Since the European debt crisis erupted in 2010, continental banks have been in a steady mode of contraction across almost all business lines, shrinking their overall capital flows by 60% since 2007. Barclays, HSBC, Deutsche Bank, and BNP Paribas, have all shuttered or severely contracted their US operations, and now US banks are poised to capitalise on the leftover business, but it will not be easy. Many of the operations were unsuccessful or had major issues, so turning the same areas into profit centers will be difficult. However, many European banks made handsome profits in asset management and private banking, partly by helping Americans dodge taxes, and their departure leaves a gaping and potentially profitable hole for US entities to fill. The business lines generally offer stable returns, low capital commitments, and low risks—all very attractive propositions to American financial firms at present.
FINSUM: The great European experiment of trying to crack US domination of investment banking has officially collapsed this year, as several banks have announced full-scale retreats from the sector. However, whether the US can convert the leftover market share into profitability remains to be seen.
A new article, published in the New York Times, argues that several European Banks may be on the verge of collapse as new analysis shows that many do not have enough of a capital buffer to absorb the bad loan rates they are experiencing. In the late 1980s an equity analyst invented a very simple ratio for assessing the health of Texas banks during a regional debt crisis—the Texas ratio, which simply compares bad loans rates versus the capital set aside by banks. The ECB is expected to come down hard on banks who do not have adequate cash buffers, so investors have been scrambling to decipher which banks may fall victim to heavy scrutiny, or even closure. According to analysis by Nomura, 11 of the Eurozone’s 100 largest banks stood out as having inadequate capital, but three in particular had ratios of over 150% (bad loans vs. capital)—Piraeus Bank, Banco Popolare in Italy, and Banco Popular Espanol in Spain.
FINSUM: This is a very good piece for understanding developments in the European banking sector, and gaining foresight into which banks might disproportionately suffer as the Eurozone potentially enters a long period of decline.
The biggest banks in the world, including Bank of America, Deutsche Bank, J.P. Morgan, Citigroup, and the like, are slowly but surely losing ground to smaller rivals in the tech upstart community. While banks and other major lenders have spent the last half decade adjusting to regulatory reform, new rivals, including huge names like Google and Amazon, as well as smaller companies, have been quietly launching new financial products that are capturing market share from the traditional pillars of the financial system. Google has launched Google Wallet, which aims to replace traditional wallets with a mobile application, and Amazon has launched its own payments system. Smaller players, like Lending Club, are now offering large fundraisings through peer-to-peer lending. Kabbage and Market Invoice, two other young companies, both offer forms of working capital to small businesses.
FINSUM: There is no doubt about it—the strain of regulatory reform, both in the focus it takes, and the markets it constrains, have caused banks to lose total market share. Wise investors should see this as an opportunity to find young stars in the space.
Major Wall Street dealmakers are missing out on massive fees in the formerly lucrative tech space as tech enterprises large and small increasingly shun the advice of banks in favour of conducting mergers and acquisitions entirely in-house. In more than 69% of all the tech deals worth more than $100m conducted this year, the acquiring company did not use an investment bank, up from just 27% a decade ago. According to the tech industry, many feel that banks are poor at evaluating business models and choosing strategic targets, being only useful for valuation and negotiation. In order to avoid banks and their formerly lucrative TMT arms, big tech companies like Google and Facebook are increasingly relying on their in-house corporate development teams, who have a better grasp of the strategic needs of the company and are significantly cheaper.
FINSUM: This is a very important development to keep an eye on as it is yet another way that traditional banking business is moving away from banks. Major dealmakers are losing tens of millions in fees every year from missing out on these opportunities.
Contingent convertible bonds, or Cocos, which are fixed income instruments which either convert to equity or get liquidated entirely in the event of a bank breaching certain capital ratios, have seen a major sell off over the last few weeks. The bonds have become a popular financing option for banks, and an equally popular asset class for investors seeking better returns, but the yields on the bonds have skyrocketed in recent weeks. The announcement this month by Bank of America Merrill Lynch that cocos did not qualify to be included in their High Yield index has led to a mass exit of the bonds, which has sent rates up 70 bp to above 6%. Another issue has been that the UK’s financial regulator, the FCA, has banned the sale of cocos to retail investors in the €45 bn market.
FINSUM: Cocos do present a major risk—especially considering some allow banks to stop paying coupons even while they continue to pay dividends—but at their current yields they may still be attractive to intrepid investors in the current rate environment.