IFR Editor-at-large Keith Mullin
So here’s where I think we got to over the weekend ahead of the crunch Wednesday meeting at which the grand plan is all supposed to come together: After Sarko and Merkel’s major blow-up row – so much for their much vaunted ‘we’re at one on the solution’ – the French have been sent packing, tail between legs, from their idea of transforming the EFSF into a bank with full access to ECB liquidity and funding windows.
· The first-loss guarantee idea for leveraging the bailout fund is still in the game.
· The bondholder haircut is accelerating from the 21% agreed in July, to the ‘30%-50% area’ first mooted by Germany a few weeks ago, to the firm 50% now being discussed with the IIF. The IMF is talking 60% (I’ve been arguing for weeks that it would need to be 70%). The banks are balking at anything beyond 40%.
· Whatever haircut is decided will be accompanied by a bank recapitalisation to be completed by the middle of 2012.
· The EBA has now apparently decided the capital shortfall for Europe’s leading banks is €108bn, a number accepted by EU finance ministers. Remember that the IMF’s number is €200bn, while analysts have gone as high as €275bn for banks to achieve 9% CT1 levels after marking sovereign debt to market. As the EBA has little credibility, in my view, I’d be cautious about anything it says. Bear in mind that only a few days ago, it had come out with a number of €80bn.
· Banks that fall below capital adequacy minimums and have no realistic option of raising capital in the short term from private sources will receive obligatory government capital injections aka taxpayer bailouts.
· Banks may be able to avail themselves of State guarantees on their debt. This may be a useful option as the senior unsecured bond market is shut for all but for the top institutions, and wholesale money markets are demanding fat premiums.
· As a quid pro quo to being quasi-nationalised, banks will be discouraged from deleveraging in an effort to keep credit flowing into the real economy.
· To the extent that they do delever, there have been calls to discourage banks from liquidating cross-border assets and retreating to their home markets, like they did in the 2007-08 crisis.
· Oh I almost forgot: Greece now needs a €450bn bailout to avoid imploding, or, better put, to halt its current implosion.
How it all ends up remains to be seen; there are some serious flaws and contradictions in all of the above. I must say I’m still sceptical that we’ll get a fully-built solution this week but the pressure to come up with something credible that the US and China in particular will buy at the Cannes G20 meeting is immense. Substantial difficulties remain and there still appears to be a lack of consensus around key elements of the tripartite plan.
Here’s one of the major touch points on the bank recap issue: even if you take the middle ground between the EBA and top-end analysts’ estimates, there won’t be sufficient aggregate investor demand for bank stock and other capital issuance in the short timeframe under discussion to make private capital-raising a reasonable option for most banks. Those that do have access to private sources typically don’t need the money.
That seemingly leaves Europe’s weaker banks on a collision course with forced nationalisation. Shareholders will doubtless be breathing a sigh of relief that the likelihood of being asked to stump up huge amounts of cash is remote, although on the flip side, they do run the risk of being forcibly diluted.
Relying on retained earnings to boost capital in an environment of severely depressed profits is off the agenda, as is withholding dividends. A no-dividend policy, incidentally, is hardly an incentive to attract equity investment. The whole thing is really all a bit circular. Deleveraging via sales of positions, assets, businesses or subsidiaries, or by running off assets is the only realistic alternative option. Despite governments’ best efforts to persuade banks to up lending, banks are aggressively targeting for sale assets deemed to be non-core, which are capital intensive or which are generating a negative return as funding costs have risen.
Deleveraging binge
Banks throughout Europe have taken to the latest round of deleveraging with renewed vigour, and the process has been given extra impetus by relatively robust demand. But the process won’t be linear and there are likely to be road bumps along the way. The extent to which asset sales are the solution to the banks’ problems is likely to be defined by the realistic size of the capital hole, the magnitude and flow of sales, the level of demand from interested buyers, and of course the price they’re prepared to pay.
Broadly speaking, though, there’s been a pretty successful start to the latest initiatives. The fact that this is not a fire-sale of distressed assets certainly helps.
Banks in peripheral Europe have been shopping assets for months and that process continues. Greek, Irish and Portuguese banks were early in with targeted programmes following their countries’ bailouts. They followed banks that had already been bailed out in the financial crisis, and have since been joined by a whole host of banks from France, Spain, Italy, Belgium and elsewhere that have announced substantial initiatives or are sniffing around in an effort to cut risk-weighted assets.
The anecdotal amount of de-leveraging that’s potentially out there is around US$2trn between now and the end of 2013. That’s a huge amount by any standards. Clearly, the pace of asset sales will dictate the extent to which the process remains orderly or descends into chaos. There’s evidence at a macro level that general over-supply concerns and, at a micro level by the same assets showing up on different for-sale sheets, are starting to put pressure on pricing.
Broadly speaking, though, there’s been a pretty successful start to the latest initiatives. The fact that this is not a fire-sale of distressed assets certainly helps. The positions being offered through the secondary loan market or via brokered auctions are predominantly liquid, performing investment-grade corporate loans, US and European commercial real estate, prime mortgage portfolios, leasing and asset-finance books and project finance assets. Non-performing loans and leveraged paper are being offered as part of the process but they’re not the drivers.
At present, banks are generally offered at levels of 97 to 98 for performing assets, within fees but still offering a pretty good entry point for buyers The big question, of course, is who the buyers are and what their long-run appetite is. A lot of cash is coming in from non-bank players such as hedge funds, private equity and institutional real-money accounts. This is helpful. Japanese banks have also been big buyers, particularly of infrastructure assets, as have Middle Eastern banks (which have snapped up dollar-denominated Middle Eastern paper as well as project loans). US and European banks have been seen sporadically but won’t emerge as major players.
My sense, though, is that as the process progresses, tension will emerge between buyers and sellers and we may see a bit of a stand-off. There is a ton of money bid at lower levels from distressed debt funds and other non-bank sources, but banks are limited in how much they can discount because they don’t mark their assets to market. If they accept bids outside fees or at stressed levels, they will have to fund the capital hit, which defeats the object of the exercise. And a lot of non-bank money is coming in with pretty aggressive return on capital targets, so there’s no juice in the market for them at these levels.
In reality, improving capital ratios is binary; you either do it on one side of the balance sheet or the other. The interplay between the various options is likely to be clarified on Wednesday.
That said, I’ve set my expectation levels at close to zero.
