EUROPEAN BANKING SECTOR KEY CHALLENGES AND OPPORTUNITIES

EUROPEAN BANKING SECTOR KEY CHALLENGES AND OPPORTUNITIES by Marios Koliopoulos Managing Director Alvarez & Marsal May 23rd, 2014 5.5 YEARS AGO LEHM...
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EUROPEAN BANKING SECTOR KEY CHALLENGES AND OPPORTUNITIES by Marios Koliopoulos Managing Director Alvarez & Marsal

May 23rd, 2014

5.5 YEARS AGO LEHMAN TRIGGERED A UNIQUE GLOBAL CRISIS. OR DID IT?

2

SEPTEMBER15th 2008: LEHMAN FILES FOR THE LARGEST BANKRUPTY IN HISTORY AND THE FIRST INVOLVING A TRULY GLOBAL FINANCIAL SERVICES FIRM

Unprecedented Scale

    

$639 billion in Assets presence in 40 countries 8,000+ legal entities

900+ operating entities derivatives portfolio: $39 trillion (notional value) 3

CRISIS SPREAD TO EUROPEAN COUNTRIES … FROM NORTH TO SOUTH … AND WHO’S NEXT? 2008

2009

2010

2011

2012

2013

2015

2014

LEHMAN UKRAINE ?

IRELAND RUSSIA ? AUSTRIA / SLOVENIA

UK

GERMANY

GREECE ICELAND

PORTUGAL SPAIN

LATVIA CYPRUS

4

FIRST WAVE OF CRISIS STARTED IN NORTHERN EUROPEAN COUNTRIES

Iceland

Latvia Ireland

UK

Austria

Slovenia

5

THE BANKTRUPTCY OF THE ICELANDIC BANKS IN 2008 RANKS 3rd IN SIZE IN THE INTERNATIONAL HISTORY OF CORPORATE FAILURES Too big to save or too big to fail?

50% of Icelandic banks’ balance sheets denominated in foreign currency

(ISK bn)

Foreign Assets

Foreign Currency Debt

2003

235

743

(%GDP)

(28%)

(89%)

2007

2,496

2,867

(%GDP)

(191%)

(219%)

Banking Assets / GDP (ISK bn) Pre-crisis (‘07) = 9,700bn / 1,300bn ~ 7.5x Post-crisis (‘13) = 3,900bn / 1,780bn ~ 2.2x

Source: Central Bank of Iceland, IMF

6

UNITED KINGDOM WAS ROCKED BY NORTHERN ROCK’S BANK RUN AND SUBSEQUENT NATIONALISATION  Northern Rock was nationalized in 2008. A carve-out creating a good/bad bank was conducted in 2010. BoE provided a £26bn funding line and £30bn in guarantees  2008: U.K. government announced a £37bn rescue package for RBS (£20bn), Lloyds (£13bn) and HBOS (£4bn)  The rescue resulted in government taking a c.60% stake in RBS and a c.40% stake in the combined Lloyds/HBOS (Lloyds Banking Group)  RBS reported a £24bn loss in February 2009, the biggest in British corporate history

7

IRELAND’S BANKING ASSETS TO GDP RATIO OF 9X COMBINED WITH A REAL ESTATE BUBBLE WERE THE CATALYSTS FOR THE CRISIS Residential property price index 150 130.0

-50%

120 90

65.6 60 30 2005

2006

2007

2008

2009

2010

2011

2012

2013

Sources: SCO, Ireland, Year Base: 2005.

2,500 8.5x

8.5x

9.1x 8.1x

2,000

8.x

7.8x 6.7x

€bn

1,500 1,000 500 0 2008

2009

Banking Assets

2010

2011

GDP

2012

2013

10 9 8 7 6 5 4 3 2 1 0

Banking Assets / GDP (x)

Banking Assets / GDP ratio

“Bailout exit does not mark the end of Ireland's financial crisis" Michael Noonan, Finance Minister, Dec. 2013

2014

Banking Assets / GDP ratio

Source: IMF World Outlook, SNL

8

SOUTHERN EUROPEAN COUNTRIES FORMED THE SECOND CRISIS WAVE

Greece Portugal Spain

Cyprus

9

GREECE: A SOVEREIGN CRISIS EVOLVING INTO A BANKING CRISIS Unstrained government spending, cheap credit and failure to implement reforms left Greece badly exposed when the global downturn 10-Year Government Bond Yield

 Govt. Balance (%GDP): -15.7% in 2010 -2.1%* in 2013

40 10/11/2011 Technocrat government under PM L. Papadimos takes over

36.6 35

6/5/2012 National elections take place

01/02/2012

17/12/2012 GB’s buyback Debt write-off: € 20bn

9/3/2012 PSI results announced Debt write-off: €105bn

30

 Primary Balance (%GDP): -10.5% in 2009 +0.8% in 2013

25

 Current Acc. Bal. (% GDP): -11.9% in 2009 +0.7% in 2013

10/4/2014 Greece returns to the bond markets (€3bn 5Y issue, yield 4.95%)

21/7/11 Second Bailout Agreed

% 20 23/4/2010 Formal Bailout Request

 Total bailout / GDP (2012) approx. 125%

 2009-13: Real GDP shrank by 21%

15 1/1/2008 Yield = 4.3%

 Debt to GDP 112% in 2008 (263 / 233bn) 173% in 2013 (316 / 182bn)

31/10/2011 PM G. Papandreou calls for referendum

6.2 5

Sources: investing.com. *excluding bank recapitalization costs

 Unemployment: 7.7% in 2008, 27.3% in 2013

Apr-14

Jul-13

Apr-13

Jan-13

Oct-12

Jul-12

Apr-12

Jan-12

Oct-11

Jul-11

Apr-11

Jan-11

Oct-10

Jul-10

Apr-10

Jan-10

Oct-09

Jul-09

Apr-09

Jan-09

Oct-08

Jul-08

Apr-08

Jan-08

0

Jan-14

01/04/2014

2/5/2010 First Bailout Agreed

Oct-13

10

10

SPAIN’S REAL ESTATE BUBBLE LED TO CONSOLIDATION AND SET-UP OF BAD BANK

Unemployment

10-year bond yield

Total Loans $bn 3,000

32% 6.8%

2,849

26.3%

7%

24%

2,750

16%

2,500

5.5% 5%

11.3%

3% 1/1/08

2,250

8%

4.0%

2,169 %

1/1/10

1/1/12

Sources: investing.com, IMF, SNL.

1/1/14

2,000

2008

2010

2012

2014

2008

2010

2012

2014

11

CYPRUS WAS THE FIRST EUROPEAN COUNTRY TO BAIL-IN DEPOSITORS  Rescue package reduced from €17bn to €10bn  No money available to rescue banks  Resolution of Laiki Bank – transfer of good assets to Bank of Cyprus  Bail-in of over €7.5bn in deposits and €1.8bn in debt

12

EUROPE IS MUCH MORE EXPOSED TO BANKS THAN THE U.S. 9.00

Luxembourg

Malta

8.00

International banking centres

Ireland

Cyprus

7.00

Large markets

Banking 6.00 Assets to GDP Ratio

UK

Medium markets

5.00 Denmark

4.00 Portugal Austria

Holland Belgium

Finland

3.00

Greece

EU Average 3.95

France

Spain

Germany

Sweden Italy

2.00

Lithuania Bulgaria Romania Slovakia Estonia Czech Republic 1.00 Latvia

Hungary

0.00 Slovenia

-

US Average 0.9

Transition economies

Poland

EU Average € 361 bn 500

1,000

1,500

2,000

2,500

3,000

GDP (in €bn) 13 Source: European Banking Federation Statistics, A&M Research.

THE CORE OF EUROPE WAS HIGHLY EXPOSED TO THE PERIPHERY COUNTRIES DEBT Net direct exposure1 to debt of Greece, Italy, Ireland, Portugal and Spain (2011) 600 507

Sovereign

500 Private Sector

$bn 400 294

300 200

186

173 120

65

100

105

35

74

52

42

8

3

19

36

15

14

1

0 France

United Kingdom

Germany

Spain

Belgium

Cyprus

Denmark

Netherlands

Italy 2

1 Net direct exposure defined as gross cash long minus gross cash short. 2 Excludes exposure to domestic debt.

Source: European Banking Authority; McKinsey Global Institute

14

EUROZONE STABILITY ACHIEVED BUT DEBT RATIOS HAVE RISEN Periphery: Debt / GDP (%) 190 170

Greece

150

Portugal 130

Italy

% 110

Ireland

90

Cyprus Spain

70 50

Source: IMF

30 2008

2009

2010

2011

2012

2013

10-year government bond yield (%) 36.6%

18 16.4%

Greece Portugal

13

11.8%

%

Ireland Spain

8

3 01/01/2008

7.1%

01/01/2009

01/01/2010

01/01/2011

01/01/2012

6.8%

01/01/2013

Italy

01/01/2014 Source: investing.com.

