Yesterday, when looking at the exposure of the Canadian banking sector to energy, we found something disturbing: according to an RBC analysis, local banks were woefully underreserved.
Yet while clearly overly optimistic about the severity and the duration of the commodity crunch, at least Canada’s banks do provide some information, which however is more than can be said about most European banks. As Morgan Stanley writes, “Europeans have not typically disclosed reserve levels against energy exposure, making comparison to US banks challenging. Moreover, quality of books can vary meaningfully. For example, we note that Wells Fargo has raised reserves against its US$17 billion substantially non-investment grade book, while BNP and Cred Ag have indicated a significant skew (75% and 90%, respectively) to IG within energy books. Equally we note that US mid-cap banks typically have a greater skew to higher-risk support services (~20-25%) compared to Europeans (~5-10%) and to E&P/upstream (~65% versus Europeans ~10-20%).”
Morgan Stanley then proceeds to make some assumptions about how rising reserves would impact European bank income statements as reserve builds flow through the P&L: in some cases the hit to EPS would be .
A ~2% reserve build in 2016 would impact EPS by 6-27%, we estimate:We believe noticeable differences exist between US and EU banks’ portfolios in terms of seniority and type of exposure. As such, applying the assumption of a ~2% further build in energy reserves in 2016, versus ~4% assumed for large US banks, we estimate that EPS would decline by 6-27% for European-exposed names (ex-UBS), with Standard Chartered, Barclays, Credit Agricole, Natixis and DNB most exposed.
Marking to market of high yield and lower DCM/credit trading is also likely to be an issue (and we forecast FICC down ~5% in 2016):We previously showed that CS had the biggest percentage of earnings from HY and already had the worst of peers YoY FICC in 3Q, which we fear could continue to drag, despite a vigorous focus on restructuring.
A matrix of boosting reserves would look as follows on bank EPS:
But the biggest apparent threat for European banks, at least according to MS calulcations, is the following: while in the US even a modest 2% reserve on loans equates to just 10% of Tangible Book value…
… in Europe a long overdue reserve build of 3-10% for the most exposed banks, would immediately soak up anywhere between 60 and a whopping 160% of tangible book!
Which means just one thing: as oil stays “lower for longer”, and as many more European banks are forced to first reserve and then charge off their existing oil and gas exposure, expect much more diluation. Which, incidentlaly also explains why European bank stocks have been plunging since the beginning of the year as existing equity investors dump ahead of inevitable capital raises.
And while that answers some of the “gross exposure to oil and commodities” question, another outstanding question is what is the net exposure to China. As a reminder, this is what Deutsche Bank’s credit analyst Dominic Konstam said in his explicit defense of what needs to be done to stop the European bloodletting:
The exposure issue has been downplayed but make no mistake banks are heavily exposed to Asia/MidEast and while 10% writedown might be worst case for China but too high for the whole, it is what investors shd and do worry about — whole wd include the contagion to banking hubs in Sing/HKong
Ironically, it is Deutsche Bank that has been hit the hardest as the full exposure answer, either at the German bank or elsewhere, remains elusive; it is also what has cost European banks billions (and counting) in market cap in just the past 6 weeks.
via Zero Hedge http://ift.tt/1KDSR2M Tyler Durden