Despite huge losses, Western banks have retained their dominance of the rankings due to massive capital raising. But what will the future hold? Geraldine Lambe reports Research by Valentina Lorenzon, Cecile Sourbes and Charles Piggott

The impact of the crisis on bank profits is a central feature of this year’s Top 1000 listing,with total profits of the listed banks plunging 85.3% from $780bn to $115bn and return on capital sinking from 20% in 2008’s ranking to a paltry 2.69%.

But as banks have written off losses, they have also recapitalised – often with government support – so that total Tier 1 capital has risen 9.7% to $4276bn. Assets have also grown by 6.8% to $96,395bn but at a much slower pace than previous years, with the doubling of the asset base between 2003 and 2008 now clearly visible as a key contributor to the crisis.

What stands out strongly in this year’s ranking is that the status quo in banking remains in place. While Chinese and Spanish banks head the table for best profit performance, it is still Western institutions that dominate the upper reaches of the ranking, with the position of some enhanced by crisis-led consolidation.

Profit shock

The shocking 85.3% collapse in profits reveals the full extent of the carnage in the global banking system. After four years of above 20% profit growth, last year’s figure, based on full-year 2007 figures, stayed relatively flat with a loss of 0.7%. Because aggregate bank profitability (total pre-tax profits to total Tier 1 capital) was still a handsome 20% in 2008’s ranking (slipping from a record 23.4% in 2007), it was hoped that healthier parts of the financial system would be able to offset losses in US and Europe.

This year, however, aggregate profitability has sunk to just 2.69%.

For the first time in the Top 1000’s 39-year history, the top 25 banks – which account for almost 40% of the Top 1000’s Tier 1 capital and almost 45% of its total assets – recorded a loss, which totalled $32.37bn (-28.1% of Top 1000 profits). Stripping out the profits of the lower reaches of the Top 25 means that the top five banks fared even worse. Representing 13.4% of total Tier 1 capital and 12.3% of total assets, the top five banks lost a staggering $95.8bn (-83.3% of total profits).

The worst losses are at the UK’s Royal Bank of Scotland, with $59.3bn (including losses attributable to minority interests), followed by the US’s Citigroup, with $53bn, and Wells Fargo, which lost $47.7bn. The UK’s HBOS produced the sixth worst losses in the world (see table of worst losses).

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Top 1000 World Banks 2009

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Top 1000 World Banks 2009 – The ranking results summarised

Surprising stability

It is either comforting or surprising, then, that the Tier 1 capital ranking itself shows little change in composition and positive growth in terms of aggregate levels. With so many banks requiring government help to shore up their capital base and many banks being forced to sell assets, some pundits (and banks) suspected that this year might see a seismic shift among the top ranks of the capital listing.
Not so. Aside from three new entrants (Goldman Sachs at 13, Morgan Stanley at 17 and Agricultural Bank of China, in at 24 from 71) the Top 25 is composed of much the same institutions as last year, dominated by Western banks with a sprinkling of Japanese and Chinese players. The same US and UK banks have jockeyed for the top five slots: JPMorgan takes pole position, followed by Bank of America, Citigroup, Royal Bank of Scotland and HSBC (see table, Top 25 by Tier 1 capital.)

Even when government capital is removed from the calculation (see table, Top 30 excluding government capital) it does not drastically alter the ranking: JPMorgan and Bank of America retain first and second positions, HSBC rises to third, Mitsubishi UFJ rises from seventh to fourth, and ICBC is lifted from eighth to fifth. Industry consolidation has played a decisive role in three of the top five banks’ positions.

JPMorgan’s takeover of Bear Stearns and Washington Mutual propelled it into first position, Bank of America’s acquisition of Merrill Lynch pushed it to second, and Wells Fargo’s acquisition of Wachovia enabled it to jump from 23rd to sixth place. UK banks Lloyds and HBOS officially combined too late for the ranking but would have entered the top 25 at 16th just behind UK rival Barclays on consolidated numbers.

The relative stability of the Top 1000 is not as counterintuitive as it may seem. With regulators pushing banks to increase capital, there has been feverish issuance activity in the capital markets. And government capital injections mostly consisted of non-cumulative preference shares, which count towards Tier 1. As a result, Tier 1 capital has still grown in the past 12 months, if at a slower pace: the Top 1000 banks’ total Tier 1 capital – including government capital injections – rose by 9.7% this year, to $4276bn, compared with 2008’s rise of 15.9%.

Value of Tier 1?

How are we to interpret the overall growth of Tier 1 capital and lack of change in the Top 1000 ranking against  the dire results across so much of the industry last year?
Some argue that Tier 1 – which in its broadest sense includes equity, preferred shares, subordinated and other long-term debt, goodwill and intangibles – has become so loose as a measure of capital strength that we can no longer by its measurement judge an institution’s capacity to absorb losses.

During the crisis, banks collapsed (or came perilously close to collapse) that previously were deemed to be adequately capitalised. In the US, critics argue that the government made its stress tests easy to pass by massaging what qualified as Tier 1.

Moreover, as a result of what the Financial Times’ John Gapper calls the “relentless deflation of asset [quality] and inflation of capital [value]” that the banks have engaged in, US banks that the government instructed to raise billions more in capital following the stress tests were, by Basel standards, in rude health.

For example, Bank of America had a Tier 1 ratio of 10.1% in the first quarter of this year, while Citi’s Tier 1 ratio was 11.9%. In other words, both had two to three times the minimum ratio of capital.

The Banker’s benchmark Top 1000 ranking is based on a much stricter definition of Tier 1 capital than the broadest interpretation. It includes only the core of a bank’s strength: common stock, disclosed reserves and retained earnings. It excludes cumulative preference shares, revaluation reserves, hidden reserves, subordinated and other long-term debt; it deducts goodwill (see How we did it). The Top 1000, then, is evidence of the success of the enormous efforts by financial institutions and governments to recapitalise and reinvigorate the banking system.

Capital raising bonanza

Globally, the financial industry has raised $998.9bn in total bank capital since the crisis began, against a total of $1040.7bn in write-downs and losses. In Europe, capital raising has exceeded losses, at $422.3bn versus $420.7bn, respectively. In Asia, banks have raised $75.9bn against losses of $37.3bn. Only in the Americas have losses outpaced capital raising, with $500.7bn versus $582.6bn (see table of credit write-downs and capital. Note: this includes losses and capital raising from H1 2009, which do not count towards The Banker’s 2009 Top 1000).

Individually, many banks have repaired holes and boosted capital on top. Citigroup, for example, has raised a total of $104.3bn against losses of $101.8bn. Barclays has raised $29.6bn against losses of $19.9bn. Our highest new entrant to the Top 1000, Goldman Sachs, last year raised $5bn in preferred shares by way of Berkshire Hathaway and $5bn in common stock by public offering, in addition to the $10bn in preferred shares taken by the US government – this against losses of $7.9bn. Already this year (which does not count towards the 2009 listing), Goldman has raised an additional $5.75bn and HK$14.86bn ($1.92bn) in common stock in two separate issues.

Increasing capital to assets

More significantly, because regulators and investors have raised the bar in terms of what level of capital is now deemed safe, the capital-to-asset ratio has increased overall, if only marginally. On an aggregate basis, the Top 1000 has increased Tier 1 capital to assets to 4.43% (or 11 basis points). The Top 1000’s average capital to assets ratio has increased to 8%.

Within the Top 25 banks, the capital-to-asset ratio has risen overall: 12 have strengthened the ratio and one is level with 2008. Perhaps surprisingly, the two new entrants, Goldman Sachs and Morgan Stanley – which only last year converted to bank holding companies – have the highest capital-to-asset ratios of the Top 25, at 7.08% and 7.68%, respectively.