Source: Eurostat.

15

THE ECB HAS PROVIDED STABILITY…SO FAR

“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. Believe me, it will be enough.”, Mario Draghi, July 2012

Source: The Economist, investing.com

16

AN INTRACTABLE EUROPEAN PROBLEM: THE SOVEREIGN-BANKING NEXUS “A European banking union is an important step towards escaping this deadly embrace.”

Jens Weidmann, President of the Deutsche Bundesbank Financial Times, October 2013

Sovereigns Highly indebted Increased sovereign

Weaker economic

Contingent liabilities

growth

Higher corporate

Higher funding costs

Bond yields

Corporates Debt overhang, Weak profits

Banks Thin Buffers Higher nonperforming loans

Constrained lending,

Lender forbearance

Higher interest rates on loans

Source: Global Financial Stability Report, IMF (October 13)

17

THE ECB IS WARNING US… “Banks do need to fail. If they do have to fail, they have to fail. There’s no question about that” Mario Draghi, Bloomberg TV October 2013

…EXPERIENCE SAYS WE SHOULD BE WARY “There was no other option than to let Lehman fail” Ben S. Bernanke , Los Angeles Times Sept. 2013

18

THE STEPS TOWARDS A EUROPEAN BANKING UNION The European Commission has proposed a Single Supervisory Mechanism (SSM) under which the ECB shall assume ultimate responsibility for specific supervisory tasks related to the financial stability of the most important Eurozone banks. A Single Resolution Mechanism (SRM) will complement SSM by developing banking resolution plans and by providing financing though a Single Resolution Fund (SRF).

Single Supervisory Mechanism (SSM)

Single Resolution Mechanism

(SRM)

Single Resolution Fund (SRF)

• • • •

130 largest banks will be supervised directly by the ECB Remaining banks (c. 6,000) supervised by national supervisors ECB will keep ultimate supervisory authority over all Eurozone banks Fully operational in November 2014

• • • •

Applies to all banks supervised by SSM Develops resolution schemes for banks supervised directly by the ECB Assesses systemic threat of failing banks Operational in January 2016

• Act as last resort after all other bail-in solutions are exhausted (i.e. shareholders, creditors and deposits over €100k) • Target level of € 55bn to be reached within 8 years

19

A FEW CONSIDERATIONS ON THE SSM/SRM/SRF SSM:  The ECB will only be the competent authority under the Capital Requirements Regulation. The national supervisor will retain competence in respect of other forms of regulation

 In each jurisdiction the ECB and national supervisor will need to rely on one another to form a complete view of the banking market in that jurisdiction. Neither alone will see the whole market  The ECB will look to the local national supervisory staff for assistance with on site inspection work.

 ECB's decision making process still gives a significant role to national supervisors  Where an EU group has banks both within the SSM area and also in non-SSM EU states ECB and the nonSSM national supervisory authorities will need to cooperate to make group-wide decisions.

SRM/ SRF:  The decision making process appears to be complicated

 A bank that is being resolved still remains subject to local laws. Therefore, not all the decisions that may need to be taken to resolve a bank will be decisions within the power of the SRM  The SRM will need to cooperate with the non-SRM resolution authorities to resolve a banking group with activities outside the SSM area  The prefunding of the SRM is small compared to the possible needs of a large bank during resolution.  The big question of how much action will the SRM require banks to take to render themselves resolvable, remains unanswered

REGULATORY LANDSCAPE & BUSINESS IMPACT REGULATORY FRAMEWORK

IMPACT

CAPITAL (BASEL III)

OPERATING MODEL RESTRICTIONS

• •

FUNDING / LIQUIDITY

FINANCIAL CONSTRAINTS



ACTIONS

• LEVERAGE Impact on ROE ranges from 250500bps

STRESS TESTS & AQRs “the whole global banking arena is changing because of regulatory moves and we are embarking on a ‘bold simplification of Barclays’…the group is too exposed to volatility in the investment bank.” Antony Jenkins, March 2014 CEO

• • •

Sell-off business lines Dispose of liquid assets Non-renewal of maturing loans Restrict new lending Equity Issuance Debt-to-equity conversion Retain Earnings

