Tuesday, December 13, 2011

EU banks selling 'crown jewels' for cash as regulators create more financial instability

A Bloomberg article discusses another unintended consequences, besides the credit crunch, that has resulted from the EU financial regulators fixation on a meaningless, highly manipulated 9% Tier 1 capital ratio.

Regular readers know that EU banks are shedding their best assets as these are the only assets the banks can sell without recognizing significant losses.  As a result, the risk profile of EU banks and the global financial system is increasing significantly.  The exact opposite outcome of what the regulators hoped to achieve with their 9% Tier I capital directive.

The Bloomberg articles looks at the sale by EU banks of their 'crown jewels'.
European banks, under pressure from regulators to bolster capital, are selling some of their fastest-growing businesses to competitors from outside the region -- at the expense of future profit and economic growth. 
Spain’s Banco Santander SA (SAN), Belgium’s KBC Groep NV (KBC) and Germany’s Deutsche Bank AG are accelerating plans to exit profitable operations outside their home markets....
Such sales risk hurting long-term profit, just as Europe enters recession, investors say. It’s the unintended consequence of the decision by European regulators to make banks increase core capital to 9 percent by June instead of 2019. 
Unwilling to raise equity because their share prices are too low, lenders are selling profitable assets because they’re struggling to find buyers willing to pay enough for their troubled loans to avoid a loss that would erode capital. Investors say the sales risk leaving banks focused on a stagnant economy and deprive them of economic growth from outside the region.
Actually, there are no investors for bank equity so long as banks are a 'black box'.  Who would buy their equity if they cannot assess if the bank is solvent or not.
“These are the most profitable parts of their business,” said Azad Zangana, European economist at London-based Schroders Plc, the 200-year-old British asset manager, citing Spanish and Portuguese banks selling assets in Latin America. “They’re being forced by regulators to sell them off. You begin to become a less profitable organization. Your business model stops working if you’re being forced to lend only to an economy that’s going through a very deep recession.”

The divestitures are likely to hurt banks’ profitability in coming years, analysts say. Shrinkage will cut their return on net asset value by 1.5 percentage points on average, according to a Dec. 6 report by Huw van Steenis, a Morgan Stanley analyst in London....
“There’s nothing wrong in theory about selling the crown jewels,” Nijdam said. “It’s always a question of price. European banks will be less profitable -- but less risky.”...
Actually, the bank's risk increases because they still have the legacy bad assets.
Banks across Europe have pledged to cut more than 950 billion euros of assets over the next two years, according to data compiled by Bloomberg. About two-thirds of that will come from sales of profitable units and performing loans, said van Steenis. Sales of distressed assets and souring loans will account for just 4 percent, or about 100 billion euros, he said. 
“European banks are likely to sell good, performing assets to foreign banks and investors,” he said in an interview. “The question is: When are you getting to the point of adverse selection? When you’re selling the good assets and you’re keeping the more risky assets. There is a risk we’re moving in that direction.” 
Buyers, for the most part private-equity and hedge funds, are offering too steep discounts for underperforming assets. For banks, a fire sale would trigger losses they can ill afford at a time when they’re required to boost capital. 
“Lenders are selling more liquid assets so they can get a price that avoids additional capital losses,” said Joseph Swanson, co-head of restructuring at Houlihan Lokey in London. 
“Unfortunately, this strategy can result in lower asset quality and increased earnings volatility.”

Regulators are forcing European banks to raise capital as the region’s sovereign-debt crisis worsens. The European Banking Authority last week ordered the region’s financial firms to raise 114.7 billion euros of additional capital. The EBA, which co-ordinates the work of the region’s 27 national regulators, told lenders to bolster their core Tier 1 capital ratios to more than 9 percent of risk-weighted assets by the middle of 2012. 
Faced with a potential credit crunch, the regulator told banks to raise the money from investors, retained earnings and lower bonuses. Failing that, companies may sell assets, provided the disposals don’t limit overall lending to the European Union’s “real” economy, the EBA said in a Dec. 8 statement.

“The family jewels are being sold,” Richard Mattione, a portfolio manager at Boston-based Grantham, Mayo, Van Otterloo & Co., wrote in a report this month. “A big chunk of private sector loans can’t be reduced because they involve property that will be inactive for years, perhaps a decade. So, once banks trim their healthiest borrowers, and perhaps reduce their overseas exposures, they quickly run into the need to cut loans to small and medium enterprises, providing another negative impulse to European growth.”... 
The regulator induced credit crunch this blog has been discussing.
“If they raise capital by selling crown jewels, the market will reward them in the short term because they’ll meet the regulator’s timeframe,” said Will James, who runs the 632 million-pound SLI European Equity Income Fund at Edinburgh-based Standard Life Plc. “That begs the longer-term question: How do you grow in an environment where customers are unwilling to borrow. That’s the missing piece from the puzzle. In a low- growth or no-growth environment, banks that have sold good assets will continue to struggle.”
That is a good question, but it misses what happens to all the bad assets on the banks' balance sheets now? 

No comments: