We’re in full-on bank earnings season in Europe. By and large, it’s been OK albeit with some ups and downs across business lines and geographies depending on each bank’s strengths and positioning. On a sector-wide basis, though, underlying businesses are intact and messaging from management remains cautiously upbeat. Despite the unsettled economic and geopolitical backdrop, there’s not yet been any notable asset-quality deterioration or perturbing capital depletion.
On the corporate and investment banking and wholesale front, robust institutional trading activity as well as wider net interest margins from incipient rate normalization have been generally positive factors. On the negative side, lower investment banking deal flow took its toll. EMEA investment banking fees fell 35% in the first half of 2022, according to Refinitiv, as international bond volumes fell 28%, European syndicated lending fell 42% to its slowest first half for 20 years, and EMEA equity capital markets activity fell 68%.
Meanwhile, banks active in leveraged finance took some reasonably large write-downs as that market continues in flagrant distress. Banks with LBO bridge commitments on the balance sheet just can’t shift them into the institutional market as deal economics have moved wildly out of sync.
Credit Suisse had already telegraphed that it would report a second-quarter loss and it duly did so. Less well telegraphed was yet another strategic review with an update at the third-quarter stage (spoiler alert: the investment bank is going to get crushed as the group hard-pivots to wealth management). The appointment of a new chief executive officer was not a total surprise. See my recent comment about the former CEO in this column.
In recent years, CS has firmly taken the baton from Deutsche Bank as the bête noire of European banking. Deutsche Bank, incidentally, said it posted its highest Q2/H1 post-tax profits since 2011, showing how it’s moved from the outlier category.
Series of mishaps
But is it reasonable to ask whether Barclays, whose earnings were also out last week, has been knocking a little too often on the door of the exclusive club of accident-prone European banks?
The UK group suffered a series of mishaps and reputational misadventures under Jes Staley (actually largely because of Staley): his relationship with Jeffrey Epstein; those whistleblower infractions that got him fined; that conflict-of-interest issue over KKR’s acquisition of his wife’s family’s company Aceco TI in Brazil that led to a bitter dispute. The blunders have continued into the tenure of C.S. Venkatakrishnan, who took over as CEO in November 2021.
Monday, August 1 will go down as an ignominious date in the Barclays diary as it marks Day 1 of a 30-day offer to buy back securities from or compensate investors as the bank rescinds a tonne of structured and exchange-traded notes it over-issued under its US shelf registration. And prepares for an SEC fine. This was no matter of a few bonds over the limit: it’s hard to figure how the bank could have sold US$14.8 billion of structured notes and US$2.8 billion of ETNs above the US$20.8 billion upper limit of its US shelf. The small-print, tightly-scripted list of securities over-sold runs to 38 pages!
The saga, running since March, dominated Venkatakrishnan’s first H1 earnings report last week, which contained just one mention of recession and 55 mentions of rescission. The financials and supporting narrative were full to bursting of references to “excluding the impact of over-issuance of securities”. The direct impacts of the over-selling were responsible for:
- a chunky £600 million (US$731 million) dent in attributable profits – £400 million from the rescission offer, £200 million accrued for an SEC penalty;
- 80% of litigation and conduct charges of £1.86 billion; L&C charges themselves were over 20% of group operating costs;
- a balance-sheet provision of £1.76 billion that the bank says may not be enough as hedges may not be sufficient to cover exposures;
- a 40 basis point reduction in the Core Equity Tier 1 ratio; and
- a reduction in return on equity from 12.5% to 10.1% (scraping the lower bound of management’s target of +10%).
Barclays acknowledged, with exquisite understatement, material weaknesses in internal controls. It said there was no evidence of intentional misconduct but there clearly were monumental monitoring failures after the bank’s status under US securities law changed from 'well-known seasoned issuer' to 'ineligible issuer' that required it to pre-register issuance limits under its US Shelf with the SEC.
Not wishing to discount further lapses coming to light, management added a 'just in case blanket get-out': “internal control systems (no matter how well designed) have inherent limitations and may not prevent or detect further mis-statements or errors (whether of a similar or different character to the foregoing)”.
Management then went all out for a domino effect of doom, saying ineffective controls leading to material misstatements in the financial statements and failure to meet reporting obligations could cause investors to lose confidence in the group's reported financial information, leading to limits to the group's access to capital markets and negatively impacting the trading price of its securities. Ineffective internal control over financial reporting, management continued, could expose the group to increased risk of fraud or misuse of corporate assets.
Potentially overstating the case but it at least covers all downside bases.
Venkatakrishnan, who as a risk manager cuts an altogether staider figure than Staley, should be alarmed about the overselling blunder. Not just because the issue has dominated his time to-date as CEO; more so because the overselling took place while he was chief risk officer. Shareholders are reportedly furious. They are demanding answers and want heads to roll.
The review into this being conducted by Barclays and external counsel is at an advanced stage, we’re told. We could be close to finding out whose heads.