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Billions in Bank Buybacks if Winter Is Mild

A gauge indicates the pressure level of liquid petroleum gas (LPG) on a storage tank at the natural gas and crude oil mine operated by Polskie Gornictwo Naftowe i Gazownictwo SA, also known as PGNiG, in Grotow, Poland, on Friday, Feb. 23, 2018. Poland, which relies on Kremlin-controlled Gazprom PJSC for about two-thirds of its gas, says diversification trumps potential price cuts it could leverage from building an import link to access Norwegian fuel. (Bloomberg)

If you want to forecast the fates of banks in the UK and Europe, the one thing you should watch is gas prices. If the winter is warm and stored gas goes unburned, the region’s unloved lenders are going to look significantly undervalued.

Third-quarter results have highlighted that many sit on billions of pounds or euros of excess capital. At some, this money will be needed partly to meet higher capital demands from regulators as the final parts of the Basel global capital rules are fully implemented in Europe. Others will want to invest in growing lending or acquisitions.

But a large part of the cash should be handed back to shareholders, especially if economies don’t suffer as much as some fear.

The reason to watch gas is simple: It is going to be one of the most important influences on the paths of inflation and interest rates — and thus on the length and depth of the seemingly inevitable recession to come. That is a major difference with the US, where Russia’s invasion of Ukraine has caused far fewer problems with regards to the economy and energy costs.

Still, Europe’s banks, like their US peers, have seen profits boosted by rising interest rates and strong trading on bond and currency desks alongside few repayment problems among borrowers. Everyone expects things to get worse, though, and banks have all been increasing provisions for bad loans — but again, much like their US peers, these often look like a return to pre-pandemic levels rather than a sharp uptick.

Even after these provisions, strong profits have helped banks build capital for high-potential handouts to investors. BNP Paribas SA leads the pack mainly because it is due to get $16 billion from the sale of its US arm, Bank of the West. BNP will do a 4 billion-euro ($3.97 billion) buyback as soon as the transaction closes, probably late this year. That alone equates to a one-off yield of nearly 6.5% on BNP’s current stock market value. On top of that, it promised in a strategic plan unveiled at the start of this year to pay out at least 50% of earnings as cash dividends annually.

Even then, BNP will be left with about 7 billion euros of excess capital that it wants to spend on deals or technology to boost growth. If it can’t find the right bolt-on acquisitions or profitable assets to invest in, the pressure will grow to return that cash to shareholders. And that would amount to another 11% yield on its current market value.

Other banks might not have monster sale proceeds coming in, but several still have plenty of capital. ING Group NV has bought back 2.1 billion euros of shares this year already and announced a further 1.5 billion-euro buyback with its third-quarter results on top of its regular dividends. After that, the Dutch bank still has 6 billion euros more capital than it needs for its target common equity tier 1 capital ratio, which is the key measure of a bank’s strength. If it paid all that spare capital out, it would be equivalent to a yield of nearly 15% on ING’s market value. 

UBS Group AG will do $5.5 billion of share buybacks by the end of this year — of which $4.3 billion have already been done — and still be left with more than $3 billion of capital above its target ratio. UBS shares are already much more highly valued than many of its European peers, so its excess only equates to a yield of about 5.5%. But again, that is on top of dividends, which offer a recurring yield worth about 3.5% next year.

Lloyds Banking Group Plc and UniCredit SpA also have excess capital for buybacks that could yield more than 10%. Meanwhile, Societe Generale SA and even Deutsche Bank AG have spare capital worth a mid-teens percentage of their market value. For these two banks, however, buyback potential might be crimped by higher capital demands from regulators or a need to invest for future growth.

There are growing tensions between banks and cautious regulators in the UK and Europe. European bankers are pushing back against what they see as heavy-handed interference from the European Central Bank. There are some fears that it might stop banks paying dividends if recessions start to look severe as it did during the Covid pandemic. On Monday, UniCredit shares fell after a Financial Times report of disagreements between the Italian bank and the regulator over its long-term payout plans and other issues.  

Still, most European bank stocks trade at deep discounts to their expected book values. That is partly warranted because profitability is relatively weak, generating returns on equity below 10%. But many also trade below what their forecast returns suggest they should be worth.

That extra discount is down to recession fears. The more that interest rates have to rise in the next two years, the longer and deeper a slump will be and the more painful for borrowers and lenders. In Europe, gas prices are the biggest and most-difficult-to-predict contributor to inflation, and so the ultimate peak of interest rates isn’t yet clear, as the Bank of England said last week.

But Europe has rebuilt its gas stocks, and if the winter is mild, Europe’s economies will look much healthier and many banks will be well stuffed with excess cash. If the winter brings a big freeze, however, the knock on-effects for borrowers could be severe and some of these banks won’t have near that much extra capital after all.

More From Bloomberg Opinion:

• City of London Bankers Better Check Rishi Sunak’s Meddling: Paul J. Davies

• The BOE Edging Toward a Rate Pivot Sends a Signal to the ECB: Marcus Ashworth

• Reasons Are Adding Up for Optimism on Inflation: John Authers

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Paul J. Davies is a Bloomberg Opinion columnist covering banking and finance. Previously, he was a reporter for the Wall Street Journal and the Financial Times.

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