Uncertainty about the scale of penalties for US retail mortgage-backed securities (RMBS) practices more than 10 years ago will continue to weigh on some European banks’ capital management and dividends, Fitch Ratings says. They expect cautious capital retention to be a theme as the 2016 results season for European banks reaches its final stage.
The threat of large, unpredictable settlements hangs over a few European banks that have not settled yet, adding to the pressure on earnings and capitalisation from low interest rates and increased regulation. As a result, we expect banks will continue to prioritise cautious capital management and dividend policies, even though most have strengthened capital positions considerably since the financial crisis.
The US Department of Justice’s (DoJ) investigation into banks’ pre-crisis RMBS business has already cost USD31bn in cash settlements for eight of the global trading and universal banks. The DoJ examined the banks’ pre-crisis practices, including packaging, securitisation, marketing, sale and issuance of RMBS. European banks Deutsche Bank and Credit Suisse are the most recent to settle with the DoJ, agreeing to pay substantial fines of USD3.1bn and USD2.5bn, respectively, and to provide consumer relief.
Investigations into other European banks, notably RBS, Barclays, UBS and HSBC are ongoing. Barclays rejected a settlement in late 2016 and now faces a lawsuit. RBS, unlike other European banks, also still has a pending lawsuit with the US Federal Housing Finance Agency, which we estimate could add about USD3bn (based on an average past settlement rate of 10% of exposure) to any settlement with the DoJ.
Monetary fines have only constituted part of the settlements, and substantial amounts have been agreed in the form of so-called consumer relief, which we believe are proving far less punitive in financial terms. Consumer relief can include loan forgiveness, origination of lower cost loans and financing for affordable housing, targeted at the most vulnerable customers. Deutsche Bank has until 2022 to complete its USD4.1bn required consumer relief, and Credit Suisse until 2021, to complete USD2.8bn.
Pending regulatory and litigation settlements are factored into our analysis as a contingent liability. When a large settlement is reached, we assess the incremental cost in cash terms above provisions already booked and the affordability of the remainder through earnings. When a settlement will absorb at least two quarters’ earnings, we assess its impact on capital and the bank’s plans to remediate the capital effect.
We do not expect the outstanding investigations to lead to significant new restrictions on banks’ businesses or to damage their franchises. Banks have tightened conduct risk controls extensively in the period since the RMBS activity under investigation took place.