A change to accounting rules would lift the capital-to-asset ratios even further for the 365 European banks in the Top 1000, because IFRS (international financial reporting standards) inflate European banks’ balance sheets relative to US banks operating under GAAP (generally accepted accounting principles) by allowing much less netting of derivatives.

If the Top 1000 instils confidence in the renewed soundness, if not the profitability, of the world’s banks, this is also reflected in investor sentiment about the broader Tier 1 market, which is again open for business. Investors that only six months ago demanded government guarantees or AAA ratings, are now soaking up perpetuals and deeply subordinated paper – such as recent deals from Standard Chartered, Crédit Agricole and Rabobank. Moreover, Standard Chartered’s $1.5bn hybrid Tier 1 was the first innovative (step-up) Tier 1 ever sold to retail investors.

Asset growth

Like Tier 1, assets have grown by 6.8% this year, to $96,395bn. There is little change to the top 10 banks by total assets. Despite shrinking its assets by 8%, the ranking is still led by Royal Bank of Scotland with $3500bn in assets as a result of its ill-fated ABN Amro acquisition; if RBS pares down its business as it has suggested this year, we can expect the bank to slip down the list in 2010’s ranking.

But there are three new entrants to the top 25 by assets this year, notably two Chinese banks. Agricultural Bank of China enters at 22, and Bank of China at 23. Again, Well’s Fargo’s acquisition of Wachovia propelled it into the Top 25 by assets for the first time, at 18 (see table, Top 25 by total assets).

However, return on assets slipped to 0.12% from 0.87% last year, and fears remain over the quality versus quantity of assets. Last year’s ranking – based on 2007 figures at the height of the financial bubble, and the biggest growth for four years in The Banker’s Top 1000 total assets – went up by 21.6% to a record $90,256bn. This was more than double the size of aggregate banking assets in the 2003 ranking.

The world is still suffering from the hangover of that undisciplined asset growth.

As the losses/capital table reveals, asset writedowns are not yet a thing of the past: 15 of the 25 banks listed wrote down assets or posted losses in the first half of this year. Moreover, many bank balance sheets still contain structured product portfolios yet to be written down, some wrapped by monoline insurers that have been reduced to junk status or that are teetering on the brink.

The shift to Asia

Looking at profitability of the Top 1000 from a global perspective, the winners have been those banks that stuck to the basics of banking – taking deposits and lending in their home markets.
China has five banks in the Top 25 by pre-tax profits, and three banks in the top three – more than any other country. Industrial Bank of China leads the ranking with $21.2bn, followed by China Construction Bank with $17.5bn and Spain’s Santander with $15.8bn (see table, Top 25 by pre-tax profit).

As Western economies search for the bottom of their recessions, the World Bank last month raised its forecast for China’s 2009 GDP growth rate to 7.2% from its earlier forecast of 6.5%, citing the success of the government’s stimulus package.

For those who posit the notion that the crisis is just one more marker in the shift of power and profitability from West to East, the Top 1000’s aggregate country performance is very revealing. China’s banks are way out in front, with aggregate pre-tax profits of $84.5bn. Japan comes second with $16.5bn and Brazil third with $11.7bn.

Western Losses

It was a very different story in the West: US banks made an aggregate loss of $91bn, the EU 27 an aggregate loss of $16.1bn, and the UK’s banks lost, on aggregate, $51.2bn. In terms of return on capital (ROC), the disparate fortunes of the world’s banks is equally as startling. On aggregate, China’s banks in the Top 1000 chalked up an ROC of 24.38%. This compares with an aggregate ROC of -15.32% for UK banks and -10.32% for US banks. Japan’s banks in the Top 1000 achieved an ROC of 4.43% and Brazil’s 15.98%.

The inexorable rise of Asia, excluding Japan, is also played out in the composition of the Top 1000. The number of banks in the rankings from Asia has risen from 174 two years ago to 193 this year, as the number of banks from the US has dropped from 185 to 159, and from the EU 27 from 279 to 258.

