European banks are preparing to deliver on massive share buyback plans and repay hundreds of billions of euros in cheap central bank funding as they look to calm investors spooked by recent turmoil in the sector.

Meanwhile, regulators have cautioned banks to be conservative with dividends and buybacks in the wake of the collapse of California-based Silicon Valley Bank (SVB) and UBS Group AG's emergency takeover of Credit Suisse Group AG. Dangers have also been highlighted regarding the repayment of funds from the ECB's third targeted longer-term refinancing operations program (TLTRO III), which could cause a shortfall in liquidity at some banks.

The demise of SVB and Credit Suisse's forced sale in March prompted a global sell-off of bank stocks, as uncertainty about the impact of rising interest rates on lenders' liquidity and funding gripped investors. The S&P Europe BMI Banks index fell almost 15% in the 10 days following the first signs of problems at SVB. It has since recovered around two-thirds of those losses.

"Confidence is very important," Gilles de Bourrousse, bank fixed-income analyst at French brokerage Octo Finances, said in an interview. "Since there is nervousness in the market, banks will want to stick to the plans they have already announced to avoid signaling that anything is wrong, which could have a broader negative impact."

Good news

Positive surprises have helped turn the sentiment tide. Deutsche Bank AG's unexpected redemption of a $1.5 billion tier 2 subordinated bond in the days after UBS' emergency takeover of Credit Suisse reassured investors and helped reverse a sharp drop in the German lender's stock. Deutsche Bank shares have risen almost 25% since it called the bond on March 24.

UniCredit SpA, Italy's second-largest lender, displayed its resolve to move on from recent market jitters when it announced the start of the first tranche of a €3.43 billion buyback on April 3.

European banks' response to the turbulence has built on the European Central Bank and Bank of England's swift action to calm markets in the wake of Credit Suisse's $3.25 billion takeover. The surprise decision by Switzerland's financial regulator to wipe out $17 billion worth of Credit Suisse's additional tier 1 bonds in favor of reimbursing shareholders had caused the value of AT1s to plummet. The European Central Bank and the Bank of England's assurances that AT1 investors would be protected before equity investors helped the $260 billion market recover much of its losses.

'Conservative scenarios'

Still, some regulators are urging banks to reconsider the scale and pace of capital distributions to shareholders through dividends and buybacks in light of recent events. The impact of rapidly rising interest rates on the economy and bank customers is still unclear, and banks should "look at conservative scenarios" when planning their use of capital, José Manuel Campa, chair of the European Banking Authority, told Reuters on April 4.

Europe's largest banks have committed to more than €33 billion in dividend payments and €26 billion of share buybacks off the back of 2022 full-year results, according to S&P Global Market Intelligence data, based on an analysis of 14 lenders. This follows almost €30 billion in dividends and more than €23 billion in buybacks in 2022, the data shows.

The wisdom of such significant share buybacks in the current environment is questionable, said Sam Theodore, senior consultant at Scope Insights.

"Share buybacks, in general, are not the greatest idea," Theodore said. "Supervisors should be more forthcoming and more forceful in guiding banks towards not engaging in these buybacks unless the banks really have an excessively high capital base, which is generally not the case given the direction of travel in the industry now."

The average common equity Tier 1 capital ratio among Europe's largest banks has slipped from a high of 15.4% in 2020 to 15.0% in 2022, Market Intelligence data shows. Still, capitalization generally remains well above the minimum levels required by regulators since the 2008 global financial crisis.

Great expectations

Upcoming first-quarter earnings are not likely to alarm regulators or investors, according to analysts' estimates. All but one of the 24 European banks with assets of more than €100 billion, and for which data is available for both periods, are set to see year-over-year increases in first-quarter revenues as higher interest rates boost income.

The higher revenues should mostly filter through to lenders' profits, as 16 of the 24 banks with assets of more than €100 billion, and for which data is available for both periods, are expected to see net income rise year over year.

"If the economy in Europe performs relatively well and results from the banks are more or less matching expectations, there should be no need for a change in capital distribution policies," said Pablo Manzano, vice president of financial institutions at DBRS Morningstar.

Repayment pressures

Investors will also closely watch eurozone banks' upcoming repayments of ultra-cheap TLTRO III funds to the ECB. The collapse of SVB and two other US lenders in March brought banks' liquidity and funding into sharp focus as investors looked for similar problems at other banks.

Eurozone banks are due to repay more than €2.1 trillion in TLTRO III funds in 2023 and 2024, with €1.3 trillion due in June alone. The repayments may cause liquidity issues for some Italian banks whose excess reserves are currently insufficient to meet the repayments, according to analysts at Société Générale.

Still, liquidity at European banks is generally at its strongest in decades. The average liquidity coverage ratio — a measure of a bank's ability to meet its short-term financial obligations — at Europe's 14 largest lenders stood at 161% at the end of 2022, up from 147% in 2018. Average loan-to-deposit ratios are similarly robust.

"The whole market is going to be looking at the repayment of TLTRO III funds and there will be a stigma for any bank that fails to repay," said Manzano. "If the situation remains like it is now, even if there is uncertainty, we expect all banks to repay."