Overshadowed by Moody’s bank downgrades, a new report from Fitch Ratings offers a somewhat less negative view of the state of big banks.
Fitch says it expects earnings from securities businesses at the leading Global Trading and Universal Banks (GTUBs) to drop in Q212 after a short reprieve in the markets in Q112. This is primarily due to the renewed erosion of confidence in securities markets resulting from a worsening eurozone crisis.
GTUBs’ Issuer Default Ratings (IDRs) are rated primarily in the ‘A’ category with Stable Outlooks following a number of rating actions in Q411. The Stable Outlooks reflect Fitch’s view on intrinsic creditworthiness and on potential extraordinary support.
(Moody’s downgraded some big banks to B-level: Bank of America and Citigroup to Baa2 and Morgan Stanley to Baa1)
Fitch says the Q1 is usually a strong one for securities businesses and earnings in Q112 bounced back from a poor Q411 for most of the 13 GTUBs. Customer flows increased as a result of restored market confidence, partly driven by the European Central Bank’s $1 trillion Long-term Refinancing Operations in Europe. However, market volumes and revenue were lower for most GTUBs compared to 2011’s very strong first quarter.
Fitch also notes that GTUBs are preparing for regulatory changes, most notably Basel III and, in the US, Dodd Frank, including the Volcker Rule. New regulatory demands include: higher liquidity and capital; segregation of certain businesses; and, reporting of transactions and clearing of derivatives through central clearing counterparties.
On balance, Fitch believes the new regulations should make the banks safer, although there are likely to be unintended consequences. Pressure on earnings resulting from the regulations will incentivise banks to seek new ways of generating profit, which usually comes with increased risk.
For details, see Global Trading and Universal Banks’ Periodic Review
In a related report, Fitch notes that U.S. bank regulatory proposals to apply unrealized gains and losses (UGL) on available-for-sale (AFS) securities to common equity tier 1 capital could reduce bank capital levels during periods of material market illiquidity. For example, if such rules had been in place during the 2008 financial crisis, Fitch Ratings estimates that nine out of 57 banks with assets of more than $25 billion would have experienced a reduction in their common equity tier 1 capital ratio of 100 bps or more.
The inclusion of unrealized gains/losses in regulatory capital is a procyclical capital policy that could exacerbate capital needs during market disruptions. Large unrealized losses are likely to occur during periods of market illiquidity rather than during period of rising rates. Therefore, the proposed rule is most punitive during times when banks have the least access to capital. Fitch views credit products, such as non-agency mortgage-backed securities and asset-backed securities, as introducing the most potential volatility to bank capital levels, given their potential to exhibit material and prolonged illiquidity during periods of market stress.
For details see Fitch: Unrealized Losses Could Create Bank Capital Volatility
Standard & Poor’s also has all large US banks with A-level ratings, but has a negative outlook on most of them. In a recent Industry Report Card S&P said “Our rating outlooks remain negative for the majority of large complex banks and trust banks. For most banks, our outlooks reflect the negative outlook on the sovereign rating on the U.S. and the likely impact that a potential downgrade of the U.S. would have on the support we factor into our bank ratings. Banks are increasing their capital and improving their credit fundamentals, though we will continue to evaluate the effects that several challenges will have on the industry, including low interest rates, volatile capital markets, possible funding stresses due to debt concerns in the GIIPS countries, litigation, representation and warranty costs, housing market weakness, and regulations.”
In explaining its ratings actions Moody’s Global Banking Managing Director Greg Bauer said “All of the banks affected by today’s actions have significant exposure to the volatility and risk of outsized losses inherent to capital markets activities. However, they also engage in other, often market leading business activities that are central to Moody’s assessment of their credit profiles. These activities can provide important ’shock absorbers’ that mitigate the potential volatility of capital markets operations, but they also present unique risks and challenges.”
For details, see Key Drivers of Rating Actions on Firms with Global Capital Markets Operations
Weak equity performance and return on investment among select U.S. investment grade corporate issuers could pose credit risks as management teams seek to maximize shareholder value at the expense of bondholders, according to a Fitch Ratings report.
For its analysis, Fitch screened U.S. investment grade corporates according to several equity performance metrics. Those companies that rank near the bottom versus their peers across several of these measures can be, in Fitch’s view, at heightened risk of engaging in shareholder value enhancing initiatives.
These include changes to operating profiles and/or capital structures. Of the 19 companies identified, 15 are in the low-to-mid ‘BBB’ category.
As measured by lagging returns on investment, corporate underperformance poses eventual risks for fixed-income holders, inviting equity-oriented actions, whether by internal or external catalysts. Negative rating actions may occur depending on the magnitude of any leverage increase for these initiatives, which include share repurchases, mergers and acquisitions, restructurings and/or spinoffs.
