European banks' asset sales face disastrous failure
People & Markets
Sales talks end in failure, leaving banks with piles of assets but no funding
European banks are being forced to abandon their efforts to sell off trillions of euros worth of loans, mortgages and real estate after a series of talks with potential investors broke down, leaving many already struggling firms with piles of assets they can barely support.
Lenders have instead turned their attention to reducing the burden of carrying such assets over months and years, with many looking at popular pre-crisis “capital alchemy” arrangements to minimise capital requirements and boost their ability to use the assets to tap central banks for cash.
Deadlocked talks with potential buyers – a mix of private equity firms, hedge funds, foreign banks and insurers – show little sign of making breakthroughs, say bankers taking part in those negotiations, with the stalemate threatening to block the industry’s ability to save itself from collapse through a mass deleveraging.
“European banks have spent far too long saying everything is fine, when it really isn’t,” said one banker at a US bank who has been advising European clients on their options. “They are slowly realising that they just won’t be able to do what the market is expecting. We are edging slowly closer to the depths of the crisis.”
Some of Europe’s largest banks, including BNP Paribas and Societe Generale, have in recent weeks pledged to sell assets. Together, firms are expected to shrink their balance sheets by as much as €5trn over the next three years – equivalent to about 20% of the region’s total annual economic output – through a combination of sales, asset run-off and recapitalisations.
Draconian measures
A funding squeeze has prompted the Draconian measures. Since the summer, most banks have been unable to tap traditional sources such as unsecured bond markets. As old debts come due – some €1.7trn will roll over in the next three years alone – banks need to find cash to avoid bankruptcy.
“Banks are feeling pain on both sides of the balance sheet,” said Alberto Gallo, head of European credit strategy at RBS. “On the one side you have a funding squeeze with banks unable to raise cash in the capital markets. At the same time, many of the assets they hold are deteriorating in quality.”
“Banks need to reduce their balance sheets as much as €5trn in assets over the next three years or so,” he added. “The problem is that there just aren’t enough buyers. Most banks will be forced to hold on to much of this stuff to maturity, which will affect their ability to lend and impact on the real economy.”
People involved in asset sale talks say price is the major sticking point. Lenders want only to sell higher-quality assets near to par value so as to avoid huge write-downs, which would erode capital further. By contrast, potential buyers want high-yielding investments and are offering only knock-down prices.
“There is a huge amount of liquidity among investors right now, but they only want to buy at distressed prices,” said Stefano Marsaglia, a chairman within the financial institutions group at Barclays Capital. “Lots of discussions are taking place but there is a gulf in terms of pricing.”
The homogeneity of assets on offer is also complicating the negotiations – a number of Dutch lenders, for example, all want to sell very similar mortgage-backed securities. Several bankers advising such clients were unanimous in saying that the deals will struggle to happen.
Vast overhang
There is also a vast overhang of unsold assets from the initial part of the crisis. Many banks such as Commerzbank, RBS, WestLB and even the Irish government set up legacy units – or bad banks – that were charged with winding down and selling those assets. That process is still ongoing.
“Selling assets is a positive to announce, but it’s going to be very challenging for all the banks that have announced asset sales to get them done,” said Marc Tempelman, head of EMEA financial institutions capital markets and financing at Bank of America Merrill Lynch. “Everyone is selling similar assets.”
He added: “Many banks in Europe have been looking to sell assets for the past couple of years. If those disposals haven’t been closed in better markets, what makes anyone think they can do it now in larger amounts and much more volatile markets?”
Looking for alternatives
Without the cash that would have been generated through outright asset sales, struggling European banks are now looking at alternative levers. The problem is that traditional options such as issuing equity, increasing deposits or consolidation just aren’t feasible.
That has prompted banks to turn to more creative solutions, with some now looking at what one banker termed as pre-crisis “capital alchemy” arrangements to reduce capital needs. Such methods can also in some cases make assets which banks hold to maturity eligible for ECB repo operations.
Securitisation is at the heart of such arrangements. Assets with low ratings are pooled together into diversified portfolios in order to attain a higher rating. The resulting asset requires less cash and as a result of the higher rating can be more readily pledged to the ECB or to other banks to borrow against.
Bankers point to an increased number of retained securitisations in recent months as an indication that banks are using the process to ease the burden of holding such assets through to maturity. Spanish banks in particular have securitised billions of euros worth of corporate loans since early October.
“It’s not just about selling,” said Marsaglia. “Banks are also looking at ways of re-evaluating the risk weightings of some assets by pooling them together and in some cases people are securitising those pools to get better ratings. There is a lot of work going on around that right now.”
Still, the practice is not a panacea to banks’ asset and liability problems. Although it can open the door to using ECB repo facilities by making collateral meet strict eligibility criteria, assets pledged are still subject to a haircut, meaning banks cannot borrow enough to fund the asset in question.
Use of the facility is surging, nevertheless. ECB lending to banks spiralled this week, with 178 lenders requesting €247bn in one-week loans, the highest in two years. Bankers warn that if banks are unable to sell assets, the ECB will have to play a much bigger role in funding banks.
“Natural deleveraging through not renewing loans is one of the few options remaining to banks to shrink their balance sheets, but the timetable for implementing this kind of strategy can be very protracted,” said Ryan O’Grady, head of fixed income syndicate for EMEA at JP Morgan.
(NOTE: This story appears in the November 26 issue of the International Financing Review, along with a range of related articles)
