Moody's: Global investment banks' exposure to legacy litigation has fallen; shock absorbers stronger

Global investment banks (GIBs) have significantly reduced their exposure to the risk of legacy litigation over the last two years, Moody's Investors Service said in a report.

At the same time, the majority of these banks have increased their share of stable earnings from strong retail, corporate and wealth-management franchises, improving their capacity to absorb earnings shocks from any large, unexpected charges. Both of these developments are positive for the GIBs' bondholders.

"Most US and European GIBs have settled the bulk of their legacy issues," said Alessandro Roccati, a Moody's Senior Vice President and co-author of the report. "The GIBs have significantly improved their shock-absorbing capacity and increased their capital bases, mitigating the financial risk of pending litigations."

Litigation costs for the rated GIBs have been on a two-year decline from their post crisis high. In 2016, the GIBs' litigation provisions in aggregate were $19 billion, nearly half of the $33 billion recorded in 2015, bringing their total litigation provisions from 2008-16 to about $273 billion. Provisions related to residential mortgage-backed securities (RMBS) accounted for around half of the total, followed by mis-selling and misrepresentation, representing around one third.

Although US banks have settled most of their large-scale cases, several European GIBs remain exposed to a variety of legacy litigation that presents tail risk. The Royal Bank of Scotland Group plc, Barclays Plc, UBS AG and HSBC Holdings plc have not yet settled their large US RMBS litigations, although they have already made related provisions or accounted for them in their capital plans.

Settlements of US RMBS litigations in line with our estimated median costs for peers would be positive for those GIBs that have not yet settled because they would reduce uncertainty and tail risk, and would allow management to focus on executing restructuring plans, which if successful, would benefit bondholders.

Other large legacy risks are company-specific: Deutsche Bank AG remains under investigation for its Russian 'mirror' trading, and Barclays Plc is under investigation on disclosures related to its 2008 rights issue.

Most GIBs have significantly improved their shock-absorbing capacity and increased their capital bases, mitigating the financial risk of pending litigations.

Capital has increased for most GIBs in the last five years. Moody's calculates that their average Basel III fully applied CET1 ratio stood at 12.5% at the end of 2016, up from 12.0% in 2015 and 10.6% in 2014.

Increasing levels of stable shock absorbers and the GIBs' improved capital bases will help mitigate any negative impact from potential further litigation settlements and support these banks' credit profiles.

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