With Credit Suisse’s rapid downfall and weekend firesale to UBS, many are wondering about the health of the world’s biggest banks and how their balance sheets can hold up to any future stress. Big banks may also be referred to as global systemically important banks (GSIBs). If you aren’t familiar with the GSIB concept and regulatory requirements, you can read more in our recent blog here.
With the CS-UBS deal now formalized and global central banks attempting to put out small fires wherever they arise, the question remains how strong are the GSIBs balance sheets and how well capitalized are they?
Our analysis shows that even though large Western European banks have slightly better capital ratios than the big U.S. banks, they have higher perceived credit risk and are expected to be less profitable. Let’s dive in.
How do the Big U.S. Banks’ Capital Ratios Stack Up to European Peers?
The large banks in western Europe are well-capitalized and stack up well to their large U.S. peers. This is encouraging as it suggests that the biggest banks are well-positioned to weather small shocks to the global economy and financial system, even as smaller banks in the U.S. and possibly other jurisdictions begin to see risks.
We define the big banks as those with more than $1 trillion of assets in the banking and financial services industry groups. In western Europe, this results in 11 companies while the U.S.yields six. It turns out that the large European banks are slightly more-capitalized than their U.S. peers, suggesting their balance sheets could prove even more resilient to potential shocks.
This may be surprising to some who remember the European banks showing signs of varying distress in the years following the Global Financial Crisis in 2008. But since those tumultuous years, they have built up significant capital buffers to prepare for the next shock.
Source: Bloomberg, Roundhill Investments, March 2023
As of their latest financial reports, the average common equity tier 1 capital ratio (CET1 ratio) of the 11 largest western European banks was 13.5% - meaning that the common equity portion of their tier 1 capital was equal to, on average, 13.5% of their risk-weighted assets. Their total tier 1 capital ratio was 15.9%. The big U.S. banks have very strong capital ratios themselves but are lower than European peers at 13.1% for CET1 and 14.5% for total tier 1 capital ratio.
Source: Bloomberg, Roundhill Investments, March 2023
Where Does the Combined UBS-Credit Suisse Stack Up?
Note that in the above analysis, pro-forma for its announced acquisition of Credit Suisse, UBS’s total assets would jump to $1.7 trillion vs. $1.1 trillion standalone. Although the bank did not provide pro-forma capital ratios during its merger presentation to investors, it expects to have a CET1 ratio “well above” 13% upon closing vs. 14.2% standalone. Given the short time frame in which the deal came together, UBS still has work to do to figure out exactly where these metrics will shake out.
UBS’s statutory incremental capital buffer under the GSIB structure is expected to increase to 2% from 1% currently as it is expected to move up to bucket 3 from bucket 1. This incremental capital buffer is on par with Bank of America, Citigroup and HSBC.
Are European Banks Perceived as Less Risky Than U.S. Peers?
Even with higher capital ratios, the market still perceives the big banks in western Europe as slightly more risky than their U.S. peers. The average Bloomberg Issuer Default Risk Implied Credit Default Swap Spread for the big European banks of 89 basis points is a good deal higher than the 71 basis point average of the big U.S. bank peers (1 basis point = 0.01%).
For reference, credit default swaps are a way for bondholders to purchase insurance against default or other credit events by paying a fixed spread, the CDS spread. A higher CDS spread suggests a higher cost to insure against a credit event, meaning the market perceives the underlying issuer to be more risky.
More-Profitable U.S. Banks
Alongside having lower perceived default risk than European peers, the big U.S. banks are also expected to be more profitable despite their slightly lower capital ratios. The consensus forward return on equity (ROE) of the big U.S. banks is 10.9%, a good deal higher than the 9.4% expected for the European peers. This makes sense - if you’re holding more capital, you’re not investing that in growing earnings and generating lower return on equity.
Source: Bloomberg, Roundhill Investments, March 2023
Among the big U.S. banks, JPMorgan Chase is forecast to post the highest ROE in the next 12 months (13.8%), per consensus, followed by Morgan Stanley (13%) and Goldman Sachs (11.4%). In Europe, consensus expects UBS to post a 12.4% ROE in the next 12 months, though that could be revised following the takeover of Credit Suisse. After UBS, HSBC (12.2%) and Lloyd’s (10.8%) have the highest consensus ROEs.
Where Next for Big Global Banks?
It’s likely that in the wake of the firesale of Credit Suisse to UBS and the collapses of Silicon Valley Bank, Silvergate Capital and Signature Bank that regulators will reassess capital requirements of banks of all sizes and increase the frequency and rigor of surveillance. Fortunately, the big banks that are designated as GSIBs and meet certain asset thresholds are already subject to much more strict standards than smaller peers such as regional banks and may see less of an impact to profitability from potentially tighter standards for those smaller peers. The big U.S. banks will continue to navigate a fine balance between risk aversion and profitability in what is an increasingly uncertain economic, financial and regulatory environment.
The information contained in this blog is for informational purposes only and does not constitute financial, investment, tax or legal advice. The information expressed herein reflects the opinion of Roundhill Investments (“Roundhill”) on the date of production and are subject to change at any time without notice due to various factors, including changing market conditions. Where data is presented that is prepared by third parties, such information will be cited, and these sources have been deemed to be reliable. Roundhill is separate and unaffiliated from any third parties listed herein and is not responsible for their products, services, policies or their content. All investments are subject to varying degrees of risk, including the risk of the loss of capital, and there can be no assurance that the future performance of any specific company, strategy or product referenced directly or indirectly in this blog will be profitable, perform equally to any corresponding indicated historical performance level(s), or be suitable for your portfolio. Past performance is not an indicator of future results.
