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For Internal Use OnlyNot For External Distribution This document is the property of Standard & Poors. It contains proprietary and confidential information and is for internal use only by Standard & Poors employees. This document shall not be shown or provided to anyone other than Standard & Poors employees. Potential Bank Rating Implications Of The Banking Union Stefan Best, Managing Director European Financial Services email@example.com Copenhagen 27 February, 2014
Agenda Topics: Western European Bank Ratings And Outlook Banking Union: Potential Rating Implications Conclusion 2
We See the Following Credit Trends 7 Deleveraging and restructuring to continue Potential for further large credit impairments (weak economy and upcoming asset quality review and stress tests) Earnings pressure will persist (weak economy, low interest rates, deleveraging, restructuring, litigation, regulatory changes) Initiatives to reduce funding gaps and repay ECB LTROs Capital strengthening Adapt to evolving bank resolution legislation
Banking Union Update InitiativeObjectiveStatus Single rule bookUniform application of Basel 3 in all member states Approved Effective Jan. 2014 Single Supervisory Mechanism Common supervision of the about 130 largest banks in the euro area but open to all EU member states Approved Effective Nov. 2014 Single Resolution Mechanism and BRRD Align supervision and resolution at central level Create single resolution fund (SRF) Comon legislation on bank resolution (BRRD) To be agreed on before the elections in May 2014 BRRD/SRM effective by Jan. 2015 Bail-in tool Jan. 2016? Direct bank recapitalization through ESM Provide financial backstop besides SRFRequires finalization of BRRD/SRM Common Deposit Guarantee Scheme Strengthen customer confidence and stability of banks' funding bases Progress uncertain Structural Reform Measures EU Too-big-too-fail banks: Reduce risk of failure Facilitate bank resolution Ease monitoring and supervision EC Proposal on Jan 29, 2014 Prop trading ban Jan. 2017? Separation other trading July 2018? 10
The ECB will conclude its assessment in October 2014 Scope: Supervisory risk assessment: liquidity, leverage, funding Asset quality review: all asset classes (valuation, provisioning) Stress test: no details on methodology/scenarios provided Goals: Greater transparency, balance sheet repair, confidence building Capital thresholds: CET 1 of 8% (AQR); 5.5% (Stress test) Timeline for follow up/corrective action uncertain National public backstops if private sources for viable banks are insufficient We believe that the review could accelerate balance sheet repair We may adjust ratings for weaknesses that we have not identified yet 11 Comprehensive Assessment By The ECB
Ban on prop trading for deposit taking institutions which would apply to ~30 of the biggest EU banks Would prohibit activities for the sole purpose of making a profit for own account without any connection to actual or anticipated client activity in banks that meet certain criteria and exceed a specified threshold (applicable from 1 Jan. 2017) Would also prohibit the same banks from investing in hedge funds Grant supervisors the power or obligation (BRRD Art.13) to require the transfer of other high-risk trading activities such as market making, complex derivatives and securitization (applicable from 1 July 2018) Rules on operational links between trading entity and rest of the banking group to ensure that separation is effective BRRD – Art. 14 already gives the authorities the powers to address or remove impediments to resolvability (including the power to require changes to the legal or operational structures of banks) Likely to apply to foreign subsidiaries of EU banks and EU branches of foreign banks (exemptions possible for third country equivalence regime) Proposed Structural Reform Measures
Uplift to the SACP for potential government support Source: Banks: Rating Methodology And Assumptions Nov. 9, 2011 Moderately high" likelihood of extraordinary government support The long-term counterparty credit ratings on highly systemically important Western European banks is up to two notches higher than the SACP, reflecting our view of a moderately high" likelihood of extraordinary government support (up to one notch higher for moderately systemically important banks) 13
Systemic importance, according to our criteria, is the degree to which a bank's failure affects all or parts of the financial system and the real economy of the country where the bank operates. We currently regard almost all top 50 Western European banks as highly systemic. In most cases, this leads to a 1 or 2 notch support uplift in their current rating, as well as to the ratings of their subsidiaries. Emerging resolution powers could have implications for the notches of government support currently included in ratings on systemically important banks –We could re-classify governments as less supportive –We could re-classify banks as less systemically important –There may be specific risks associated with particular classes of debt (e.g. subordinated) –Parental support for foreign subsidiaries and branches may be less certain Changes to business and financial profile could affect ratings up or down There may be other specific implications –For example, in the U.S., the FDICs proposal for a single point of entry could affect ratings on bank holding companies 14 Measures To Reduce Implicit Government Support
Although political consensus is emerging, obstacles for resolution remain which means that providing extraordinary government support to senior creditors in a timely fashion remains a strong possibility Resolvability of banks: that is, the ability to stabilize a failing institution and effect an orderly wind-down The need to preserve confidence in the banking system and support economic recovery Common resolution tools and legislation Sufficient long-term liabilities eligible for bail-in For internationally-active banks, it remains unclear how authorities will be able to ensure coordination when executing a resolution We expect most Western governments to remain supportive of the senior creditors of systemic banks while economies recover and resolution regimes develop We will continue to review rating implications as resolution powers become more advanced and harmonized, and more banks become easily resolvable 15 Measures To Reduce Implicit Government Support
Regulation, Supervision, Legislation: Single Rule Book Single Supervisory Mechanism Single resolution mechanism/BRRD Structural reform Financial backstops Rating factors: BICRA: Economic and Industry Risk Business position: Stability, Diversity, Restructuring needs Capital & Earnings: Capital buffers, Operational cost, Earnings potential Risk position: Growth, Concentration, Complexity Funding & Liquidity: Liquidity buffers; Funding mismatches; Funding access; Asset Encumbrance Government support: Ability and willingness Group support: Fungibility/Ringfencing 17 New regulation, supervision, and legislation can affect bank ratings positively and negatively in multiple ways
Conclusions European banks are navigating in uncertain times The five key risks that we have identified some time ago continue dominating bank ratings 1.Weakening sovereign creditworthiness 2.Threat of economic recession or only sluggish recovery 3.Funding constraints 4.Transition to more stringent regulatory requirements 5.Changing nature of government support Extraordinary support has been the key stabilizing factor for many European bank ratings Banking Union can affect bank ratings positively and negatively in multiple ways Impact depends on banks´ business and financial profile and how banks´ managements, authorities and market participants respond to these changes
Contact Information Stefan Best, Managing Director Tel. +49 69 33 999 154 Email: firstname.lastname@example.org You wish to receive information crisp and visual? Visit http://www.understandingratings.com to find recent research articles promoted with 5 minute video clips (CMTVs).
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