European Banks Shaping Up Five Years After Lehman
Europe’s biggest banks are stepping up efforts to boost capital and trim assets as pressure from regulators and investors increases, half a decade after the global financial crisis began.
Deutsche Bank AG (DBK), Germany’s biggest banks, plans to shrink its balance sheet after turning to shareholders for funds in April, while Barclays Plc (BARC), Britain’s No. 2 bank, will sell shares to increase capital and cut assets. France’s BNP Paribas SA (BNP) and Germany’s Commerzbank AG (CBK) for the first time published figures on equity as a share of total assets, after regulators focused attention on the measure.
While the Federal Reserve forced the biggest U.S. banks to clean up their balance sheets eight months after the September 2008 collapse of Lehman Brothers Holdings Inc., European regulators tolerated lower capital levels to keep loans flowing during the sovereign-debt crisis. For Emmanuel Hauptmann, who helps oversee more than $3 billion at Reyl Asset Management SA, steps to bolster reserves and cut leverage are overdue.
“We look at leverage quite a bit,” said Hauptmann, a senior equity fund manager at the Geneva-based firm. “The very high leverage that the European banks still have makes them relatively unappealing” compared with U.S. lenders, he said.
U.S. commercial bank assets shrank by 10 percent in 2009 and 2010, while euro-area assets have fallen only 5 percent from peak levels, according to an Ernst & Young LLP report in July.
One reason European banks are showing greater zeal in fortifying their balance sheets is the prospect of tougher oversight from the European Central Bank, which takes charge of euro-area banking supervision next year. The ECB will start reviewing the assets of the biggest lenders in coming months, a process that may accelerate capital raisings as European banks still need to trim balance sheets by as much as 1.5 trillion euros ($2 trillion), Ernst & Young estimated.
In Britain and Switzerland, regulators have joined the Federal Reserve in highlighting the importance of the leverage ratio, which compares equity to total assets, a shift some investors have applauded. U.K. banks still must raise about 120 billion pounds ($185 billion) of fresh capital by 2019 to comply with Basel III standards, the Bank of England said in a report last month.
“There’s a new wind in Europe,” Martin Hellmich, a professor of risk management and regulation at the Frankfurt School of Finance & Management, said by phone. “Complying with regulation quickly is a competitive advantage. The market rewards compliance with more funds and equity at lower cost.”
BNP Paribas, France’s biggest bank by market value, reached a two-year high in Paris trading on July 31 after saying it won’t need to shrink further to meet capital and leverage rules.
Commerzbank jumped 21 percent in Frankfurt trading since Aug. 8, the day the company posted profit that beat analysts’ estimates and said its leverage ratio meets European Union standards. Germany’s second-largest bank sold 2.5 billion euros of stock in May to repay state aid and bolster equity in its fifth capital increase in four years.
UBS AG (UBSN), the biggest Swiss bank, rose to a 29-month high on July 30 in Zurich after announcing plans to further boost its capital ratio, already the highest among Europe’s largest investment banks, by repurchasing the fund set up with state aid as part of the bank’s bailout in 2008.
“Equity markets are quite efficient at pricing in the capital banks hold,” said Raimund Saxinger, who helps manage 15 billion euros at Frankfurt-Trust Investment GmbH. “The best capitalized are usually the most expensive.”
Sweden’s four biggest lenders, among the most highly capitalized in Europe, have climbed 31 percent this year on average, more than double the 14 percent gain in the 44-company Bloomberg Europe Banks and Financial Services Index.
The median capital ratio under Basel III rules of the 16 biggest European banks that reported the figure for the second quarter stood at 10 percent, up from 9.1 percent six months earlier, data compiled from company reports show. Those standards weight assets according to the risk banks and their regulators assign to them.
Efforts to accumulate capital have been complicated by the euro area’s sovereign-debt debacle, now in its fourth year.
Lenders have faced pressure to maintain lending to companies and governments as widening budget deficits and doubts about the future of the common currency sent borrowing costs in Spain and Italy to euro-era highs and led to international bailouts for Greece, Ireland, Portugal and Cyprus, as well as a rescue of Spain’s banking system.
Before expanding by 0.3 percent in the three months through June, the euro-area economy had shrunk for six quarters, squeezing banks’ earnings and increasing bad loans. The U.S. economy, by contrast, grew each quarter on an annualized basis since the three months ending in June 2011.
