European Crisis: Should US Banks Be Concerned?

Posted on September 10, 2012 at 6:35 pm.

As Europe continues to experience a financial breakdown, there is no doubt that U.S. banks are and should be worried. All banks will be affected, although some more than others, depending on their relationship abroad. Business will be impacted in a number of ways, but according to the attorneys we polled, it’s not all bad.

Should boards at U.S. banks be concerned about the ongoing problems in Europe?

The boards of U.S. banks that may be affected the most (such as banks that hold a significant amount of European debt, deal in Euros or otherwise engage in business in Europe or with European banks) should be particularly mindful of the situation. On the flipside, in some cases, the problems in Europe may actually open up new opportunities for U.S. banks, which are opportunities that boards of U.S. banks may want to consider. For instance, European banks may begin to lend less in the U.S. and focus on preserving capital and lending in their home countries, which would present increased lending opportunities to U.S. banks (including through loan syndications).

– Doug McClintock & Sara Lenet, Alston & Bird

Yes. On an immediate basis, the problems with the calculation of LIBOR will result in a different rate, although how that may be calculated is unclear. Since the rates on many commercial and consumer loans are based on LIBOR, any replacement will at a minimum complicate the lives of both borrowers and lenders. For lending going forward, a bank probably should not use a LIBOR-based rate and may want to consider whether to base lending on any standard rate. More broadly, on a macro basis, problems in Europe inevitably spill over into the United States.

Even though the spill-over seems unlikely to cause a second recession here, any resulting slow down necessarily will have an adverse effect on the U.S. banking industry—a phenomenon we are already experiencing. The macro consequences of the European problems are beyond the control of any bank, but on an individual basis, a U.S. bank should have a deep understanding of its European exposure. This would include not only any direct exposures, for example in the form of bonds, but also exposures to commercial borrowers that may depend to a material extent on their European businesses. A bank should re-visit the use of any foreign instruments that it may use for hedging purposes. The use of foreign exchange also may require more careful monitoring.

– Dwight Smith, Morrison Foerster

Ongoing problems in Europe affect U.S. monetary and fiscal policies, especially in a presidential election year. Concerns over Europe have led to an influx in foreign investment in U.S. Treasury securities as a safe haven investment. This has reduced yields upon Treasury instruments, and TIPs (Treasury Inflation Protected Securities) have even sold at negative rates. Lower Treasury rates adversely affect the yields on bank investment portfolios and compress margins on loans and other credit assets. This makes it more difficult for banks to generate returns on equity and funds available for dividends and repurchases of common stock. Current low interest policies may have created new systemic risks by encouraging investors to “reach” for higher yields in longer maturity securities with riskier credit quality.

All directors should be concerned about current levels of interest rates, potential future inflation, and interest rate risks resulting from these policies driven by European and domestic U.S. concerns. The regulators are especially concerned about interest rate risks and their future effects on bank balance sheets and earnings.

– Chip MacDonald, Jones Day

Yes. Boards of banks, regardless of asset size, must understand generally the business of their bank and the environment in which their bank operates. For example, it was not long ago that many bank directors had never heard of or made a subprime real estate loan. They quickly came to appreciate the many challenges to their banks that that loan product presented. The European Union is the largest trading partner of the U.S. Threats and the challenges presented by the second largest economy in the world (the combined economies of the euro zone) cannot and should not be ignored. Problems in Europe could have very real consequences for financial stability in the U.S. in areas such as employment and credit availability.

– John Bowman, Venable

Fortunately or unfortunately, the world in which we live is interconnected. What once appeared to be vast oceans now seem like small ponds (unless one is flying internationally in coach). With the current global economy, it is hard to avoid thinking of the Woody Allen quote, “More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness; the other, to total extinction. Let us pray we have the wisdom to choose correctly.” Unfortunately, there are not many ways to inoculate our economy, and thus, the life blood of community banks from the contagion taking hold in Europe. Only if we as a country can get our own financial house in order will we be in a position not only to withstand, but to help the European economy to grow out of its problems.

