Macaskill on markets: Charlie Brown banks are losing leverage

Jon Macaskill
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The recently discovered regulatory zeal for a focus on gross leverage ratios at banks, rather than capital assessed on risk-weighted assets, is creating a new set of problems for some of the biggest dealers. Barclays and Deutsche Bank in particular have been put on the back foot by the regulatory bait and switch, which comes at an awkward time – just as key engines of their profitability, such as rates trading, are sputtering.

Banks that once took pride in being fleeter of foot and better resourced than their regulators are increasingly looking like Charlie Brown in the Peanuts comic strips. Every time they think they are about to kick the issue of capital decisively down the park they find the regulators have whipped the ball away from their feet.

Barclays was a victim of an obsession that Mervyn King appeared to develop with forcing the firm to make a substantial capital increase before he bowed out as governor of the Bank of England. King clearly felt a personal responsibility for the Bank of England’s failure to head off the excesses that preceded the 2008 credit crisis. He had an excuse for inaction – the central bank’s regulatory powers had been diminished when the Financial Services Authority was established in the UK in 2001.

But King might well have shared the view of many of his critics that, as governor of the Bank of England, he could and should have done much more to rein in the UK’s banks. He certainly developed an antipathy towards Barclays that seems to have stemmed from a view that its senior managers could not be trusted.

King played a key role in ensuring that Bob Diamond was ousted as Barclays CEO last year, even though the return of the FSA’s regulatory authority to the Bank of England had not been completed. And this year King was behind an aggressive move by the new Prudential Regulatory Authority, headed by Andrew Bailey, to force UK banks to move swiftly to increase their capital.

Barclays’ chief executive Antony Jenkins would have hoped he had run out the clock on King’s tenure without backing down on a capital raise when he formally stepped down as governor on July 1, but it turned out the wheels were already in motion and the firm was forced into an embarrassing announcement of a £5.8 billion ($9 billion) share issue when it unveiled its half-yearly results on July 30.

Barclays also felt compelled to announce an acceleration of its existing deleveraging plan by shedding assets of up to another £80 billion. This risks further undercutting morale at its investment bank, which has already been bruised by the departure of many of its most experienced managers in the wake of the ousting of Diamond and former president Jerry del Missier.

Eric Bommensath, veteran fixed-income head at Barclays, remains in place as co-head of investment banking, but he is one of the last figures of the old regime still in a senior role. Bommensath, a French derivatives dealer by background with extensive experience in London and New York, was part of a cosmopolitan team of sales and trading experts who dominated decision-making at Barclays under Diamond.

Bommensath might now feel that his is a lonelier voice at a firm run by a UK retail banker with limited investment banking experience, and he is unlikely to relish scaling back assets in areas such as the rates-trading business that he built into a top-three player by revenue, alongside market leader JPMorgan and Deutsche Bank.

The new focus on leverage ratios as a key measure of capital adequacy that was announced by global central bankers in June also forced Deutsche Bank onto the defensive. Like Barclays and other European universal banks with big investment banking operations, Deutsche should be able to record a 3% leverage ratio as long as the revenue backdrop remains benign.

But it felt the need to add to existing plans to slash trading assets by earmarking another €250 billion for cuts only a few months after a capital increase that was designed to put the many questions about its balance sheet to rest. The €2.96 billion share issue came after Deutsche Bank had resisted calls for a capital increase for years, and it must be disheartening for its senior managers to find the issue of leverage back in the spotlight so soon after they reversed course.

One reason why the issue refuses to go away is that it is not at all clear where individual regulators will eventually set the line for minimum leverage ratios for the biggest banks. The assumption that European banks will need to hit a minimum level of 3% and US banks 5% is just that: an assumption. Regulators could easily reprise the role of Lucy to the Charlie Brown banks and shift the target higher just as firms think they have met their goals.

The gap between expected minimum ratios for European and US banks is not as simple as the uneven regulatory playing field that JPMorgan chairman and CEO Jamie Dimon regularly complains about. Different treatment of derivatives netting for European banks under IFRS accounting rules and US banks under GAAP standards results in balance-sheet size calculations that are not consistent.

Analysts at Exane BNP Paribas attempted in August to come up with comparable leverage ratios for big global banks by taking these inconsistencies into account. They found that while Barclays and Deutsche Bank were at headline 3% ratios, big US banks should be viewed as having lower totals than those either announced by the firms, or adopted as consensus among analysts.

For example, Exane found that JPMorgan would have a ratio of 4% if consistent methodology were used, rather than an indicated 4.7%, and Goldman Sachs would be at a 4.3% leverage ratio, not 4.9%.

US banks nevertheless have higher leverage ratios at the moment than their main European competitors. This, along with the relative health of the US economy and capital markets compared with Europe, helps to explain why the main US banks have finally all clawed their way back to a price that is equal to the book value of their assets, while many European banks continue to trade below notional value.

At the beginning of August, Citigroup finally edged back to a stock level equal to its book value, joining Morgan Stanley and Bank of America at a level around book value, and coming closer to stronger banks such as Well Fargo, which trades at twice its book value.

In Europe, Barclays and Deutsche Bank remain stuck at levels around 0.8 times book value, although firms with a business mix that is more biased towards retail and private banking, such as HSBC and UBS, trade at higher multiples.

US banks are understandably keen to promote the idea that this difference in the relative fortunes of banks on either side of the Atlantic will lead to an increase in their own market share in Europe. That thesis remains unproven.

But strong revenue generation by the sales and trading arms of European firms with substantial investment banking arms will be key if they are to fight off this competitive threat and deliver an eventual recovery in value for shareholders.