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Banks Around The World Face Significant Profits Pressure For The Foreseeable Future

Numerous indicators in the U.S. and around the world are signaling a slowing economy at best and a near-term recession at worst.  The slowing global economy, along with low interest rates, ongoing trade tensions, and intensifying Brexit uncertainty will weigh on banks’ profitability for the foreseeable future.  In the US, whatever benefits banks derived from Trump’s tax reform, if any, are long gone.

Global Macroeconomic Outlook for the G-20

Moody’s Global Macroeconomic Outlook, August 2019

Last week’s announcement from Coalition that American and European investment banks’ capital markets and advisory’s revenues hit a thirteen-year low is likely to be the beginning of more challenges to come.  Even before that announcement, Moody’s Investor Services had changed its positive outlook on global investment banks to stable precisely due to slower economic growth and lower interest rates.

Today In: Money

Drivers of Moody’s Stable Outlook for Global Investment Banks

Moody’s Investors Services

As a recession comes closer, bank risk managers, investors, regulators, and rating agencies will be monitoring banks’ loan impairments carefully.  According to the Fitch Ratings’ Large European Banks Quarterly Credit Tracker – 2Q19, released last week, “The economic slow down in Europe has not resulted in material new impaired loans yet, but the substantially weakened economic outlook has increased the likelihood of an at  least modest increase in impaired loans.”

Impaired Loans/Gross Loans

Fitch Ratings, Large European Banks Quarterly Credit Tracker

Banks’ high holdings of leveraged loans and below investment grade bonds and securitizations, especially those that are less liquid and harder to value, will also weigh on their earnings as the global economy slowdown intensifies.  Fitch Ratings’ recent ‘U.S. Leveraged Loan Default Insight’ shows that its “Top Loans and Tier 2 Loans of Concern combined total jumped to $94.1 billion from $74.5 billion in July. The Top Loans of Concern amount ($40.9 billion) is the largest since March 2017, with six names added to the list and nearly all bid below 70 in the secondary market.”  Unfortunately, underwriting continues to deteriorate. The Federal Reserve Senior Loan Officer Survey showed a modest loosening of lending standards on corporate loans for the second consecutive quarter.

Leveraged Loans of Concern Amount Outstanding

Fitch U.S. Leveraged Loan Default Index.

A slowing economy and low interest rate environment are outside of bank managers’ control. Yet, cost efficiency, is something that banks can influence; it needs to improve for banks to be more profitable.  European banks’ median/cost income ratio, for example, is 66%. “The sector’s structural cost inefficiency will eventually have to be addressed given the persistently weak rate and revenue outlook. Improving cost efficiency faster and developing fee-generating businesses are crucial to sustain profitability in 2H19 and beyond.”

Cost Efficiency

Fitch Ratings, Large European Banks Quarterly Credit Tracker

Global investment banks will also have to be very attentive to what changes need to be made to their business models. While there will be demand for their advisory and distribution services, the demand will slow down in what is likely an upcoming recession.

Capital Markets Revenue Relative to Total Revenue, 2018

Source: Moody’s Investors

Moreover, as banks continue to lay-off front office professionals, some top latent to effect deals well will be lost.  Volatility from Trump’s multiple front trade wars and Brexit will put a lot of pressure on banks with capital market activities.

Aggregate capital markets revenue first-half 2009-19 (USD billions)

Moody’s Investor Services

Banks in emerging markets are also under profit pressure.  Many of the banks in Latin America already have a negative outlook by ratings agencies, particularly due to a slowdown in Mexico and recessionary pressures in Brazil. Asian banks are particularly sensitive to US-Chinese trade tensions.

Emerging Markets: Median GDP Growth by Region

Fitch Ratings

More than ever, to increase profitability, bank executives will need to find ways to diversify their revenue streams in all parts of their banks, commercial, investment bank, asset management as well as in custody and clearing services.  Banks need to be profitable to be liquid and to be well capitalized to sustain unexpected losses. What worries me is that a slowing global economy, coupled with increasing deregulation in the US, such as the recent gutting of the Volcker Rule, will embolden banks to chase yield even more and take excessive risks that could imperil depositors and taxpayers.  More than ever, investors, bank regulators, and rating agencies should remain vigilant so as to spare ordinary citizens the pain of when banks run into trouble.

