Regulation-burdened European banks cede ground

Any conversation with a European bank executive these days quickly turns to talk of how their US rivals are in better shape. American banks were much quicker in bolstering their capital bases after the financial crisis; they also have more regulatory certainty (in part because they didn’t challenge every proposed rule change).

And in at least one corner of the financial markets, Europeans are ceding market share at an accelerating rate.

International bond underwriting is where the biggest US and European banks compete for the right to raise capital for the world’s biggest borrowers. This year, the total borrowed has reached almost $4 trillion. What has become clear is that European banks are ceding this business to the US, and the consequences will be felt in other areas of their businesses:

At the start of this decade, Deutsche Bank was consistently the No. 2 underwriter of international bonds. Last year, it dropped to sixth place; this year, Germany’s biggest bank is down to seventh. In 2010, Deutsche Bank controlled 7.3 per cent of the international bond market; this year, its share is down to 5.1 per cent.

With CEO John Cryan continuing to make cuts to the investment bank, it seems unlikely that Deutsche Bank’s appetite for bond sales will return anytime soon.

Who will fly the European flag? Not the UK’s Barclays, which led the pack for international bond management at the start of the decade, topping the 2010 table with a market share of more than 8 per cent. Like Deutsche Bank, Barclay’s has been shrinking its investment-banking activity amid tougher post-crisis capital regulations from regulators.

While it remains third in the league table, its share has dropped to 6.8 per cent, behind both JPMorgan and Citigroup.

Barclays is now poised to discard as many as 7,000 of its least-profitable corporate customers, in addition to the 17,000 clients it’s already jettisoned since 2014. Shedding customers is a sure-fire way to shrink your balance sheet — as well as your revenue and your potential profit.

Other European banks seem to be giving up on bond underwriting altogether. In 2010, Royal Bank of Scotland was a credible player in international bond management, with a market share of a bit less than 4 per cent putting it in 11th place in the underwriting table. Now, it has less than 1.4 per cent of the business.

The bank has been distracted by scandals and management problems. It mis-sold loan insurance to UK retail customers, faces investor lawsuits over how it raised capital in 2008, and is being probed in the US over mortgage-backed securities.

It failed the Bank of England’s stress tests last month, eight years after a taxpayer bailout that saw it made a ward of the state at a cost of more than 45 billion pounds. Little wonder it’s poised to report its ninth consecutive annual loss in February.

The Swiss banks have fared no better. At the start of the decade, Credit Suisse and UBS were, respectively, the sixth and seventh biggest managers of international bond sales, each with about 4.3 per cent of the market.

This year, Credit Suisse is down to 11th with 2.5 per cent of the business. UBS is 16th, with a 1.8 per cent share. That’s a major decline from the early days of the Eurobond market when some three-quarters of all the newfangled securities were bought by Swiss investors.

So if the Europeans are effectively letting the international bond market slip away, who’s benefiting? JPMorgan tops the table with 7.8 per cent, as it did last year with 8 per cent; that’s about the same as its position at the start of the decade.

Citigroup has improved its standing to second from third, and increased its business to 7.2 per cent from 6.5 per cent in 2015; in 2010, it was a lowly eighth, with 4 per cent.

But it’s Goldman Sachs that has been making hay. In sixth place with 5.6 per cent of the market, it’s little changed from last year but up from 10th with less than 3.9 per cent in 2010.

The one bright spot on the European map comes courtesy of HSBC Holdings. As the US sub-prime mortgage crisis took off, the UK bank was quick to realise that Household International, the US lending business it paid $15.5 billion for in 2003, was bust. It was the first European bank to make provision against sub-prime losses, and was quick off the mark in raising almost $18 billion in fresh equity in 2009.

As a result, HSBC is one of the few European firms that hasn’t been actively shrinking its balance sheet. Its total assets of $2.6 trillion are bang in line with the average for the first half of the decade.

With its market share rising to 6.6 per cent from 5.2 per cent, HSBC Holdings is also one of the few European banks to have increased its international bond underwriting business since 2010 (France’s BNP Paribas has improved a tad to 4 per cent from 3.9 per cent, leaving it little changed from last year).

It’s telling, then, that HSBC’s shares are up more than 20 per cent this year, compared with Deutsche Bank’s 20 per cent decline and Barclays’s basically unchanged valuation in 2016.

The universal banking model — in which banks both serve retail and corporate customers — was always likely to struggle as market overseers try to resolve the too-big-to-fail problem. Trying to provide a one-stop shop in finance is hard enough in the good times, let alone in an environment where regulation makes some businesses unprofitable by increasing how much capital has to be set aside against potential risks and losses.

But banks that don’t commit capital to underwriting bond sales for their clients are likely to miss out on more lucrative deals, such as mergers and acquisitions.

Europe’s finance firms risk becoming irrelevant if they concede too many markets to their American cousins, and that can’t be good for the companies or the economies that they serve.