“With that regulatory oversight comes more strict standards for how much the • Increase deposits bank can fund its operations with • Increase long-term borrowing, which means that its capital wholesale funding is precious and has to be allocated to where it can find high returns.” James Gorman May 2014 CEO “Deutsche Bank has turned to the Qatari royal family as part of plans to raise €8bn as the lender attempts to draw a line under fears over its capital strengths” The Financial Times, 19 May 2014 21

IS IT A LEVEL PLAYING FIELD FOR THE BANKS? Multiple jurisdictional differences exist in financial constraints being imposed by SIFI(*) regulation

15%

15%

15%

14%

14%

14%

13%

13%

13%

12%

12%

12%

11%

TBD Countercyclical ST wholesale funding buffer

10% 9% 8%

5% 4% 3% 2%

11%

TBD Countercyclical Buffer

9%

100250bbps SIFI Buffer

8%

10% 100250bbps SIFI Buffer

9% 8% Minimum Baseline Stress

7% 250bps Conservation Buffer

6% IDI 5%

5% Minimum Post Stress Tier 1 Common Minimum 4.5%

1%

3% 2%

250bps Conservation Buffer

6%

5.5% Minimum Post Stress

Tier 1 Common Minimum 4.5%

3%

Leverage 3%

Leverage

TBD Minimum Post Stress

2%

Tier 1 Common Minimum 4.5%

Leverage 3%

1%

0%

CET1

5%

250bps Conservation Buffer

4%

1%

0%

8%

100250bbps SIFI Buffer

7%

4% Supplementary Leverage 5%

TBD Countercyclical Buffer

10%

7% 6%

11%

0%

CET1

Leverage

CET1

Leverage

* Systemically Important Financial Institutions. 22

THE FUTURE BANKING LANDSCAPE WILL REFLECT ON HOW QUICKLY AND PROACTIVELY BANKS ADJUST TO THE NEW FRAMEWORK  The financial crisis that started in 2008 has subsided in the Eurozone, however there are still substantial structural problems to be dealt with  It brought to surface the need to address the nexus between the sovereigns and the banking sector.  Within this context, steps are taken to create an European Banking Union a part of which is through the establishment of a Single Supervisory Mechanism, a Single Resolution Mechanism and a Single Resolution Fund

“The investment bank will focus on its market-leading and high returning businesses including equities, underwriting, advisory, credit securitized products and emerging markets.” Brady Dougan, CEO Credit Suisse May 2013

 Furthermore, the new Regulatory Framework is and will continue to be the catalyst for the evolving changes in the banking sector given the impact it has on the operating model of banks.  With all these changes underway, the future banking landscape will reflect on how quickly and proactively banks adjust to the new framework; for some banks this is an opportunity; for others a challenge… “The bank has suffered its share of losses and is in the process of reshaping itself, by shifting its focus away from risky trading in its investment banking division toward its wealth management operations.” Sergio Ermotti, CEO UBS September 2013 23

Audience Quiz

24

Which country has defaulted the most times since 1800?

25

Reinhardt and Rogoff have documented more than 200 sovereign defaults and debt restructurings since 1800, including: Ecuador, Venezuela

• 11x

Brazil

• 10x

Spain, Mexico

• 9x

Germany, Greece, Argentina

• 7x

Russia

• 6x

UK

• 4x

Poland

• 3x

France

• 1x

Source: This Time is Different; Eight Centuries of Financial Folly, Carmen Reinhardt and Kenneth Rogoff. Princeton, 2009

Source: Wikipedia

26

Who has spent the most time in default?

27

Over this same period, 23 countries have spent more than 20% of this time in default Honduras

• 64%

Ecuador

• 58%

Greece

• 51%

Russia

• 39%

Poland

• 33%

Spain

• 23%

Germany France

Italy

• 13% • 4% • 3%

Source: This time is different, Reinhardt and Rogoff 2008

28

How many countries grew their way out of default, of 53 defaults between 1970 - 2000?)

There are three possible ways to get out of default: 1) Reduce your debt to match the size o f your economy 2) Grow your economy to match your debt 3) Debase your domestic currency denominated debt

29

Swaziland Only one country grew out of default: 85% of the cases involved debt restructuring

Historically, from 1200 to 1900, currency debasement was the primary tool for sovereign debt relief

Source: This time is different, Reinhardt & Rogoff 2008

30