Wednesday, July 25, 2012

Basel III requirements hurting some European bank shares

Published Basel III-based capital measures are exposing European banks who will need to raise the most amounts of capital to meet the latest regulatory capital requirements (see attached Basel III handbook). There is also an expectation from investors, analysts, and some regulators that these banks will need to meet the minimum Basel III based Tier 1 ratio of 8% before the year-end. 

But when it comes to European banks, it's not only the Eurozone periphery institutions that are in a race to improve their capital ratios. It turns out that some Swiss institutions, particularly Credit Suisse (CS) will look undercapitalized once Basel III becomes official.

Common Equity Tier 1 capital under Basel III

Responding to recent comments from the Swiss National Bank, CS announced an aggressive capital raising program.
Barclays Capital: - Credit Suisse acknowledged this challenge on 18 July when it announced a new set of capital enhancing measures in response to pressure from the Swiss National Bank. As of March 2012, Credit Suisse had a fully-loaded Basel III CET1 [Common Equity Tier 1 ] ratio of just 5.3%, among the weakest in Europe. In its 2012 Financial Stability Report published on 14 June 2012, the Swiss National Bank highlighted the weaker capital position of the Swiss banks relative to international peers, and that of Credit Suisse in particular. The SNB recommended that both CS and UBS increase their loss-absorbing capital buffers, which in the case of Credit Suisse had to be done in a ‘substantial’ manner and ‘during the course of the current year’. Reacting to these pressures, Credit Suisse announced last week a set of immediate capital measures for up to SFR8.7bn, expected to boost the bank’s fully-loaded Basel III CET1 ratio by 1.5pp and additional measures totalling SFR6.6bn to be implemented by the end of 2012, when the bank’s Basel III CET1 ratio will increase to 8.6% (fully-loaded). Although anecdotal so far, the SNB move indicates that, in practice, the Basel III transition period will be much shorter than scheduled. In our opinion, the focus regarding capital is shifting from the strength of reported ratios to the weakness of ‘fully-loaded’ ratios.
This year banks have been boosting capital ratios by improving core equity capital (in many cases via retained earnings but in some instances issuing equity) as well as reducing Risk Weighted Assets (RWA) - roughly in equal amounts. Credit Suisse's goal of catching up to its peers in terms of Basel III based capitalization this year will be difficult. Shutting down capital intensive businesses (that will involve significant layoffs), selling assets (which will cut into earnings) and possibly issuing more equity (diluting existing investors) does not bode well for the share price. That's one of the key reasons CS shares just hit a 20-year low.

Credit Suisse share price

UBS and some other banks are struggling with this issue as well.

Basel III will clearly improve bank capitalization, but some institutions will end up with significantly lower share valuations as a result of trying to meet their target capital ratios.

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