By Cyrus Sanati
FORTUNE -- Banks in the U.S. have had a tough earnings season, but their counterparts across the pond in Europe seem to be having an even harder one. From Deutsche Bank to UBS to Rabobank, it seems that old demons and lackluster performance have hit the purse of nearly every integrated European bank.
But European banks have an even more worrisome problem in the form of nonperforming loans, which have more than doubled to an estimated 1.2 trillion euros in the last five years. And banks had hoped to pay off their commitments and square their legal woes with future earnings, but that hasn't gone very well. It may be time for them to finally face facts and start truly selling assets to cover their bills and clean up their balance sheets once and for all.
Deutsche Bank (DB), Europe's largest bank, shocked the market earlier this week when it reported results that were well below analyst estimates. A surprise 1.2 billion euro provision for litigation charges in the quarter ending in September pushed the firm's net income down some 94% from the same time last year to 41 million euros. That was less than a tenth of the 430 million euros expected.
And Deutsche Bank is far from alone here. It seems like every major international bank is facing similar issues -- to varying degrees of severity. Rabobank, the Dutch bank, recently said it paid some $1.1 billion for its role in manipulating Libor. Regulators aren't taking any chances here and are pushing banks to put aside the necessary cash to cover their future legal claims. Swiss regulators actually ordered UBS (UBS) to add to its litigation reserves last quarter even though it had already settled its Libor legal woes, promising to pay some $1.5 billion for its role in the worldwide scheme.
In the last few quarters the banks had actually started to decrease their legal reserves for the first time in years as many had believed that the worst was behind them. After all, it had been well over five years since the lead-up to the financial crisis. If there were any future legal issues, they gathered they could simply pay for them using current earnings.
Unfortunately it hasn't worked out that way. Not only have the legal issues continued to gnaw at earnings, the banks have had a hard time making money. For example, Deutsche took a 10% hit to its overall revenue in the last quarter thanks to poor operating performance in several key divisions. The firm's massive fixed income trading desk reported revenues that were down some 50% from the previous year.
As the banks struggle to keep their head above water they will also be expected to meet new and stringent capital reserve requirements. The European Central Bank announced last week it would be conducting new stress tests on 128 banks to see if they have the necessary capital on hand to deal with another financial crisis. With diminished cash on hand due to the poor operations and even more stashed away in litigation reserves, the banks will need to somehow pump up their equity to meet the European capital requirements, which call for banks to have at least 8% of their capital on hand at all times.
Banks in the eurozone have clearly been backed into a corner. The stress tests performed by the ECB are expected to be more stringent than the ones in the past, so many banks will need to shore up their capital base. This is made even more pressing given that the banks have some 1.2 trillion euros of nonperforming loans on their books, according to a report by PwC. That means that they will probably need to be written down, requiring the banks to raise even more capital.
Banks have several ways to address this solvency issue. They could hoard capital by cutting back on lending, but regulators probably won't let them do that. They could sell more stock, but issuing equity in this manner dilutes current shareholders, making them very angry. Banks that are in real trouble could ask for assistance from their respective governments, but this really hurts the bank's reputation and adds a whole host of new problems.
Probably the best way to get out of this mess would be for the banks to simply offload assets. This would lower the amount of capital they would need to have on hand, since it shrinks the denominator in the capital buffer equation. Banks in Europe have around 46 trillion euros in assets, so there is plenty of stuff they can sell. But they have been reticent to shrink. So far this year, European banks have sold just 46 billion euros in assets, equating to a tiny 1% of total assets.
As such, the European banks will need to step up their asset sales in the next few months if they hope to meet their capital requirements and fill the holes left by failed loans. PwC estimates that the banks could offload some 2.4 trillion euros next year. While that is a significant bump up from sales this year, it still might not be enough to meet the new capital requirements.
But too many assets hitting the market at the same time could be counterproductive as it would send asset prices tumbling. The ECB could prevent a massive fire sale by creating a resolution trust corporation that the banks could transfer assets to for sale at a later date. This would get the assets off the banks' balance sheets without having to take a nasty write-down, which would make the situation even worse.
It seems like the earliest movers will be able to gain the best prices for their assets. American and Asian investors have poured billions into the continent this year betting on an economic recovery in the region, so they will probably be hungry for any kind of European investment vehicle. If the recent dismal earnings reports are any measure, then there will probably be plenty of assets for investors to pick through.
