Europe’s biggest investment banks, caught between worsening earnings prospects and demands for more capital, may have little choice but to accelerate asset reductions and job cuts.
UBS AG, Deutsche Bank AG, Barclays Plc and Credit Suisse Group AG, which all report third-quarter results over the next eight days, may eliminate more jobs, speed disposals and scale down some businesses to slash costs and build up reserves amid the region’s sovereign debt crisis, said JPMorgan Chase & Co. analyst Kian Abouhossein.
The four banks have disclosed plans to shrink their combined risk-weighted assets by as much as $415 billion to prepare for stricter capital requirements under Basel III rules. As the euro area’s sovereign debt crisis erodes earnings, the banks may have to speed up reorganization plans at their securities units, which will be most affected by the changes in Basel rules, if they want to avoid selling new shares.
“Everybody is trying to reduce risk-weighted assets as soon as possible,” said Abouhossein, who is based in London. “They’ve already all started, but they’ll probably find it harder than expected because the environment is clearly getting tougher.”
European Union leaders met in Brussels yesterday, seeking a breakthrough in efforts to resolve the Greek sovereign debt crisis without triggering a default, beef up the euro bailout fund, shield banks from the fallout and ensure Italy and Spain don’t succumb to the contagion. They will hold a second summit on Oct. 26 to complete their plans.
EU banks may need about 100 billion euros ($139 billion) in capital after marking sovereign-debt holdings to market values, said a person familiar with the weekend discussions. This amount would be needed to reach a core tier 1 capital level of 9 percent based on a European Banking Authority test, said the person, who declined to be identified because the talks are private. The Swiss regulator has been urging UBS and Credit Suisse to build up high quality capital as quickly as possible.
Zurich-based UBS will probably report an 83 percent drop in third-quarter net income tomorrow to 285 million Swiss francs ($322 million), according to the mean estimate of 9 analysts surveyed by Bloomberg, after announcing a $2.3 billion loss from unauthorized trading last month.
Deutsche Bank of Frankfurt may report profit of 343 million euros, according to analyst estimates, after a net loss of 1.21 billion euros in the year-earlier period on writedowns related to the acquisition of Deutsche Postbank AG.
Earnings Forecasts Cut
Barclays of London releases third-quarter results on Oct. 31, and Zurich-based Credit Suisse on Nov. 1. Spokespeople at all four banks declined to comment before the publication of earnings.
UBS gained 1.6 percent to 11.17 francs by 9:52 a.m. in Swiss trading, while Deutsche Bank rose 1.4 percent to 28.23 euros. Barclays advanced 1.6 percent to 184.9 pence, and Credit Suisse rose 2.3 percent to 24.41 francs. Before today, UBS had declined 28 percent this year, while Deutsche Bank fell 29 percent, Barclays slid 30 percent and Credit Suisse tumbled 37 percent.
Europe’s investment banks may be seeking to cut assets, and therefore their capital needs, by outright sales, hedging and netting of exposures, as well as by reducing the volume of business they do in fixed-income trading, interbank lending and lending to companies, analysts said. This may become a priority as efforts to build up reserves by retaining earnings founder. Analysts lowered profit forecasts for the four banks by an average of 36 percent for 2011 and 29 percent for 2012 since the beginning of this year, data compiled by Bloomberg show.
Missed Profit Goals
“We see capital generation forecasts as increasingly at risk, along with future dividend payments,” UBS analyst Philipp Zieschang said in a note on Oct. 18. “No surprise that most of the investment banks are in the process of reducing costs and further cuts beyond those already announced seem likely.”
Deutsche Bank, Europe’s biggest investment bank by revenue, said this month it won’t meet its profit target for the year after earnings at the securities unit were “significantly lower” than expected in the third quarter. UBS, Switzerland’s biggest bank, abandoned its mid-term profit targets in July, while Credit Suisse cut its return-on-equity goal in February to more than 15 percent from more than 18 percent previously, citing stricter regulation and challenging markets. Barclays set an ROE target in February of 13 percent for 2013, down from an average of 18 percent over the past 30 years.
Investors would probably prefer safety over returns in banking stocks at the moment, said Christian Gattiker, head of research at Bank Julius Baer & Co.
Premium for Safety
“For a more continuous and more stable income stream, by now investors would except a discount in terms of dividends, or would pay a premium to own a share that provides that in the financial industry,” Gattiker said.
The banks have taken some measures to adjust to the environment that Deutsche Bank Chief Executive Officer Josef Ackermann, 63, described as “very challenging” earlier this month. He said the bank doesn’t have any plans to raise capital and will focus on improving ratios by retaining earnings and reducing risk-weighted assets.
The German lender said on Oct. 4 it will cut 500 jobs, or 4.7 percent of staff at its securities unit. UBS said in August it will eliminate 3,500 jobs, with about 1,575 of those at the investment bank, while Barclays and Credit Suisse announced plans to reduce staffing by 3,000 and 2,000, respectively.
More job cuts are likely to come as the ones already announced were in response to weak business in the first half of the year and markets have deteriorated since, said Matthew Clark, a London-based analyst at Keefe, Bruyette & Woods Ltd.
Compelled to Act
“A lot of banks that were adopting wait-and-see strategies are now compelled to take further action because of the lower revenue environment currently,” Clark said. “There are businesses that will be borderline under the new regulatory environment. Now that the market environment has turned down, it will serve as a catalyst to restructure.”
UBS may tell investors in November that it will slash an additional 70 billion francs of risk-weighted assets on top of cuts already announced and eliminate 1,700 more jobs at the investment bank, Abouhossein estimated. The bank may shrink its rates and structured credit businesses to one-third of their current size, exit the commodities business and slim the credit trading unit by about 20 percent, he said.
UBS, which has been struggling to rebuild its investment bank after the subprime crisis, is under more pressure to reorganize faster, while Deutsche Bank may have some more time, he said.
UBS Chairman Kaspar Villiger told journalists following the resignation of Chief Executive Officer Oswald Gruebel, 67, last month that the bank had started a strategy review even before it discovered the trading loss. “It became clear a few months ago that a change, which is probably here to stay, is taking place” in investment banking, said Villiger, 70.
“The investment banking industry is an industry that is due to shrink, and is not due to expand,” Sergio Ermotti, 51, UBS’s interim CEO, said on the call.
Morgan Stanley analyst Huw van Steenis estimated that European wholesale banks may have to shrink their balance sheets by a cumulative 1 trillion euros to 2 trillion euros in the next year in response to funding pressures and a worsening market outlook. UBS may be looking to cut about 100 billion francs of risk-weighted assets at its investment bank, he estimated.
The Basel III rules, which come fully in effect in 2019, make some of the riskier businesses like proprietary trading and securitization less profitable for banks because of higher capital requirements and risk weightings assigned to those assets. Requirements for the highest-quality of capital, including a buffer for systemically important firms, are set to almost quintuple for the four lenders to 9.5 percent to 10 percent.
Credit Suisse, which said in March it will seek to optimize returns at its securities unit and realign businesses to higher capital requirements, this month informed about 50 employees that it’s shutting the unit responsible for making commercial mortgages and that their jobs will likely be eliminated, said two people with knowledge of the matter who declined to be identified because the matter isn’t public.
“Pressure is rising on investment banks to change their business model,” said Lutz Roehmeyer, who helps manage about 11.5 billion euros at Landesbank Berlin Investment in Berlin. “The market expected several years to boost capital and to spare shareholders. Now, in the matter of a weekend, Basel III has been moved forward.”