The forward march of China’s banks in the Top 1000 is also reflected in their market capitalisation as of July 8 (see Top 25 by market capitalisation). Chinese banks still occupy the top three positions, led by ICBC in the top spot; ICBC, alongside Bank of China (up from fourth last year), managed to grow its market cap during the past year. HSBC, JPMorgan, Wells Fargo and Bank of America are fourth, fifth, sixth and seventh, respectively. Helping to shake-up the lower reaches of the Top 25 are three Canadian banks – led by Royal Bank of Canada, up 11 places to ninth – and three Australian banks, led by Commonwealth Bank of Australia, new to the Top 25 at number 12.

The Future

It is hard to argue against the idea that the rise of Asian banks, led by China, signifies a continued reordering of world finance – especially when as it runs alongside the growing economic importance of the region. With their vast domestic market, huge liquidity and supportive government policy, Chinese banks are the natural eventual successors to the US crown. The reality is that there are four Chinese banks in the Top 25 – three of them in the top 13 – whereas six years ago there were none. But it is far too early to write off US banks – or European banks such as HSBC and Banco Santander – which still dominate the ranking in terms of size and strength, if not all in profitability.

It is also worth remembering that the 2009 Top 1000 listing is based on 2008’s year-end figures – the worst year in the industry’s history since the depression; Q1 and Q2 this year have already seen better results, with either smaller net losses or small net profits (even large, in some cases). Equally, last year some banks with big trading operations, for example, went from super-charged results to very bad results; it is unlikely that such extremes will occur next year.

With next year’s profits largely determined by the ability of Western economies to emerge from recession and generate growth, it may seem axiomatic that China’s banks – and those from other emerging economies that are weathering the downturn a little more smoothly – will climb even higher up the Top 1000. This cannot be taken for granted. For one thing, the very creativity that got the West’s banks into this mess will be the thing that gets them out of it. Over and over again, Western banks have displayed a remarkable ability to reinvent themselves to keep pace with global change.

Moreover, it is only a few years ago that the Chinese banking system was weighed down with non-performing loans (NPLs). The banks did well then to eliminate bad debt from their balance sheets, but many fear that one unwanted side-effect of the Chinese government pumping money into the economy to offset falling export markets may be the return of NPLs.

Examining capital

The issue of bank capital will be high on the political and regulatory agenda for some time to come as policy makers seek a formula that both reins in excess but frees up banks to play a full role in economic growth. If regulators decide that only equity qualifies in the broadest definition of Tier 1, this could lead to further deleveraging by the banks and a knock-on effect in the broader economy at a time when lending is already scarce.

Bankers are lobbying hard that more innovative forms of Tier 1 still have a role to play in bank capital structures. They argue that a tiering of capital is perfectly valid, allowing for better return on equity and alignment with liquidity.

Capital structures will be moving targets for the foreseeable future, because of capital injections, regulatory initiatives, subordinated debt buybacks and deleveraging. Ratios will see further change as regulators apply lessons learned from this crisis. It is already possible to see an increased focus on the capital ratio denominator, for example, with the Swiss regulator FINMA, the Basel Committee and the UK Financial Services Authority’s Turner Review all implementing or discussing the idea of leverage ratios based on non-riskweighted balance sheets.

A tough call

While we wait for the results of policy makers’ deliberations, it is hard to predict what the Top 1000 will look like next year. US and UK banks are queuing up to pay back government capital.
Having met the government’s stress tests, in June 10 of the US’s strongest banks, including JPMorgan and Goldman Sachs, were given approval to buy back a collective total of $68bn of government shares.

In the UK, Lloyds Banking Group has begun to give the state some of its money back.

Other banks are selling assets to increase capital and stay independent, or divesting in order to pay back government money. What will the impact be on Barclays, for example, when it has divested BGI? Now that they seem to be out of danger, will Goldman Sachs and Morgan Stanley – which rocketed into the top 25 banks – remain as bank holding companies?

What we do know, is that the results of The Banker’s Top 1000 banks will always be eagerly awaited.

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