August 21, 2013 / 10:30 AM / 6 years ago

Leverage crackdown puts spotlight on Credit Agricole, Deutsche

PARIS/FRANKFURT (Reuters) - A regulatory crackdown on debt could hit Deutsche Bank (DBKGn.DE) harder than expected and embroil Credit Agricole (CAGR.PA) despite the French bank’s insistence that its ownership structure reinforces its capital defenses.

The headquarters of Deutsche Bank AG is pictured in Frankfurt May 25, 2013. REUTERS/Ralph Orlowski

Global regulators meeting in the Swiss city of Basel in June surprised banks with a new focus on leverage to measure risk, prompting banks holding large amounts of financial derivatives such as Barclays (BARC.L) and Deutsche Bank to either tap investors for more equity funding or make plans for yet another purge of assets to free up capital.

With euro zone banks still considered too large - their assets are over three times the size of the bloc’s economy - others are expected to have to raise capital and shrink with Credit Agricole seen by some analysts as most at risk.

France’s third-biggest bank will have to reduce its balance sheet by 242 billion euros, or 14 percent, and generate 17 billion euros in capital over the next three to five years to meet new regulatory requirements, according to a recent study by analysts at Royal Bank of Scotland (RBS).

The analysts estimate that banks in the euro zone will have to cut 3.2 trillion euros in assets over the next three to five years, with the 11 largest, including Credit Agricole, Deutsche, Societe Generale (SOGN.PA) and Commerzbank (CBKG.DE), axing 661 billion euros and having to raise 47 billion in capital.

The capital cloud is putting off some investors.

“I have a neutral stance on banks worldwide at this point for several reasons, but I am more underweight the euro zone banks because they have a chronic problem of being undercapitalized, even if there are some exceptions,” said Jacques-Pascal Porta, a portfolio manager for OFI Optima International fund.

Credit Agricole has declined to disclose capital or leverage ratios for its listed bank under the proposed new Basel III rules. The regulations call for a leverage ratio of 3 percent, meaning for every dollar of assets and some off-balance-sheet commitments, a bank has to hold at least three cents of equity.

Credit Agricole has said regulators and rating agencies are focused only on the capital of the broader Credit Agricole group, which is bolstered by its wealthy regional savings banks.

At a group level, Credit Agricole says it has a 3.5 percent leverage ratio using existing European requirements, which are less strict than the proposed new rules. On a standalone basis, the listed bank’s leverage ratio is 1.6 percent, the lowest among large euro zone banks, according to RBS research.

Credit Agricole said RBS’s estimate reflected transactions between its regional savings banks and the listed bank.

“So the only good way of looking at things is to calculate a leverage ratio at the group level,” said a spokeswoman.

Key to Credit Agricole’s confidence is a guarantee, or “switch mechanism”, from the parent company set to be strengthened early next year, but details of which remain sparse pending an “Investors’ Day” in November or December.

Fitch ratings agency said Credit Agricole’s group structure was a key support - if the listed arm needed more capital, it could raise it internally without resorting to the market as long as the wider group had enough capital of its own.

Not everyone is convinced the “switch” is iron-clad.

“A guarantee is never the same as having the capital at hand for emergencies,” said KBW analyst Jean-Pierre Lambert. “There’s still a risk of a capital increase,” Lambert said. “There will be a component of switch, yes, but they could balance this by doing some form of capital increase.”

Issuing debt or equity or curbing dividends would cap a recent rally in Credit Agricole stock. It has gained 35 percent in 2013, nearly triple the European sector, as confidence grows over its exit from Greece and a refocus on its home market.


Until recently, regulators focused mainly on getting banks to hold more capital and liquidity so they can better absorb losses in future financial crises. But concern that banks might be underestimating the riskiness of their lending prompted regulators to lean more heavily on the leverage ratio, which does not rely on banks’ in-house risk models.

The Basel III proposals on leverage, which measure a bank’s capital against all its assets, including loans and derivatives, require the ratio to be based on gross derivatives rather than lower net figures, hitting banks such as Deutsche and Barclays.

Shrinking bank balance sheets by trillions of euros is likely to cut lending and weigh on the fragile European economy.

Given the large banks on their patch and the severity of their banking crises, the British, along with the Swiss and the United States, are taking a tougher line on leverage beyond the Basel III rules.

Heeding a warning from the Bank of England not to damage the domestic economy in trying to meet the leverage target, Barclays opted for a 5.8-billion-pound rights issue and issued 2 billion pounds in debt to meet a June 2014 deadline for a 3 percent leverage ratio, up from 2.2 percent now.

Barclays stock has dropped nearly 12 percent since rumors of a rights issue first surfaced late last month, but the capital hike has pleased some investors.

“We’re taking another look at Barclays because they’ve finally managed to put their house in order - they are now a bit less bothered by undercapitalization,” said Porta.

Having already tapped investors for 3 billion euros in a rights issue in April, Deutsche Bank is planning to shrink its balance sheet, one of Europe’s biggest, by some 250 billion euros by 2015, to meet the new Basel III leverage rules.

A study by JP Morgan analysts argued that Deutsche Bank needed to axe 500 billion euros rather than 250 billion euros.

Deutsche has already said that shrinking its balance sheet as planned could cost it approximately 600 million euros in one-off costs and roughly 300 million euros in future pretax profit.

Any further cuts could see its profits further crimped.

A spokesman for Deutsche Bank declined to comment on the JP Morgan estimate, and referred to recent comments by Chief Financial Officer Stefan Krause, who said the bank meets all current regulatory demands and has sufficient flexibility to meet more severe requirements if necessary.

Deutsche’s balance sheet has already contracted by 15 percent to 1.91 trillion euros in less than a year, putting pressure on its flagship fixed-income business, which underperformed in the second quarter.

“Deutsche meets the rules on leverage and capital, where German regulators have taken a less aggressive approach than their UK, U.S. and Swiss counterparts. That said, the bank faces pressure from investors to comply with the rules in all jurisdictions,” said Chris Wheeler, analyst at Mediobanca.

“The big worry is what additional cutbacks on balance sheet size will mean for earnings.”

Editing by Carmel Crimmins and Tom Pfeiffer

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