Basel III Around the World: Core Europe

We look at how the tough, new Basel III rules may impact the largest banks in France, Germany, Switzerland other other core European states

Jaime Peters, CFA, CPA 10 May, 2011 | 10:03AM
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Read our analysis of the impact of Basel III elsewhere in the world.

Belgian Central Bank Governor Luc Coene has stated that the nation's banks will meet Basel III rules without raising capital, as any current shortfall could be earned over the phase-in period. In fact, Coene suggested there would be room for dividends, though lower payout ratios are expected.

Dexia (DEXB)
Dexia’s core Tier 1 ratio was 12.1% at Dec. 31 under Basel II, but the bank expects risk-weighted assets to increase by EUR 25 billion, reducing its core Tier 1 ratio to 10.3% under Basel III standards. This easily meets the minimum guidelines set for 2019 but falls short of the 15% core Tier 1 ratio the company has targeted for 2014. However, even though it looks ready to meet the Basel III capital standards without issuing shares, the leverage ratio issue may come into play. The bank's equity/asset ratio is 1.5%--far below the minimum 3% ratio required by the Basel Committee. The bank expects to be fully compliant by 2015, but we expect Dexia to raise EUR 4 billion in 2011 at EUR 3 per share in order to increase its equity/asset ratio to 3%. Additionally, Dexia must find a way to repay the governments of France, Belgium, and Luxembourg for the EUR 6 billion bailout it received during the crisis.

KBC Group (KBC)
KBC Groep's situation is even worse. This bank must repay the government EUR 10.5 billion for the EUR 7 billion in bailout funds it received (just under half of its equity), and its chances of doing so without a dilutive capital raise look increasingly slim to us. Even though KBC plans to reduce its risk-weighted assets by 25% and shed noncore business to achieve a repurchase and become Basel III compliant by 2013, we simply cannot see a way around a capital raise. The bank believes it already has EUR 4 billion of excess capital saved up so far for repayment, but KBC's plans hit a recent setback when Luxembourg's financial regulator--the CSSF--announced it was unlikely to approve the sale of its KBL European Private Bankers business to the Hinduja Group, a deal valued at EUR 1.35 billion.

Denmark is teaming up with Germany and France to fight Basel III liquidity rules that will penalise the world's third- largest covered bond market. Denmark wants the European Commission to change rules set out by the Basel Committee that would disrupt the mortgage bond market by essentially forcing banks to sell mortgage bonds. Some have gone as far as to suggest the rules could create a massive credit crisis. Denmark's major lenders (their biggest banks) could be forced to sell off mortgage bonds to comply with the 40% cap on using top-rated securities as liquid assets. Activists also point out that the government bond market is too small by about DKK 300 million to meet the liquidity gap the rules would create.

Danske Bank (DANSKE)
On the capital front, Nordic banks are, in general, some of the best capitalised banks in Europe. Danske Bank is currently in the middle of a fully subscribed DKK 20 billion rights offering. The company will use the proceeds to repay the hybrid capital bailout it received from the Danish Financial Authority during the height of the crisis. Danske's core Tier 1 ratio under Basel II rules was 10.1% at year end, giving it plenty of room to meet the Basel III capital requirements.

Nordea (NDA SEK)
Nordea--the largest Nordic bank--is also fully compliant with the Basel III capital requirements after raising funds in the Spring of 2009. However, this bank has a much larger presence in Sweden and must contend with the possibility of a tougher stance that its regulator is proposing (discussed later). CEO Clausen has suggested the higher capital or liquidity standards or faster-paced adoption timeline is bad for competition.

France's regulators appear to be very protective of their banks' competitive positioning in the global market. The country has said it will not follow Basel III standards unless the U.S. does as well. While the U.S. is planning on adopting the Basel III standards, France's scepticism is understandable considering the U.S. is still on Basel I standards.

BNP Paribas (BNP)
BNP Paribas currently maintains a Basel II measured core Tier 1 of 9%. The risk-weighted changes will have a "significant but manageable impact" on the ratio, but the company believes it can meet the Basel III standards without issuing new shares. Like its regulator, BNP appears to be very concerned about operating on a level playing field, but also suggests that a one-size-fits-all approach is not the best approach. Overall, it seems to us that CEO Baudoin Prot is upset that his firm has to comply with the stricter capital levels even though it made it through the crisis without taking any taxpayer funds and never touched subprime securities. As a result of his comments, we believe it is possible that BNP's resulting capital ratios will hover fairly close to the minimum

Société Générale (GLE)
Société Générale expects its core Tier 1 capital to hit 7.5% under Basel III definitions by the implementation date without raising additional funds in the market. With a current core Tier 1 ratio of over 8%, we believe this target is within its ability, but the risk-weighted asset issue will not make it easy. Basel III is likely to increase SocGen's risk-weighted assets by about a third. Additionally, SocGen's exposure to Greek bonds makes it is likely that the bank would need to raise additional equity if that troubled country ultimately ends up defaulting on its bonds, in our opinion.

Crédit Agricole (ACA)
While Credit Agricole enjoys a hefty capital cushion, with a core Tier 1 Capital ratio well over 9%, it also has the largest exposure to Greece of all of France's banks. We think Credit Agricole's capital base is large enough to absorb further elevated loan losses, but the group would probably need to raise capital in the wake of an acute crisis in Greece. The proposed new Basel capital regulation had threatened not to recognise minority stakes in its subsidiary banks when calculating capital, which would be disastrous for the group, but mid- 2010 revisions indicate that exceptions will be made in cases like this. However, the final form of the rules and their implementation is unknown and remains a risk factor for the group.

