By Edward Harrison of Credit Writedowns
My post title is an ode to Yves Smith, who likes to feign surprise when the blindingly obvious finally comes into plain view for all to see. The latest sign that underneath the surface weakness remains at large financial institutions comes courtesy of Standard & Poors. According to the Telegraph’s Ambrose Evans-Pritchard, S&P believes many are horribly short of capital.
Every single bank in Japan, the US, Germany, Spain, and Italy included in S&P’s list of 45 global lenders fails the 8pc safety level under the agency’s risk-adjusted capital (RAC) ratio. Most fall woefully short.
The most vulnerable are Mizuho Financial (2.0), Citigroup (2.1), UBS (2.2), Sumitomo Mitsui (3.5), Mitsubishi (4.9), Allied Irish (5.0), DZ Deutsche Zentral (5.3), Danske Bank (5.4), BBVA (5.4), Bank of Ireland (6.2), Bank of America (5.8), Deutsche Bank (6.1), Caja de Ahorros Barcelona (6.2), and UniCredit (6.3).
While some banks may look healthy under normal Tier 1 and leverage targets, critics claim these measures can be highly misleading since they fail to discriminate between high-risk and low-risk uses of leverage. The system failed to pick up the danger signals before the financial crisis. The supposedly moderate leverage of US banks in 2007 proved to be a spectacularly useless indicator.
This shouldn’t come as a shocker. Recently, I mentioned that Citigroup was well-capitalized according to standard metrics due to government bailout money. But questions linger about whether this profile masks large holes in Citi’s balance sheet. Irrespective, Credit Suisse believes that regulatory hurdles for Citigroup will restrict its earnings potential. The S&P article bears this out.
S&P has shifted to a tougher code. It is less tolerant of hybrid capital – a liability rather than an asset, and no defence in a crunch – and insists that banks must quadruple capital put aside to cover trading desks. Private equity exposure will be treated more harshly.
The Bank for International Settlements unveiled its own version in September. The regulatory framework worldwide is clearly shifting in this direction, a move that will hit some banks harder than others. "We expect banks to continue strengthening capital ratios over the next 18 months to meet more stringent requirements. Failure to achieve this could put renewed pressure on ratings," said Bernard de Longevialle, S&P’s credit strategist.
If S&P understands the weaknesses masked by measures such as Tier 1 capital or even tangible common equity as proxies for bank health, I suspect national regulators do as well. However, the recovery to date has been built on the back of avoidance of this unpleasant fact lest we risk a renewed bout of panic and another downturn. Under no circumstances do policy makers want large financial institutions to be subject to tougher regulations before they have rebuilt capital via government purchases of toxic assets, government backstops, low interest rates, and a steep yield curve.
Tougher rules at this juncture may prove "pro-cyclical", if banks respond by cutting loans. This may perpetuate the credit crunch for smaller borrowers unable to tap the bond markets. "There is a risk that the increase in regulatory capital requirements could weigh on banks’ ability to finance recovery," said Mr de Longevialle.
Below is a list of the safest institutions according to S&P. While I expected to see HSBC and Standard Chartered on the list, Santander is a notable absence. Also a bit surprising, Deutsche Bank, generally deemed to have weathered the storm (despite large CRE exposure), is one of the weakest, not the strongest. I never would have expected Dexia, ING and Barclays to be on the list of strongest. And Nordea still has large exposure to the Baltics. But ING and Dexia have received large bailouts from the Benelux governments. See my list of bank writedowns for specific events by institution.
The "safest" global bank is HSBC (9.2), followed by Dexia (9.0), ING (8.9) and Nordea (8.8). UK banks fare relatively well: Standard Chartered (8.1) is in the top quintile; Barclays (6.9) is in the middle. The study left out RBS and Lloyds because their status is unclear. Chinese banks – the world’s largest – were excluded.
On the whole, this report leaves me more convinced than ever that a double dip recession would tip us into a 1931-style panic. When I make the Obama-Hoover analogy, this is what I am referring to. As Barack Obama pushes forward with his deficit reduction scheme, perhaps 1931 should be top of mind more than 1937 — or 1994 as seems to be the case for him.
Most global banks are still unsafe, warns S&P – Ambrose Evans-Pritchard, Telegraph