U.S. investment banks have gained market share as European lenders grappled with a sputtering economy and pressure to increase capital. Total revenue posted by the securities units of the top U.S. firms rose by 24 percent in the second quarter from a year earlier, more than twice the 11 percent gain at Europe’s biggest firms, among them Deutsche Bank and Barclays, according to data compiled by Bloomberg.
Europe’s banks may find it easier to shrink if an economic recovery takes hold, said Hellmich.
“You need to be making profit to absorb losses from cutting assets,” he said. “We haven’t had that situation in Europe.”
Federico Ghizzoni, chief executive officer of UniCredit SpA (UCG), Italy’s biggest bank, said the ECB’s asset reviews risk reducing credit if banks put building capital before lending.
“We have very limited information about the methodology” of the ECB, and that may “push banks to be more cautious in managing their capital and maybe also their lending,” Ghizzoni, 57, told analysts on a conference call last week. He said the review won’t stop UniCredit from meeting a goal of increasing loans in Italy, according to a Bloomberg transcript of the call.
Progress aside, Europe’s banks need to do more, according to credit analysts at Royal Bank of Scotland Group Plc. An additional 3.2 trillion euros of deleveraging may be needed in the next three to five years, the analysts, led by Alberto Gallo, said in a note to clients last week.
National banking industries are on average 3.2 times the size of their domestic economies in Europe, compared with about two times as large in Canada, Australia and Japan and about the same size as the economy in the U.S., they wrote.
“Bank deleveraging has accelerated over the past few months,” the analysts said. “We’re only halfway to sustainable levels, in our view, as banks prepare for new regulation on capital and leverage.”
There are signs that national banking supervisors are increasing scrutiny before the ECB takes over. German regulators will review how banks made loans that didn’t appear on their balance sheets, two people briefed on the talks said last week. Italy’s central bank started examining the assets of 20 of the nation’s lenders last year and will do an extended probe of the loan portfolios of eight banks, it said July 29, without identifying the companies.
The Basel Committee on Banking Supervision, which sets global standards, will review EU bank-capital rules again, Wayne Byres, the group’s secretary general, said last month after a compliance probe in 2012 cast doubt on the EU’s claim to be fully in line with a global pact to beef up lenders’ defenses.
Basel III rules are scheduled to be fully implemented globally by 2019, and will set a minimum core capital level of 7 percent for larger banks. The most systemically important lenders face additional capital buffers of as much as 3 percent.
The U.K. and Switzerland are underlining the importance of the leverage ratio, which regulators say provides a safeguard against the potential for gaming risk-based rules.
The events of the financial crisis, when top-rated mortgage-backed debt plunged in value, freezing credit markets, cast doubt on how well banks, rating companies and regulators can judge the riskiness of assets. The Swiss state and central bank rescued UBS to prevent a potential collapse of the banking industry in 2008, while the U.K. bailed out Edinburgh-based RBS and Lloyds Banking Group Plc, based in London.
“The euro zone didn’t face the same existential crisis as the U.K., U.S. and Switzerland” during the crisis, Sony Kapoor, a visiting fellow at the London School of Economics, said in a phone interview. “They had no choice but to grab the nettle.”
UBS, which shrank assets excluding derivatives by 59 percent to 841 billion Swiss francs ($901 billion) between 2006 and 2012, plans to cut the so-called funded balance sheet to about 600 billion francs by the end of 2015. Credit Suisse Group AG (CSGN), Switzerland’s second-largest bank, plans to trim its balance sheet to less than 900 billion francs this year from 1.02 trillion francs at the end of September. The Swiss National Bank said in June that both need to boost their leverage ratios.
London-based Barclays, one of two U.K. lenders to miss its regulator’s targeted leverage ratio in June, will sell 5.8 billion pounds of stock, shrink assets by as much as 80 billion pounds to 1.5 trillion pounds and sell as much as 2 billion pounds of loss-absorbing securities, it said last month.
Deutsche Bank will reduce its 1.58 trillion-euro balance sheet by 16 percent to meet the stricter leverage standards suggested by the Basel Committee by changing the way it accounts for derivatives and winding down a 73 billion-euro portfolio of assets, it said on July 30.