– Peter Weinstock, Hunton & Williams

Obviously, boards at U.S. banks with European operations should pay close attention to country developments. However, boards at U.S. banks without European operations also should monitor Europe’s problems, because they have the potential for a major ripple effect if country initiatives are unsuccessful. A board should consider whether its bank has particular exposure to Europe and determine whether special contingency planning is necessary.

—Jean Veta and Michael Nonaka, Covington & Burling

Bank stocks: “It’s really been a lost decade.”

Posted on June 27, 2012 at 1:16 pm.

Written by Naomi Snyder

Bank stocks rallied earlier this year but then faltered mid-year in the throng of worries about the European debt crisis.

“It’s really been a lost decade,’’ said Steve Hovde, the president and chief executive officer of The Hovde Group, an investment bank that focuses on the financial services sector. He was speaking at Bank Director’s Bank Audit Committee Conference this month in Chicago.

Looking at bank stocks going back to 2007, when valuations reached their peak, the U.S. SNL Bank and Thrift index was down about 60 percent through May.

The current global outlook has put a good deal of pressure on bank stocks lately, as well. Even banks that don’t have exposure to European debt are feeling the heat, as the crisis will put a drag on the U.S. economy, Hovde said. And a weak U.S. economy will do nothing for U.S. banks.

“Until we see a healthy economy, we’re not going to have a healthy banking sector,’’ he said. “Until we get employment back, the banking sector is going to have pressure.”

Housing

Housing still is a drag on the economy. Moody’s Analytics has predicted that home values, while improving in some markets, won’t return to pre-crisis levels until 2017. Home prices have lost about one-third of their value since hitting a peak in 2006, according to the Fiserv Case-Shiller composite index.

Profits

On the other hand, banks have been getting rid of bad loans and improving their balance sheets. On the credit side, net-charge offs of bad loans are declining, and tangible capital ratios are slowly being rebuilt, Hovde said.

Profitability has improved, as well, as banks reduced their loan loss provisions year-over-year in each of the past four quarters.

Return on average assets has risen to an average of 1 percent in the first quarter of 2012, up from .76 percent in the fourth quarter of last year, according to the Federal Deposit Insurance Corp.

M&A

A strengthening bank sector has led to slightly better deal pricing in mergers and acquisitions, but deal volume is still very low.

Uncertainty about commercial real estate and housing values still is hindering deals, as well as the fact that the stock of many buyers and sellers’ is trading below book value, Hovde said.

The glut of failed banks could also be putting a crimp on deals in some markets, and Hovde predicted that the Chicago area alone will probably have another 10 to 15 bank failures. Nationwide, there were 403 banks with a Texas ratio greater than 100 percent as of March 31, according to SNL Financial LC. A Texas ratio greater than 100 is an indicator of potential failure. There were 59 banks with a Texas ratio greater than 300 percent, and 36 of them are in the Southeast.

Still, the pace of bank failures has slowed and many buyers are beginning to turn their focus to non-FDIC assisted deals, he said.

“With M&A I think we’ve probably hit the bottom and will probably see it pick up absent another global financial crisis,’’ Hovde said.

A Butterfly Flaps Its Wings In Europe

Posted on April 9, 2012 at 3:54 pm.

Written by Lee Sachs

The Opportunities for Community Banks Arising From the European Debt Crisis

Most of the commentary on the financial crisis in Europe has focused on the acute challenges policymakers must address today, an approach that makes sense given the consequences for the global economy if those issues are not addressed adequately. Less attention has been focused on the opportunity the crisis has created for our own community banks.

The combination of the financial crisis that struck our own country three years ago and the fallout from the European debt crisis may be creating an opportunity for community and regional banks to retake market share lost over the past 20 years. During that period, community and regional banks lost significant market share in almost every loan class, with the glaring exception of real estate lending. The resulting real estate dependent business model has now been called into question by both investors and regulators, and it is hard to see growth opportunities or even long-term survival for community banks that do not adapt to the new environment, in which balance sheets saturated with real estate loans are regarded with growing skepticism.

