Ahead of the Curve | Friday, 6th August 2021

ECB lifts dividend ban – banks poised to return significant amounts of excess capital to shareholders.
The ECB finally lifted its dividend ban on the European banking sector. Importantly, in its statement it also explicitly acknowledged for the first time the important role that buybacks will play in banks’ capital management plans. Before the onset of the COVID crisis, we had highlighted the shifting regulatory stance towards European bank capital in general, and share buybacks in particular. The onset of the COVID crisis put this on hold, however the sector continued to build excess capital during this time, and we are now seeing clear signs of intent to return it to shareholders. As a result, we see all-in shareholder yields for the sector in 2021 (including catch-up dividends and buybacks) of 8%, and on a more sustainable basis approaching 7% thereafter. In a world where rates are marching lower, we find the presence of such large yields extraordinary. At current share price levels buybacks will significantly accrete tangible book value per share, resulting in higher ROTEs as well. In addition, the results of the first post-COVID stress test were recently announced, with better-than-expected results for the sector despite significantly more onerous macroeconomic assumptions than in prior stress tests. For example, the assumed decline in GDP is 55% higher and peak unemployment rate is 52% higher. Nevertheless, nearly all banks fared well, with significant remaining buffers to minimum capital requirements after the harsh modeled hits to their capital ratios. While the stress test exercise is somewhat theoretical, it is just another sign that the regulator views European banks’ capital levels as more than adequately capitalized to withstand a severe potential economic shock (in addition to the COVID crisis just endured). The recent moves in interest rates have captured the market’s attention for the time being, but these extraordinary yields are here to stay (at current share prices, at least).

Societe Generale shines as European Bank earnings continue.
European bank earnings continue to roll in. As we discussed previously, UBS printed very impressive numbers but another large holding of our Fund, Societe Generale, may have had an even better quarter, at least relative to expectations. Pre-tax profit beat consensus by over 50%. Benign credit helped – as was the case with virtually every other bank this quarter – but the beat at the pre-provision line was also a stunning 21%. This was driven by the revenue line, which beat across all lines outside of FICC (another area of softness for most capital markets banks this quarter). And importantly, capital – for many years the weak link at SocGen – continues to march higher (CET1 = 13.4%) and the company announced a catch-up buyback for its missed 2020 dividend and is accruing for a 50% dividend payout which implies a nearly 5% yield on first-half profits alone. The stock has been left for dead, trading below half of tangible book. This implies no future growth and a ROTE of ~5% into perpetuity, even as the company just printed an underlying ROTE over 10% in a soft FICC quarter and with rates pinned at -50 bps. The forward earnings power here is close to €5/share (in fact they have already made a run-rate of €4.80 EPS in the first half of this year), which in our view should justify upside of at least 50% from current levels even before considering the robust and growing dividend yield.

UniCredit enters negotiations for takeover of Monte dei Paschi on attractive terms.
Late last week it was announced that UniCredit has entered exclusive negotiations with the Italian government for the potential takeover of MPS. This deal has long been rumored, particularly since Andrea Orcel was tapped to be the new CEO at UCG. However, it was unclear whether Orcel would prefer an acquisition of the troubled MPS, or perhaps set his sights on a bank like Banco BPM, or forgo acquisitions altogether and look to aggressively buy back stock instead. Some of the key terms which have been agreed to in principle include capital neutrality, earnings neutrality (pre-synergies), immunity from extraordinary litigation risk, and exclusion of non-performing assets. In our view, while there remains much uncertainty as to the actual structure of a potential deal, it would be a significant strategic and financial win for Unicredit if they can execute a transaction on these high-level terms. The stock already is amongst the cheapest in Europe (6x ’23 earnings) even before we strip out their excess capital, which is more than half the current market cap. Adjusting for excess capital – which will still be in place after a deal with MPS according to the prerequisite terms – and assuming low double digit EPS accretion on an MPS deal, UCG is currently valued at just over 2x ’23 earnings.