While leverage doesn’t assess the quality of a lender’s assets or funding and may push some companies to boost risk, the bank opted to shrink after noting interest in the measure by regulators and investors, said Chief Financial Officer Stefan Krause, 50, on a July 30 conference call with investors.
The RBS analysts, who studied 43 banks in the euro area and U.K., listed Deutsche Bank and Barclays -- along with Commerzbank and Credit Agricole SA (ACA) of France -- as the large banks that need to raise the most capital from external investors to meet new rules. The 13 largest banks will need to generate 60 billion euros of capital and cut assets by 661 billion euros, they said.
Armin Niedermeier, a spokesman for Frankfurt-based Deutsche Bank, declined to comment on the calculations by the RBS analysts, as did Nils Happich, a spokesman for Commerzbank, and Barclays spokeswoman Gemma Walmsley. Charlotte de Chavagnac, a spokeswoman for Credit Agricole, based near Paris, didn’t immediately respond to an e-mailed request for comment.
For smaller European banks, the situation may be worse. Because of difficulty raising equity from investors, they will have to shed as much as 2.6 trillion euros of assets, according to RBS estimates. The troubles of smaller banks are at the heart of the euro area’s economic woes, as the region relies on bank lending for about 70 percent of credit, according to ECB data.
“Without fresh capital, mid-tier banks are stuck in a catch-22,” the analysts wrote. “They can’t sell bad assets at a loss, as this would deplete their capital, but at the same time they cannot raise new capital either, as asset risk deters investors.”
Letting the situation fester may have worse consequences, according to research by a task force of the monetary policy committee of the European System of Central Banks.
The region risks “the emergence of a situation of the type experienced in Japan during its ‘lost decade,”’ as fragile banks continue to finance troubled firms to avoid recognizing losses, the group said in a report published on the ECB’s website this month. “Policy interventions should, therefore, avoid delaying the necessary adjustment process.”
When the ECB takes on supervision of lenders next year, it may seek to avoid comparisons with EU stress tests in 2010 and 2011, which were criticized for failing to reveal weaknesses in the bloc’s banks.
“This is going to be a test of the credibility of the ECB,” said Kapoor. “It will test whether the ECB can be seen to take decisions against the interests of the banks.”
In 2010, the now-defunct Committee of European Banking Supervisors said that seven EU banks needed 3.5 billion euros of capital, a 10th of the lowest analyst estimate. Within months, Ireland’s two biggest banks, which both passed the stress test, needed a bailout.
A year later, eight banks failed the stress tests with a combined shortfall of 2.5 billion euros, according to the European Banking Authority, which took over from CEBS. Investors had expected as many as 15 banks to fail and need to raise 29 billion euros, according to a survey by Goldman Sachs Group Inc.
By contrast, the U.S. test results, published in May 2009, determined that 10 banks, including Charlotte, North Carolina-based Bank of America Corp. and New York-based Citigroup Inc. (C), needed to raise $74.6 billion in capital. The lenders raised almost $100 billion by the end of that month.
“About a third of European banks don’t fulfill Basel III standards and if the ECB conducts an asset review that number will probably rise,” said Markus Rudolf, a professor of banking and finance at the WHU Otto Beisheim School of Management in Vallendar, Germany. “Looking back at 2008, I’d have thought we’d be further on capital by now.”
The ECB bought lenders time to improve their finances. Last year, Mario Draghi, the central bank’s president, calmed market turmoil by pledging to buy the bonds of states that sign up to reforms. That intervention, which has yet to be tested, comes on top of more than 1 trillion euros the ECB lent banks in December 2011 and February 2012 to help them extend credit while repaying maturing debt.
“The U.S. addressed the pressing issue, which is capital, whereas in Europe banks just got liquidity in the hope that better times will come at some point,” said Christian Fischer, a partner and banking analyst at Independent Credit View AG, a Swiss rating company.
Banks have been reluctant to recognize non-performing assets because cleaning them up would hurt capital, he said.
At 25 banks in Germany, Italy, Spain, the U.K., France, Austria, Denmark, the Netherlands, Poland and Ireland that ICV examined, non-performing loans made up 7.3 percent of the total in 2012, up from 6.6 percent in 2011. Only 52 percent of the doubtful loans were covered by provisions last year, compared with 57 percent in 2011, the study found.
In Europe, “many banks are still sailing close to the wind,” ICV said in the study, published in June. “A structural clean-up of the financial system is overdue.”
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