The underperformers identified in Fitch’s analysis are heavily focused on technology companies, with six of the companies being part of this sector. U.S. technology companies continue to mature in non-emerging markets, resulting in slower growth and accounting in part for lagging equity performance.
For details, see the full report Lagging Equity Performance Unveils Potential Risks for Bondholders
Fear of what could happen if Greece abandons the euro, the dangers facing some of Europe’s largest banks, and a global economy experiencing sluggish or slowing growth are uppermost in the minds of Standard & Poor’s credit analysts covering major financial institutions. Among the key points the participants made at a recent discussion with CreditWeek editors were that:
- Global financial institutions will continue to face a period of transition as they respond to greater regulatory oversight and increased capital and liquidity requirements. In this context, the nature and extent of government support for large financial institutions remain key questions.
- European governments are likely to continue supporting their large troubled banks because the cost of letting them go under could prove too high.
- Despite low interest rates, a sluggish global economy will continue to thwart the consumer lending that could energize a rebound.
- Risk will always be a part of the equation for large, complex financial institutions–a fact that JP Morgan’s trading losses underscore.
- Capital remains important, but regulation is addressing that and starting to diminish it as a ratings factor. Banks’ business models are becoming more important, and those that can generate and sustain solid earnings are likely to fare better.
- However, capital requirements vary from jurisdiction to jurisdiction, which diminishes some of the advantages of large global operations.
- Life insurers are finding that low interest rates are cutting into their investment margins.
- Property/casualty insurance and reinsurance have shown resilience, despite a larger-than-usual number of natural catastrophes in 2011.
For a transcript of the discussion is available in 2012 Midyear Global Financial Institutions Outlook: Managing Risk, Managing Change
The wave of US bank failures in 2008-09 is now often seen as an unavoidable by-product of the global financial crisis that began in the United States. Yet excusing these failures due to the severity of the credit crunch obscures the responsibility of many individual managers involved, according to Oxford Analytica.
While the crisis itself had many causes (from excessively low interest rates to federal regulatory policies encouraging homeownership), well-run banks can survive the most severe shifts in the credit cycle; most US banks came through 2008. Those that did not shared many characteristics with other major US banking collapses over the past 30 years. At their core, bank failures are usually attributable to serious internal management and moral failings — which offer valuable lessons to business leaders well beyond the fields of banking and finance.
- Banks with strong internal social capital among employees tend to be better equipped to ride out crises.
- It is insufficient to blame securitisation and financial innovation for the crisis; many of these products existed for decades.
- The tendency towards greater risk aversion within the financial industry is likely to persist — perhaps for a generation.
In the largest US bank failures of each of the last three decades, Continental Illinois and Bank of New England ran into trouble with specialised loans to highly cyclical businesses (oil and media companies, respectively), while Washington Mutual was knee-deep in disastrous subprime mortgage lending.
These forays into new lines of business were accompanied by deliberate executive decisions to privilege loan growth over creditworthiness. Moreover, it eventually became obvious to many executives that they were making loans that might flatter short-term paper profits, but that did not serve the long-term interests of customers or shareholders.
Ultimately, banks only prosper when their customers do — a truism that applies to most other businesses. The common denominator of most major banking crises is a breakdown of this ethos, which erodes social capital within the bank — leading to short-termist, exploitative behaviour. Most banks avoid these tendencies. For those that do not, even the best risk management is unlikely to protect the bank from severe problems over the long term.
The most important lesson of the 2008-09 US banking crisis is that building a robust institutional culture of service to all stakeholders (shareholders, customers and employees) may be the best guarantee of effective risk management. It helps protect banks from a narrow focus on rapid revenue and market share growth — which can leave them dangerously exposed when the credit cycle turns.
For details see Moral shortcomings drive most banking failures
A new report from Audit Analytics shows that although the total quantity has leveled off, the number of financial restatements by companies listed on the New York Stock Exchange has increased steadily over the last three full years. Restatements for Over The Counter (OTC) companies have also risen.
During 2009, 65 NYSE companies disclosed restatements, followed by 90 in 2010, and 108 in 2011.
Restatements involving debt, quasi-debt, warrants & equity security issues rose further in 2011 and remained the top reason for restatement.
The largest financial restatement for each of the last three years was disclosed by a foreign registrant.
During 2011, Revision Restatements (restatements revealed in a periodic report without a prior 8-K, Item 4.02 disclosure that past financials can no longer be relied upon) represented about 57% of the restatements disclosed by 10-K filers. This percentage represents the highest percentage calculated since the disclosure requirement came into effect August 2004.
Details are available in the report 2011 Financial Restatements An Eleven Year Comparison.