Banking's Winners

HSBC tower, the 42-story headquarters of Europe's biggest bank in the heart of London's Canary Wharf, is emblematic of why its tenant is one of a tiny handful of global giants that aren't just surviving, but aggressively prospering amid the financial- industry shakeout. Last year, just before Britain's sky-high property market crashed, the bank sold its high-rise to the Spanish group Metrovacesa for a massive 1.1 billion Sterling, the highest price ever paid for a British property.

It was a smart move typical of a bank that's now looking a whole lot smarter than its rivals. Most of its major British competitors have been forced to accept the tough terms of the government's £50 billion bailout. But the bank's CEO, Michael Geoghegan, could even afford to stay away from the crucial meeting with the chancellor of the Exchequer, Alistair Darling, earlier this month, sending an executive instead. With its finances and reputation more than secure, HSBC simply doesn't need the state's help. The markets agree. They've sent the DJ Stoxx European bank-share index south by 48 percent since January and slashed the S&P 500 bank index by 40 percent. But they've left HSBC's stock virtually even for the year, one of the best performances of any major bank.

HSBC is the biggest and most obvious of the New Giants of Banking—the select club of survivors that have used the unfolding crisis to grow stronger as most banks continue to struggle, shrink and disappear. In the U.S., JPMorgan and Wells Fargo have not only avoided the worst stock declines but have gobbled up their beleaguered rivals. Japanese banks like Nomura and Mitsubishi, resilient and free of toxic assets, are snapping up Western banking assets at fire-sale prices. Spain's Banco Santander, flush with capital, has been going on a predatory hunt for smaller rivals. Last week it added to its growing share of the British market when it picked up 200 branches and $30 billion worth of deposits from the distressed British bank Bradford & Bingley for just $1.1 billion. It was Santander's sixth acquisition since the start of the crisis. BNP Paribas has emerged as another newly powerful champion, saying non, merci, to offers of a French-government bailout and snapping up the better parts of collapsed Belgian rival Fortis in a $14.5 billion emergency deal orchestrated by the Belgian government in early October. It is these banks—along with just a very few others, like Bank of America in the U.S. and Italy's Intesa Sanpaolo—that analysts say are most likely to emerge as the winners of the crisis and dominate global banking in the years to come.

What did these banks do right that their competitors didn't? Part of the explanation is as powerful as it is banal: what was a conservative, boring business model in the past decade's financial-engineering frenzy is now a guarantor of much-needed stability. Santander, for example, has always considered itself a retail bank focusing on consumers and small- to midsize businesses; 84 percent of its earnings are generated by retail banking at its 13,500 branches, the world's biggest international retail network. It has virtually no exposure to investment banking, and funds itself with predictable long-term bonds. HSBC, too, is shaped by a conservative banking culture dating from its days as Hong Kong's de facto central bank. It is also one of the few banks whose deposits exceed their loan book. This conservatism has helped the banks stay clear of the worst and riskiest excesses, such as big bets on structured finance or overreliance on short-term funding in the now frozen money markets. Their plunge into such risky activities has turned once powerful rivals like the Royal Bank of Scotland and Switzerland's UBS into shadows of their former selves. The price of caution was modest growth earlier in the decade. In the boom years, HSBC was managing a rate of only about 5 percent, aside from acquisitions, while others hit figures at least three times as high. "It was always seen as ultra-conservative and traded at a discount to some of its major peers," says Mark Durling, a banking analyst with London brokers Brewin Dolphin. Back then, many of today's survivors were dissed by analysts for not being adventurous enough.

But it's more than just conservative inertia that's given these new giants their advantage. HSBC was prescient in selling its skyscraper at the height of the boom. And though the bank did dabble in risky assets, HSBC executives made the choice very early on to announce and write off $17.2 billion in losses. "They get 11 out of 10 for admitting that they had a problem and never hiding anything," says David Buik of the London brokerage BGC. Santander, too, made a number of brilliant moves. It also sold out of real estate in 2007, before Spain's property bubble popped. When Santander joined RBS and Fortis in a consortium to buy and dismember the Dutch bank ABN AMRO earlier this year, the Spaniards cherry-picked some of its best retail arms, while the Belgians and the British collapsed under the debt they took up for their mammoth acquisition. Santander also flipped part of its ABN purchase to an Italian bank for an immediate €4.5 billion profit.

The survivors offer a clear model for the post-crisis financial industry in Britain and elsewhere. "You're going to see a banking sector that is more cautious and more geared toward providing loans to businesses and individuals," says Commerzbank economist Peter Dixon. New regulations will force banks to be more conservative, hold more capital against their loans and wind down leverage. In effect, say analysts, that means converging around a more Continental Europe-style business model of a diversified universal bank with strong retail operations. "Retail and deposits is the new paradigm," says Fox-Pitt Kelton analyst Alessandro Roccati. That is the spot the New Giants already occupy. This new paradigm doesn't necessarily mean the end of fat profits—despite the ongoing shrinkage of the financial sector. Santander, for example, has increased its profits at an average rate of 30 percent a year over the last decade based almost completely on "boring" retail banking. That's a growth not even investment banks like Goldman could match.

With the contours of a post-crisis financial world just emerging, some of today's winners may, of course, still stumble along the way. Britain's Lloyds TSB was seen as strong last month when it came to the rescue of struggling rival HBOS; last week, it saw its share price collapse as it became one of the first British banks to line up for public recapitalization funds—a £5.5 billion bailout in return for a government stake of up to 50 percent. Barclays, too, had been hailed as one of the emerging winners, having snapped up choice parts of Lehman Brothers without any nasty liabilities. But last week it looked as if the highly leveraged bank was still struggling to assemble a fresh £6.5 billion infusion of private capital to avoid the onerous conditions attached to state funding. Another giant question mark is how broader state ownership will affect competition. Governments have vowed to limit their interference in the banks they suddenly own. Yet it's hard to expect politicians to stand idly by if a troubled bank starts sacking workers or repossessing homes. Already, both the British and German governments have announced that banks taking state recapitalization funds will have to ensure certain levels of lending. That could make competition tougher for those banks strong enough to stay private.

Banco Santander CEO Emilio Botin gives a simple, Warren Buffett-style recipe for succeeding in this new financial world. "If you don't understand an instrument, don't buy it," he advised young British bankers at a dinner in London in June. "If you do not know your customers very well, don't lend them any money. If you do these things, you will be a better banker, my son." Whether these words make Botin the new sage of Madrid or just a lucky financier with perfect hindsight, there is no denying that they describe banking's new era.