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Investors raised a cheer yesterday after JP Morgan (JPM) posted a strong set of second quarter numbers. The US banking giant reported earnings per share of $1.55 which was way above the $1.43 consensus estimate. Revenues came in at $25.2 billion on expectations of $24.16 billion.

Earlier today Citigroup (C) also pleased the markets when it reported earnings per share of $1.24 with revenues of $17.55 billion. This compared with consensus expectations of $1.10 and $17.47 billion respectively. However, it’s worth noting that yet again earnings and revenues were well down on the same period last year. US stock indices may be trading at record highs, but the earnings and revenue recession carries on.

But while investors seem convinced that US banks are on the mend, it is the European banking sector which continues to cause concern. As the chart below of STOXX® Europe 600 Banks indicates, the sector is in trouble:

PM Bulletin

Chief amongst the problems is Deutsche Bank. This one-time giant financial institution now has a market capitalisation of less than €18 billion. This is a big issue which even the International Monetary Fund (IMF) acknowledges. According to the Fund Deutsche is not only a “globally systemically important financial institution” but also one of the riskiest banks in the world. As the chart below shows, the share price reflects investor concerns. 

PM Bulletin

But Deutsche isn’t the only European bank having problems. Italy’s banking sector is also facing a potential tsunami of grief with an estimated €360 billion of non-performing loans on their collective balance sheets. Just to put this in some perspective, Italy’s nominal Gross Domestic Product (GDP) is around €1.6 trillion per annum which means that the banks’ potential bad debt is equivalent to more than 20% of the country’s GDP.

There has been talk of the Italian government putting together a rescue package to bailout the Italian banks. However, new Euro zone rules say that this can only be done if bondholders take losses first. Generally this wouldn’t be too much of a problem as bank bondholders tend to be pension funds and other large financial institutions. However, in Italy’s case it is retail investors who hold around €200 billion in bank bonds. Private individuals and small businesses were encouraged to purchase bonds in the country’s banks through favourable tax breaks. Consequently, unless the EU changes the rules, any bailout will hit Italian savers hard and for this reason it is politically unpalatable, to say the least.

But as things stand a rule-change seems unlikely. Just this week Dutch finance minister and Eurogroup head (the group comprising EU finance ministers) Jeroen Dijsselbloem responded to a call for a €150 billion European bank bailout fund by saying he would resist it “very strongly”. But Italian Prime Minister Matteo Renzi’s Democratic Party is fervently pro-euro and EU. Brussels may feel it is better to bend the rules for Italy now rather than say “no” and face the prospect of the anti-EU Five Star party making sweeping political gains in the future.

David :  Italy’s banking sector is also facing a potential tsunami of grief with an estimated €360 billion of non-performing loans on their collective balance sheets.

Disclaimer:

Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Tagged: Bulletin

Category: PM Bulletin


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