark 7.4 Austria 7.3 Germany 7.2 France 7.1 Poland 7.1 Turkey 7.1 United Kingdom 6.8 Malta 6.7 Estonia 6.3 Belgium 6.3 Lithuania 6.2 United States 6.2 Source: ECR

Among European sovereigns, the biggest single fall was recorded in Greece (–0.9), with Denmark and France second (–0.6). The Czech Republic (–0.3), Germany (–0.3) and the UK (–0.2) also declined.

Banks in France have suffered from a collapse in investor confidence comparable to the one that affected Italian banks earlier in the summer. French banks’ exposure to Italy, which the Bank for International Settlements estimates at €276 billion or half of all European bank lending to the country, has resulted in US investors in particular rushing for the exits.

Fitch, the rating agency, estimates that US money market funds have reduced their exposure to French banks by 42% in dollar terms since August. The resulting funding shutdown has coincided with a dramatic sell-off in bank equities and a corresponding reduction in French banks’ ECR score.

The change in bank stability outlook has been modest, given the challenges facing French banks. Although France registered the second-biggest fall in Europe after Greece, its banks have retained a similar rating (7.1) to their German counterparts (7.2). While there is little doubt that both German and French banks would suffer from the impact of a Greek default, there are two important differences: the large Italian exposure of the French banks and the relative health of Germany’s public finances.

While the yield spread between French and German sovereign debt has soared on French contagion fears, Germany, the driving economic force in the eurozone, remains exempt from market scrutiny.

Bank stability scores have been deteriorating in Denmark since March. During this period, Fjordbank, a Danish lender with €1.8 billion in deposits, had to be bailed out by the state. In June, Moody’s downgraded six Danish banks, citing the likelihood of rising funding costs and a lack of systemic support.

Although Ulrik Noedgaard, director general at the Copenhagen-based Financial Supervisory Authority, has insisted that "the bigger banks are putting the crisis behind them after having done the necessary write-downs", the deteriorating outlook means that Denmark, whose banks had been ranked alongside the other Nordic countries and Switzerland by ECR economists, now has a ranking in line with sovereigns such as France and Germany, whose banks are directly threatened by the crisis in the periphery.

Some eurozone countries’ bank stability scores increased during the quarter. Ireland’s score improved by 0.4 points after a quarter in which several banks successfully raised capital secured against existing loans. Bank stability was the only criteria in the economic section of the survey where analysts increased their scores during the quarter, although Ireland’s bank score (3.2) remains one of the lowest in Europe. The Baltic banking sectors, notably Lithuania (+0.5) and Estonia (+0.2), also showed improvement during the quarter, boosted by their strong connections to the Nordic countries and low exposure to the periphery.

European banks

The health of Europe’s banks is put into a global perspective when Euromoney’s bank stability metric is graphed against credit rating scores for European sovereigns and a range of emerging markets. Among European countries with a triple-A rating, the most highly rated banking sectors are the Nordic countries (excluding Denmark), Switzerland and Luxembourg. Each sovereign in this group has a score in excess of eight out of 10, indicating that the national banking sector represents only a limited risk to the creditworthiness of the sovereign. Banking sectors in this group have only limited exposure to peripheral sovereign debt, while each is also included in the ECR global top 10.

The remaining triple-A sovereigns, which include the Netherlands, Germany, Austria, France, Denmark and the UK, each score less than eight out of 10. Analysts see a higher probability of banking distress in the second group than in the first, while banks in the former group are also experiencing less of a funding squeeze than those in the latter group. Credit default swap prices, in which the cost of insuring Swiss and Nordic banks debt is considerably lower than elsewhere in Europe, indicate that the market perceives greater default risk among banks in the second group than in the first.

The Nordic countries and Switzerland are not the only European countries to receive positive assessments from economists. Bank stability scores for central and eastern European countries, such as the Czech Republic, Poland, Slovakia and Lithuania, are strong in comparison with similarly rated peers. The Czech Republic has the highest score of any CEE country (7.6), while Poland (7.2) is also well ahead of the EU average. Slovakia (7.5) also scores well above average for eurozone countries.

ECR bank stability score

Europe vs emerging market sovereigns, Sept 2011

Source: ECR

A number of outliers in the survey have higher bank stability scores than other similarly rated sovereigns. Brazil, whose banks have a high minimum capital requirement of 11%, receives a positive assessment from economists in this section of the survey. In June, Brazilian banks had a systemic capital ratio of 17%, according to central bank figures. Turkey, whose banks were largely unaffected by the global financial crisis, also received a superior bank score to many sovereigns with higher ratings from the agencies.

US and UK fragilities

The US (6.8) and UK (6.2) receive low scores in the bank stability section of the survey. Both received inferior scores to many eurozone countries, including France, Germany and the Netherlands. Although US and British banks do not face the same immediate challenges as their European counterparts, both are perceived as a risk to the creditworthiness of their respective sovereigns.

CDS prices remain high on US bank debt as uncertainty remains over the outlook for trading, fee income and retail banking divisions, while high unemployment and rising figures for mortgage delinquency suggest the outlook for the real economy is uninspiring. In the UK, the price of insuring the debt of RBS, Lloyds and, to a lesser extent, HSBC has risen steeply since August.

Bank scores in the US and UK are also being influenced by proposed regulatory changes. In the UK, Fitch has lowered its support rating for UK banks after the Independent Commission on Banking’s final report in September, citing "more advanced political will to reduce the implicit support for the country’s banks".

Simon Adamson, CEO of CreditSights, an independent research provider, says: "The ring-fencing of retail banking divisions is putting pressure on bank ratings, but the long lead-in time, to 2019, gives the banks time to prepare."

Banks in the UK and US have limited direct exposure to eurozone sovereign debt, but an interwoven global banking system means CDS prices for both sovereigns remain sensitive to the effects of the crisis.