In a silver lining to the European debt crisis, the retreat by many of the world’s largest banks is providing new lending opportunities for those community banks that have steadily grown their capital and liquidity over the past few years, and are contemplating new ways of generating prudent loan growth.

Until recently, European banks have provided credit to American borrowers across a wide range of sectors, including small and medium business enterprises. Historically, these markets were fertile ground for community banks, but in recent years those banks have seen themselves become less relevant in many of those sectors. While the ultimate outcome of the European situation is unclear, we can be confident that European banks are going to continue to be severely constrained, with substantially less capital reaching our own lending markets.

To give some context for the magnitude of this withdrawal, the European Banking Authority last year announced that European banks must reach a 9 percent Tier 1 capital ratio by June 2012. In aggregate, European banks would have to raise over 100 billion euros of new capital to reach this target with their existing balance sheets. Rather than raise this much equity, however, many European banks have indicated that they intend to reduce their balance sheets to meet the capital target. Estimates suggest that balance sheet reductions could exceed 1 trillion euros. While we do not yet know how much of that reduction will take place in the U.S., some European banks are already pulling back from our market.

There is no reason for this void to be filled exclusively by the country’s largest banks. Many, if not most, of these U.S.-based assets and loans are appropriate for banks both large and small. The challenge for community banks in accessing these loans is two-fold: a question of access and a question of understanding the credits. As these banks engage in markets they may have exited years ago, they need to ensure that they understand the loans they put on their books, and remember lessons learned from the recent real estate crisis. In some cases, the move back to traditional commercial (non-real estate) lending may require investing in the education of loan underwriters and credit officers who find their skills outside of real estate lending may have become rusty.

In order to have access to the best credits surfacing because of this disruption, and to defray the associated sourcing, underwriting and servicing costs, we believe that community banks that choose to work together will be best positioned to compete with their larger brethren. They will be able to fill lending gaps left by the European banks and take advantage of the tail winds finally blowing in their direction.

Do the Europeans have it right?

Posted on July 25, 2011 at 6:58 pm.

Written by Naomi Snyder

European bank boards, it turns out, are a lot different than in the U.S. A study earlier this year by the English bank consultancy Nestor Advisors compared nine of the largest European banks with their nine counterparts in the U.S. (e.g. Banco Santander versus U.S. Bancorp and Wells Fargo & Company). Here is what the firm found:

U.S bank boards tend to have older members. The median age is 63 compared to 59 on the European boards.
U.S. bank boards have fewer designated financial experts than European boards. The difference is 30 percent of board members on European banks versus 15 percent in the U.S.
Six out the largest nine U.S. banks have chairmen who also serve as the bank’s CEO, compared to only two of their European counterparts (BBVA and Société Générale).
U.S. non-executive directors are more often senior executives at other institutions than in Europe. The median number of non-executive directors with outside senior-level jobs is five in the U.S. versus three in Europe.
U.S. bank boards pay their directors with more stock options and less cash than European boards.

By reading the report, you could almost conclude that European banks do a better job following best practices in corporate governance than U.S. bank boards.

Paying stock options could encourage more risk taking, the firm notes. Financial experts might be better qualified to challenge management on matters than impact the bank. Directors who are busy with outside jobs have less time for the bank’s business, presumably.

However, the report notes that large U.S. bank boards tend to be smaller than European bank boards. (The median is 13 directors in the U.S. versus 16 in Europe.) That can encourage more cohesiveness and ability to get work done. U.S. banks tend to have fewer executives and more non-executive directors on the board than European banks. (The median U.S. big bank has 85 percent non-executive directors versus 69 percent for big European banks).

Whether or not these significant differences in board structure translated into any meaningful value for shareholders, or meant European banks avoided the financial crisis better than American banks is another question. (Interestingly, one of the U.S. banks in the study, Goldman Sachs, previously was an investment bank and wasn’t even regulated as a bank before the financial crisis).

Europe is still embroiled in its own problems with an overheated housing market, just like the United States. The Spanish bank bailout fund alone has committed the equivalent of $14 billion in today’s U.S. dollars to recapitalize banks there.

Europe hasn’t recovered yet from its financial hangover, and neither has the United States.