Banks build capital to keep regulators and investors sweet

AUG 10, 20159:57 PM

[LONDON] Europe's biggest banks have stockpiled capital this year to cushion them against unexpected demands from regulators and also to show their long-suffering shareholders higher dividend payouts could be just over the horizon.

Even when the banks' earnings have disappointed, the need to stay one step ahead of regulators has encouraged managements to step up capital rebuilding, analysts said.

Europe's 24 biggest banks strengthened their common equity ratios, the most-watched measure of capital strength, by an average of 49 basis points in the first six months of this year, up from a 40 bps rise in the previous six months and beating most analysts' expectations, according to data compiled by Reuters.

"Capital build has moved from being by stealth to being overt. It's been a regulatory shift to gold-plate and now it seems to platinum-plate capital ratios," said Matthew Beesley, head of global equities at fund manager Henderson, which owns European bank stocks. "Ever increasing capital has gone from being advised by the regulators and encouraged by shareholders, to being insisted upon by the regulators and cheered by investors," he said.

Analysts said banks were continuing to build capital because of doubts over whether regulators are happy with efforts to shore up balance sheets since the financial crisis.

Regulators have become more demanding in terms of how much capital they want banks to hold to avoid tax-payer funded bank rescues in the future.

A year ago, many banks regarded 10 percent as the acceptable level of common equity to hold but now, the consensus is 11-12 per cent or more, several bankers and analysts said.

Some countries have gone beyond the global standards and "gold plated" the rules for their banks, especially in the Nordic region.

Nordea's common equity ratio of 16 per cent is well above most global rivals. Even so, the bank said it might not be high enough as supervisors take a "more harsh" view on minimum levels and risk weightings, especially in Sweden.

Swedbank said it had improved its"top-of-the-class" common equity ratio to 22.4 per cent because its regulator demanded at least 19.6 per cent. As the bar could rise still higher, the bank said the capital it held was not excessive.

The six biggest Nordic banks added an average of 47 basis points to those ratios in the first six months of the year. Britain's big five banks improved by an average of 74 bps, UBS improved by 1 percentage point and Belgium's KBC rose by 2.4 percentage points.

Other banks are cutting the number of loans they hold to improve their reported capital ratios.

Standard Chartered, for example, strengthened its common equity ratio by 80 basis points in the first half of the year despite a 44 per cent profit slump, as it halved its dividend and reduced assets by 5 per cent.

The capital boost was unexpected and will reduce pressure on the bank's new Chief Executive Bill Winters to raise capital, although he said he will do so if he needs to.

Some banks are retaining earnings to increase the cash they hold in reserve in case regulators take unexpected action, such as standardising the calculation of risk weightings on assets or changing rules on when lenders should provision for bad debts.

Investors are buying into banks which are ahead of the regulatory curve in terms of capital or which appear to be building sufficient balance sheet strength to return surplus cash, including Switzerland's UBS and Britain's Lloyds, as well as the Nordic lenders.

Analysts suggest they could generate billions of euros of surplus cash in 2016 and some already anticipating special payouts or share buybacks as well as higher dividends.

"Investors seem happy to watch and wait and bid up banks that have the capital base assured, in the belief that when it comes to paying out dividends, they will be the first in the queue," Henderson's Beesley said.

Swedbank and Handelsbanken shares trade at twice book value, UBS and Nordea shares trade at 1.6 times and Lloyds trades at 1.2 times, compared to an average of near book value across Europe.

Shares in Deutsche Bank, one of the few banks whose capital position weakened in the first half, trade at a 40 per cent discount to book value.

The capital strength of Santander, Credit Suisse and Deutsche Bank remain under most scrutiny among the big banks. New CEOs at Credit Suisse and Deutsche could raise capital later this year or early in 2016, investors and analysts have said.

Credit Agricole, Societe Generale and UniCredit could benefit from measures to improve ratios too, analysts said.

These banks reported common equity ratios below the average 13.2 percent seen across Europe's top 24 banks, which was lifted by the higher Nordic ratios, according to Reuters calculations.

Investors also look at the quality of capital as well as the amount, because of concerns that not all banks' capital positions are comparable.

Analysts at Berenberg estimated that more than 150 national discretions exist in Europe that affect the amount and quality of capital calculation.

In particular, banks in Italy and Spain could be hurt if the European Central Bank, their new regulator, no longer allows them to include deferred tax assets as core capital. "Some of the measures used by some banks to increase their capital levels in the past few years make these numbers look fatter than they really are," Paul Vrouwes, senior investment manager at NN Investment Partners, said. "If the ECB demands that banks stop using these extra capital lifts, then some of these numbers could look very meagre relative to other stronger banks, who have retained earnings or raised capital."

REUTERS