Banks rally on stronger capital

There were holes in balance sheets and profits missing expectations but European bank CDS still managed to rally on Tuesday.

Barclays dominated the headlines after it announced a "5.8 billion rights issue as part of a plan to shore up its balance sheet. The UK bank will also reduce its risk-weighted assets, issue "2bn in contingent convertible debt and retain earnings to fill its capital shortfall.

Balance sheet strengthening is normally positive for a company's credit standing, and that proved to be the case today. Barclays' CDS tightened 6bps to 122bps as credit investors focused on the bank's financing plans rather than the quarterly earnings, which were underwhelming.

It was a similar story with Deutsche Bank. Its CDS rallied 4bps to 106bps after it reported that its Basel III core tier one ratio rose to 10% and the bank's CRD IV leverage ratio improved to 3%. Like Barclays, Deutsche is planning to shrink its balance sheet by a considerable amount in the coming years. The news more than offset disappointing numbers from its fixed income trading division.

Swiss bank UBS has been more focused on capital than some of its European competitors, and its core tier one ratio of 11.2% is set to improve further after it buys back its distressed assets from the Swiss National Bank. UBS expects a 70-90bps improvement in its core tier one ratio in the fourth-quarter. Its CDS tightened 4bps to 87bps.

Spanish group Banco Santander trades considerably wider than most of its rivals, due to its exposure to the ailing domestic economy. Spain announced that the economy continued to contract in the second quarter - although by just 0.1% - and Santander's ration of non-performing loans rose to 5.18%, up from 4.76% in the last quarter.

Many think that Santander still needs to strengthen its capital position and the slowdown in Brazil - which accounts for about 25% of its profits - is a concern.

Overall, though, the mood was positive, with the Markit iTraxx Europe tightening almost 3.5bps to 100bps. Earnings continued to be robust - ITV and EDF were among the firms to beat expectations. BP provided one of the few disappointments.

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