For the past two to three years, hedge fund and other investors have been eagerly anticipating opportunities expected to emerge from the swift and substantial deleveraging of European banks.
The belief was that attractive assets at bargain prices would be available in abundance.
But years have gone by and relatively few opportunities of this nature have materialized.
Why? First, extensive intervention by the European Central Bank (ECB) stabilized capital markets and decreased the urgency for banks to sell assets at distressed prices.
Second, selling assets at distressed prices (and thereby taking losses) undermines the main goal set out by regulators for banks (that is, to improve capital ratios). This does not mean that investment opportunities have not presented or will not present themselves.
The International Monetary Fund (IMF) estimates that there is another $2.8trn1 in deleveraging necessary for the European banking sector. This Viewpoint discusses current investment opportunities in the ongoing European deleveraging process.
Current state of European banks
Total assets in the European banking system are a relatively large percentage of European GDP compared to the US ratio,2 as Europe-based corporations tend to rely more on bank funding than corporations in other regions.
As a result, the health of the banking system is very important to the overall European economy. Improvements were made in bank capital ratios as illustrated by the increase in Core Tier 1 (CT1)3 levels and slight decrease in risk-weighted assets (RWA)4 (Figure 1), yet there is large dispersion in capital adequacy and other factors (e.g., private sector loan and deposits growth, see Figure 2) among different European banks. Core Europe banks are showing significantly stronger improvement than periphery-nation banks.