Status Update: In my original post a month or so ago, I covered multi-year (possibly decade long) themes that will drive investing in the European financial services sector. These have not changed over the past month. That being said the European Hamilton Moment I described is very much alive and well and moving ahead. In late June, Germany’s Finance Ministry backed a disputed stimulus program pushed by the European Central Bank (ECB), paving a way past the power struggle between Germany’s Constitutional Court and the European Court of Justice (ECJ). New information shared by the ECB ‘fully satisfied’ the demands made by the Constitutional Court, Finance Minister Olaf Scholz said in a letter to Germany’s parliamentary speaker. Further supporting the Hamilton Moment, the ECB announced on June 18 that banks took up a record €1.31trn in new loans under the 3-year TLTRO facility which, subject to banks maintaining their eligible lending volumes (mainly corporate and SME lending) could be at an interest rate of negative 1% (you read that correctly — banks get paid to borrow).
Perhaps counter intuitively, the push for more integration in the EU may be aided by preparations for a no-deal Brexit, following a somewhat acrimonious breakdown of negotiations between the UK and the EU. European politics is full of last minute deals and new deadlines even after the old ones have elapsed. It is therefore quite possible the proverbial political ‘chessboard’ has moved by the time you are reading this article.
Noteworthy Developments: The collapse of Wirecard — formerly a European fintech and payments bellwether — at the end of June took many by surprise. While at the time of writing it is too soon for any definitive answers, the repercussions will probably be with us for some time. The cynic in me wonders whether the announcement of a European Payments Initiative (EPI) to challenge Visa and Mastercard’s dominance announced on 2 July was a coincidence or an effort to redirect the spotlight from the past to the future. EPI is to be operational by 2022.
Another curiosity worth highlighting is that Austria recently issued a 100-year bond, maturing in 2120 with a 0.88% coupon. You read that correctly, a less than 1% coupon for 100 years of risk. Contemplating what this actually means is tough. On the one hand the buyers of this bond are clearly not worried about inflation — at least not in the short term (and the punters surely hope they will sell before everybody else does, should inflation pick up). That said if rates stay this low for the next 100 years, that means there is no economic recovery — surely not a great prospect either.
Important Variables: In my original post I singled out Commercial Real Estate (CRE) as a key area of concern for European financial institutions. The Economist magazine seemed to agree and has recently followed up with and in depth article, highlighting the perils in the space. Of particular interest is the following chart that highlights the ‘rent strike’, which is worse than during the Global Financial Crisis (GFC).
To reiterate the problem isn’t so much an asset becoming non-performing — credit card portfolios for example tend to have high levels of default and yet are generally very profitable for banks, because high risk is priced into the high rates charged and the losses don’t exceed the coupon. Similarly with leveraged loans, even in the worst of times the losses generally don’t exceed the coupon. The problem is that CRE assets were considered some of the safest loans on the loan books and therefore likely under-provisioned and under-capitalized given the recent drastic change in circumstance due to COVID-19. In CRE, the risk was not priced in, because It was thought to be a safe-haven asset class. Turns out, this was no safe-haven, and falls into the dangerous quadrant. Good assets priced to be good = fine. Bad assets priced to be bad = fine. Good assets priced to be bad = great. Bad assets (especially ones like CRE that the entire herd was convinced were good) priced to be good = “hold onto your hats, you’re in for a rough ride!”
Emerging Players and Themes: We see tremendous potential for growth in both digital payments with full-data-capture (Barion) and cloud-banking services (Nymbus). Consider that there are a number of wealthy, developed markets in Europe where the penetration of e-commerce is still in single or at most low double digits. This seems like an obvious opportunity akin to online advertising a decade ago — the direction of travel is clear.
On the Horizon: At the beginning of July, the ECB has lowered the bar for bank mergers in the eurozone, hoping to encourage an elusive wave of consolidation in a sector plagued by low profits and unresolved issues inherited from the last financial crisis. In a guide published on 1 July, the ECB clarified that merged entities won’t necessarily be asked for extra capital and will be allowed to use their own accounting models as well as any bad-will. We at FSC are ready to be an active participant in the process and we believe this is likely to accelerate the divestiture of non-core banking units, into a buyers market with few financial buyers.
Useful Sources: At FSC we pride ourselves on our deep industry expertise. Shared below are a few useful sources — and there is a lot more where this came from. Feel free to reach out to us for a more in-depth discussion:
Personal Note: While feeling guilty to be excited amidst all the pandemic-associated calamity, for the lucky few who have no “back books” and only have to focus on the opportunity ahead, this environment is a once-in-a-career type opportunity set upon which to capitalise.
You need 3 things to do so:
In conclusion, having built a bespoke firm dedicated to the 3 concepts above for this enormous (but nuanced) opportunity, call me guiltily excited for the opportunity set to come in financial services in Europe in the next 5+ years.