Some Swiss bank holders may choose to move funds to other offshore havens like Singapore or the Cook Islands.
By Lynnley Browning
FORTUNE -- Americans living and working in Switzerland aren't feeling much joy these days on strolls along the Rue du Rhone in Geneva, where luxury watch shops and Gucci and Hermes boutiques nestle amid a clutch of private banks.
Thanks to a landmark settlement last Friday between Switzerland and the MORESep 3, 2013 10:26 AM ET
Nigel Dawn leaving at the end of July.
FORTUNE -- Nigel Dawn has stepped down as a managing director with UBS, where he is co-head of the investment bank's private funds group and head of its private equity secondaries business.
Fortune has learned that Dawn informed his 20-person team of the move within the past week, and that no formal decision has been made on his successor. He will remain with UBS MOREDan Primack - Jun 12, 2013 4:57 PM ET
If the recent quarter's pace continues, 2013 will become a landmark year for saying goodbye to America, tax-wise.
By Lynnley Browning
FORTUNE -- Americans are ditching their U.S. passports in record numbers, a sign of growing frustration with a system that taxes U.S. citizens on their global wealth whether they live in Montana or Mongolia.
The latest bold-faced names to relinquish their U.S. citizenship include Mahmood Karzai, a brother of Hamid Karzai, MOREMay 8, 2013 1:35 PM ET
The Justice Department got a black eye last week in a case involving a 79-year old Florida widow with $43 million in offshore accounts.
By Lynnley Browning
FORTUNE -- Federal judges usually dislike tax evaders, and in recent years they have imposed hefty fines, lengthy probation, and even prison sentences on dozens of Americans with offshore bank accounts. But the watershed case of Mary Estelle Curran, a 79-year-old widow who earned MOREApr 29, 2013 2:33 PM ET
Mark Zanoli leaves UBS.
FORTUNE -- Mark Zanoli has stepped down as head of U.S. technology investment banking at UBS, Fortune has learned.
Zanoli originally joined UBS (UBS) in July 2010, following 17 years with J.P. Morgan (JPM) and Hamrecht & Quist.
He was based in San Francisco, and at one point led a team of around 40 professionals. That figure was slashed by more than half late last year in a large round MOREDan Primack - Mar 25, 2013 2:44 PM ET
Deal marks the second mega-buyout this week, expands John Malone's empire
FORTUNE -- Liberty Global (LBTYA) today agreed to acquire UK- based cable company Virgin Media (VMED) for $23.3 billion, a move that signals the market is willing to support big, high-price deals and also creates one of the world's largest broadband communications companies.
Liberty's announcement about the acquisition was released just hours after computer maker Dell Inc. (DELL) said it was being MOREKatie Benner - Feb 5, 2013 9:20 PM ET
The Justice Department's case against UBS shows borrowers were likely hurt.
FORTUNE -- Early on in the Libor scandal, there was a sense that the systematic rigging of a key lending rate was a victimless crime. Wednesday's Justice Department charges against UBS should finally dispel that notion.
It was assumed that if Libor rates had been pushed lower, as appeared to be the case, borrowers would have benefited. Even some municipal finance MOREStephen Gandel, senior editor - Dec 19, 2012 1:01 PM ET
Behold an exciting new feature of the post-bailout era: the megabank that wanders the globe with the weapons of financial mass destruction strapped to its chest.
UBS (UBS), the giant Swiss bank that took $59 billion in bailout funds three years ago in addition to billions of dollars in conveniently cheap Fed loans, is chafing at the restrictions that terrified regulators there are imposing.
The government wants to avoid having its Godzilla-scale financial firms – MOREColin Barr - May 26, 2011 11:19 AM ET
Another day, another black eye for Wall Street.
UBS (UBS) agreed Wednesday to pay $160 million to settle charges it defrauded local government bond issuers for five years through a bid-rigging scheme. The scheme drove up the prices municipal issuers paid, the authorities said, and delivered millions of dollars in ill-gotten gains to the Swiss bank.
UBS rigged more than 100 bond auctions in 36 states between 2000 and 2004, officials said. UBS, MOREColin Barr - May 4, 2011 3:52 PM ET
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