The biggest issue for German banks is their use of hybrids called "silent participations," which will not qualify as Tier 1 under the new Basel III rules. Before the rules were officially announced, German regulators warned that its top 10 banks would have to raise as much as EUR 105 billion of fresh capital under the guidelines. Consequently, Germany was the only country not to approve the June 2010 draft of the rules. However, it seems like the country used that as leverage for final results. It is the smaller, regional banks that really are in trouble over Basel III. These banks--depending on their status as joint stock companies or not--have varying timelines for reaching compliance. Since they don't have ready access to capital markets due to their ownership structures, their reliance on the silent participations is quite high. Some believe that German regulators (the Bundesbank and BaFin) used the Basel negotiations to pressure these types of banks into restructuring.

Deutsche Bank (DBK)
Deutsche Bank’s risk chief thinks Basel III is good for the financial system and believes the bank will fulfill the capital requirements on-time. Deutsche was already in the process of raising funds when the Basel III rules were announced in September 2010. Set to fulfil capital requirements by 2013, Deutsche announced an almost EUR 10.2 billion rights offering shortly before the Basel III accords came out so it could absorb Deutsche Postbank. The bank's core Tier 1 ratio was 8.7% at the end of the year, giving it a decent capital base to meet the new requirements. In our opinion, this bank is likely to meet the systemically important threshold and may be subject to additional capital requirements.

Commerzbank (CBK)
Commerzbank will raise EUR 8.25 billion as a part of a plan to repay about EUR 14.3 billion of state aid by June. This will represent 90% of state aid repayment, with the remaining sum of 1.9 billion paid from excess capital by 2014 at the latest. Since the silent participations were government bailouts, the length of time they are grandfathered into the system was slightly longer than the 2013 implementation of Basel III--so Commerzbank's plan to retain some until 2014 is not worrisome. After the transaction, the core Tier 1 ratio will be leaving it in a strong position to comply with Basel III requirements.  

The Netherlands
Overall, Dutch banks are in a fairly strong position to meet the Basel III requirements. Importantly, Nout Wellink president of the Dutch Central Bank and current head of the Basel III committee--told The Hague "we're not likely to stick to the minimum requirements because that wouldn't be in the interest of the Dutch financial sector." Consequently, we expect Dutch banks to have to hold even more capital than the 7% Tier 1 common minimum requirement.

Governor Stefan Ingves--head of the Swedish central bank, Riksbank--has proposed implementing stronger measures on Swedish banks than outlined under Basel III. Sweden's Financial Supervisory Authority has come out with suggestions of 15%-16% total capital levels and 10%-12% core Tier 1 levels, which would exceed the Basel recommendations. The Financial Supervisory Authority also wants a quicker adoption timeline than the Basel Committee laid out. Swedish Financial Minister Anders Borg has warned banks to expect an annual increase of 1% in capital requirements over the next few years. While the banks are pushing back, suggesting such levels would impair their ability to compete, the Swedish government appears unmoved, pointing to the continued burden of the Baltic countries and fears about household credit levels. Sweden's banks are already well capitalised by industry standards, but are still highly leveraged in our opinion. Svenska Handelsbanken (SHB A) ended 2010 with a core Tier 1 ratio of 15.4% under Basel II standards. Skandinaviska Enskilda Banken's (SEB A) core Tier 1 ratio was 12.2% at Dec. 31, 2010. Skandinaviska's capital is set to go up another 50 basis points upon the closing of the sale of its German retail business.

Upsetting its large banks, Switzerland's proposed set of rules for its too-big-to-fail banks-- tougher rules than Basel III--has passed its commentary period and is now in Parliament. The government has proposed total capital requirements of 19% and common equity requirements of at least 10% of risk-weighted assets. The current Basel III rules call for 7% common equity plus something for systemically important firms.

We have little doubt that UBS AG (UBS) and Credit Suisse (CS) will be labelled systemically important, meaning the difference may not be as great as it looks at first glance. Systemically important firms are likely to have to hold some form of additional capital under Basel III anyway. The banks and the Swiss Bankers' Association fear the high requirements go too far and risk damaging the banks' competitive positions.

Of the two banks facing these problems, UBS is in the worse position, in our opinion. The bank is also a lot more vocal about its objections, going so far as to suggest it would consider moving its headquarters or spinning out divisions if the new rules prove too onerous. CEO Oswald Gruebel has gone as far as to call the contingent convertible securities (CoCos) to be used to make up the difference between the 10% common equity requirement and the 19% total equity requirements "dangerous." However, it may be that the bank does not have many hybrids to replace with the CoCos and so may be worried about the increased cost of funding it may face. Currently, UBS has a Tier 1 ratio of 17.7% and expects to grow it as it continues to accumulate capital and forgo dividends in the near term.

Credit Suisse has already tested the Coco waters. The bank issued or agreed to exchange securities worth $8.2 billion for CoCos. The hybrids exchanged for CoCos were no longer going to count toward the Tier 1 ratio under Basel III and consequently did not have a major impact on the bank's funding costs. However, the bank has cut its ROE targets to account for the additional capital burden it will have going forward. With a core Tier 1 ratio of 12.1% and a Tier 1 ratio of 17.2%, we expect Credit Suisse will continue to build capital to meet the new standards.

Julius Baer Gruppe (BAER) is in quite different circumstances. The bank is much smaller than the big investment banks and is not subject to the rules going through Parliament. The bank is in fact overcapitalised, with a Tier 1 capital ratio of 23.8%. While many banks are likely to hold off on acquisitions during this transition period, Julius Baer has the ammunition to be on the hunt.

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Jaime Peters, CFA, CPA  Jaime Peters, CFA, CPA, is a senior stock analyst with Morningstar.

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