Europe’s Banks in trouble… again?

Europe’s banking system has undergone a huge overhaul since the financial crisis, but it would appear the sector is still financially weak.

If the year-to-date debt issuance figures by European banks are anything to go by, even after a decade of restructuring, Europe’s banking sector is still weak at the knees and supported by extremely patient investors who are prepared to throw money at these struggling instructions in return for some form of yield.

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Europe’s banks Face €310 Billion Capital Gap

Spain’s three biggest banks, Banco Santander, BBVA and Caixa Bank have issued a staggering €8.6 billion in new debt so far this year, seven times more than the total issued in the same period last year. The only comparable period in recent history where so much debt was issued so quickly was back in 2007 when Spain’s real estate bubble was reaching its peak.

Europe's banks
Europe’s banks

Investors in seemingly insatiable demand for bank debt will be tested over the next few years as Europe’s leading banks scrambled to raise capital ahead of new capital requirements slated to come in at the beginning of 2019.

Most of this debt will be raised via the issue of so-called senior non-preferred bonds, a bail-in type of security. These bonds carry effectively the same credit guarantees as equities and holders could lose all of their money if the issuing bank collapses.

But one does have to wonder if these instruments will eventually replace bank shares. After all, if senior non-preferred bonds have the same rights as equity, but offer a fixed payout surely they offer a better risk-reward profile than many bank stocks in the current environment?

Bank profits will likely only come under more pressure more debt securities are issued at higher than average interest rates to meet capital requirements. At the end of last year, Credit Agricole issued €1.5 billion of senior non-preferred 10-year bonds with a coupon 45 basis points more than traditional senior debt and 65 basis points less than traditional subordinated debt.

These interest costs will eat away at banks’ already slim profit margins, and by the time Europe’s largest lenders finish issuing debt to fill capital holes, it’s likely there will be nothing left for equity holders. Indeed, BNP Paribas intends to issue €30 billion of senior non-preferred debt by 2019, and Santander hopes to raise €43 billion to €57 billion in new debt by 2019, that’s 75% of the bank’s entire market at current prices. With a prospective interest rate of 2.5% per annum, the interest cost from this debt alone will be an additional €1.5 billion for the bank. Last year, Santander’s group profit was €6.2 billion.

Overall, the European Banking Authority recently estimated a €310 billion gap (in today’s dollars that is about $330 billion) in all the region’s banks meeting their total loss absorbing capital requirements before the 2019 deadline.

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