Eurozone banks: deferring the inevitable

In the great post-crisis re-regulation, many bank regulators in the eurozone's periphery indulged their wards. Now Brussels may investigate whether deferred tax assets of banks in Greece, Italy, Portugal and Spain - which those regulators counted towards the banks' capital - amount to illegal state aid. Some €40bn of core capital is at stake. Deferred tax assets appear when banks make losses. They can offset subsequent profits. The eurozone has in effect parlayed them into deferred tax credits by promising that the states will stump up the value of assets should the bank fail.

DTCs make up varying proportions of banks' common equity tier one (CET1) capital ratios. In Greece, they account for about a third, providing an uplift of 4 to 6 percentage points, notes Berenberg. At Italian lenders Intesa Sanpaolo and UniCredit, they add 230 and 190 basis points respectively to the CET1 ratio. At Spanish lender BBVA, the boost is about 70bp.

DTCs cannot be a permanent fixture. Basel III rules outlaw some deferred tax assets, but allow DTCs, for now. The trouble is, they create precisely the sort of harmful feedback loop between eurozone sovereigns and banks that culminated in bailouts of both.

The European Central Bank, as sole supervisor of eurozone banks, has to break that link and ensure that DTCs are replaced by true equity. It wants all lenders - even those that passed its stress test - to be properly capitalised.

Greek banks cannot be fixed quickly. Others can be. Investors assume that greater awareness of ECB capital scrutiny partly explains Santander's capital raising so soon after it passed the ECB test. DTCs still account for 100bp of its CET1 ratio after its capital raising. Sabadell may view the capital surplus of UK lender TSB, which it is buying, as a way to bolster its own CET1 ratio.

Capital requires core, not peripheral, solutions. Until eurozone banks grasp that, their valuations will continue to languish below 0.9 times book value, compared with, say, 1.1 times in the US.

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