Country risk: Bank scores plunge across Europe

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By:
Andrew Mortimer
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The health of Europe’s banks is in alarming decline, according to the latest results of Euromoney’s country risk survey. And in the US, the signals are no better. Andrew Mortimer reports.

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 recapitalisation plan, hammered out in Brussels at the end of last month, was rumoured to require Europe’s banks to raise €108bn ($150bn) during the next six to nine months. Some estimate the shortfall to be 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 (ECR) data brings into sharp focus the declining stability of Europe’s banks. In the poll, 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: Biggest fallers, September 2011
CountryScore change (June-Sept 2011)
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

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 comparable collapse in investor confidence to that which affected Italian banks earlier in the summer. The large Italian exposure of French banks, which the Bank for International Settlements estimates at €276 billion, or half of all European bank lending to Italy, 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 shut-down has coincided with a dramatic sell-off in bank equities, and a corresponding reduction in French banks’ ECR score.

Given the increasing challenges facing French banks, the change in bank stability outlook has been modest. 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 within 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, the 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 saw increases in bank stability scores 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.

ECR bank stability score
Europe vs emerging market sovereigns, Sept 2011
 
Source: ECR 

European banks score poorly compared to global counterparts, CEE

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, show significant strength relative to 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.

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 countries 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 sectors are perceived as a significant risk to the creditworthiness of their respective sovereign.

European Bank Stability scores: Selected European countries, UK and US (September 2011)
Country nameBank stability
Sweden8.3
Netherlands7.7
Czech Republic7.6
Slovak Republic7.5
Denmark7.4
Austria7.3
Germany7.2
France7.1
Poland7.1
Turkey7.1
United Kingdom6.8
Malta6.7
Estonia6.3
Belgium6.3
Lithuania6.2
United States6.2
CDS prices remain elevated 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 that the outlook for the real economy remains muted. 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 to some extent being influenced by proposed regulatory changes. In the UK, Fitch has lowered its support rating for UK banks following the publication of the final report of the Independent Commission on Banking 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 the interlinked nature of the global banking system means that CDS prices for both sovereigns remain sensitive to the effects of the crisis on European financial institutions.






This article was published using data from Euromoney Country Risk (ECR), the online service from Euromoney dedicated to country and sovereign risk. To view the latest country rankings go to www.euromoneycountryrisk.com