Euro banks' equity valuations - credit still to catch up?

Yesterday saw the equity valuation of European banks (the price/book ratio for the Euro Stoxx Banks Index) hit its lowest point (0.599) since 2 August 2012 (shortly after Draghi’s “whatever it takes” speech). This drop in equity valuations, particularly since the start of this year, reflects not only the general risk-off mood in equities, but also what appear to be growing fears around the health of the banking sector in Europe.

But while equity valuations have tanked, the move in CDS has been much less pronounced. European banks’ CDS is currently trading around 106, 30 points wider from the start of the year, but still a far cry from 280 level that was hit on 2 August 2012.

EUR Stoxx Banks Index vs. iTraxx SNRFINEuro banks - Equity valuations  Chart 1Source: Bloomberg

Of course bond investors now feel more confident for a number of reasons, including:

  • a now-negligible risk of euro break up;
  • a better macroeconomic backdrop;
  • improved bank capitalisation;
  • significant restructuring efforts that banks have undergone since 2012, and; 
  • better regulatory oversight. All of this should theoretically protect banks’ creditors.

Risk absorption metrics for European banks have improvedEuro banks - Equity valuations  Chart 2Source: European Banking Authority – Risk Dashboard

However, these positive developments must be balanced against:

  • regulatory initiatives (e.g. Bank Recovery and Resolution Directive) that severely limit the use of state support in assisting bank recapitalisations; 
  • regulatory changes that allow losses to be imposed on banks’ senior debt outside of resolution, i.e. through bail-in;
  • the unpredictability of the regulatory response to problems in the banking sector (e.g. the recent case of Novo Banco/Banco Espirito Santo), and;
  • ongoing uncertainty around the true valuations of banks’ assets and any outstanding legacy issues (RBS’s surprise announcement regarding pension charges is a case in point).

More generally, perennially high impaired loans metrics continue to pose risks and leave banks very vulnerable to an economic downturn. As such, while we accept that CDS spreads should not be back at the highs seen in 2012, the current disconnect between CDS and equity valuations looks odd to us, not least given the fundamental changes in the regulatory framework in recent years (with more potentially to come).

Impaired loan ratio – European banksEuro banks - Equity valuations  Chart 3Source: European Banking Authority – Risk Dashboard

Categories : 

Back to research list


This research report is produced by Daiwa Securities Co. Ltd., and/or its affiliates and is distributed by Daiwa Capital Markets Europe Limited in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Conduct Authority and is a member of the London Stock Exchange and Eurex Exchange. Daiwa Capital Markets Europe Limited and its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients.

This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FCA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available.

Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at  /about-us/corporate-governance-regulatory. Regulatory disclosures of investment banking relationships are available at