 

 

Source: Banks Around The World Face Significant Profits Pressure For The Foreseeable Future

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U.S. Bank Regulatory Easing Is Negative For Investors And Taxpayers

Storm clouds behind the exterior of the Federal Reserve building in Washington, DC

Storm clouds behind the exterior of the Federal Reserve building in Washington, DC

In a disappointing decision, the Federal Reserve Board announced yesterday that effective this year, it will limit its use of the “qualitative objection” in Dodd-Frank’s Comprehensive Capital Analysis and Review (CCAR). Under Dodd-Frank’s Title I, banks that are designated as systemically important are required banks to design a model using stress scenarios from the Federal Reserve. In order to pass the stress test, banks need to demonstrate that they would be able to meet Basel III capital and leverage requirements even in a period of stress.  It is in the qualitative portion of CCAR, that the Federal Reserve can identify and communicate to the market if a bank is having problems with its internal controls, model risk management, information technology, risk data aggregation, and whether a bank has the ability to identify, measure, control, and monitor credit, market, liquidity and operational risks even during periods of stress.  Easing this requirement, in combination with all the changes to Dodd-Frank that have been taking place since last year, is dangerous to investors, not to mention taxpayers, especially so late in the credit cycle.

Parts of the test that each firm is subject to this year in addition to the hypothetical scenario.

Parts of the test that each firm is subject to this year in addition to the hypothetical scenario.

*All firms subject to the qualitative objection, except TD Group, will have their fourth year in the 2020 cycle. TD Group’s fourth year will be the 2019 cycle.

According to the Federal Reserve’s press release “The changes eliminate the qualitative objection for most firms due to the improvements in capital planning made by the largest firms.”  Yes, there have been improvements in capital planning precisely, because there were consequences to banks which failed the qualitative portion of CCAR. Banks were prohibited from making capital distributions until they could rectify the problems the Federal Reserve found in the CCAR exercise.  This decision essentially defangs the CCAR qualitative review of banks’ capital planning process.

Nomi Prins

Nomi Prins

Dean Zatkowsky

“It is absolutely reckless of the Fed to relinquish its regulatory authority in such a manner, rather than retain the option of qualitative oversight, which has turned up red flags in the past,” said Nomi Prins former international investment banker. “We are after all, talking about what the banks deem a reporting burden versus necessary oversight that could detect signs of a coming credit or other form of banking related crisis from a capital or internal risk management perspective. Why take that risk on behalf of the rest of our country or the world?”

In writing about the Federal Reserve’s decision, the Wall Street Journal wrote that “Regulators dialed back a practice of publicly shaming the nation’s biggest banks through “stress test” exams, taking one of the biggest steps yet to ease scrutiny put in place after the 2008 crisis.” It is not public shaming. It is called regulators doing their job, that is, providing transparency to markets about what challenges banks may be having. Without transparency, the bank share and bond investors cannot discipline banks.

Just last month, the Federal Reserve Board announced that it would be “providing relief to less-complex firms from stress testing requirements and CCAR by effectively moving the firms to an extended stress test cycle for this year. The relief applies to firms generally with total consolidated assets between $100 billion and $250 billion.”

Christopher Wolfe

Christopher Wolfe

Fitch Ratings

Investors in bank bonds, especially, should be concerned about recent easing of bank regulations. Immediately after the Federal Reserve decision was announced yesterday, Christopher Wolfe, Head of North American Banks and Managing Director at Fitch Ratings stated that “Taken together, these regulatory announcements raising the bar for systemic risk designation and relaxed standard for qualitative objection on the CCAR stress test reinforce our view that the regulatory environment is easing, which is a negative for bank creditors.”  Fitch Rating analysts have written several reports about the easing bank regulatory environment being credit negative for investors in bank bonds and to  counterparties of banks in a wide array of financial transactions.

Dennis Kelleher

Dennis Kelleher

Better Markets

Also, a month ago, the Federal Reserve announced that it will give more information to banks about how it uses banks’ data in its model to determine whether banks are adequately capitalized in a period of stress.  In commenting on the Federal Recent decisions, Better Markets President and CEO Dennis Kelleher stated that “Stress tests and their fulsome disclosure have been one of the key mechanisms used to restore trust in those banks and regulators.  By providing more transparency to the banks in response to their complaints while reducing the transparency to the public risks snatching defeat from the jaws of victory in the Fed’s stress test regime.”

Gregg Gelzinis

Gregg Gelzinis

Center for American Progress

Gregg Gelznis, Policy Analyst at the Center for American Progress also expressed his concern about the Federal Reserve’s recent changes to the CCAR stress tests.  “While Federal Reserve Chairman Jay Powell and Vice Chairman for Supervision Randal Quarles have spoken at length about the need for increased stress testing transparency, this transparency only cuts in one direction.” He elaborated that the Federal Reserve’s decision “benefits Wall Street at the expense of the public. The Fed has advanced rules that would provide banks with more information on the stress testing scenarios and models. At the same time, they have now made the stress testing regime less transparent for the public by removing the qualitative objection—instead evaluating capital planning controls and risk management privately in the supervisory process.”

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Source: U.S. Bank Regulatory Easing Is Negative For Investors And Taxpayers

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