September 17, 2019

DealBook: European Banks Shuffle Bonds to Bolster Capital

BNP Paribas of France is one of the European banks raising capital by rejiggering bond holdings.Chris Ratcliffe/Bloomberg NewsBNP Paribas of France is one of the European banks raising capital by rejiggering bond holdings.

LONDON — European regulators are pressing banks to shore up their balance sheets and bolster their capital cushions as the sovereign debt crisis continues to wreak havoc on the Continent.

But some financial firms, including Barclays of Britain, Commerzbank of Germany and BNP Paribas of France, are rejiggering their bond holdings in a complex maneuver that allows them to improve their capital levels without raising additional funds. It’s a costly accounting strategy that may drain cash, leaving firms more vulnerable to the economic turmoil.

“Banks have to conjure up extra capital from thin air,” said Bridget Gandy, co-head of European banks at Fitch Ratings in London. “New debt is expensive if they have to refinance using the capital markets.”

Faced with a tight deadline to raise new capital, many big European banks are reorganizing existing debt to increase their buffers. The strategy, known as liability management, involves buying back or exchanging hybrid securities — investments that pay dividends like bonds, but can be converted into equity — at a discount.

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Under accounting rules, financial firms can then book the difference between the original face value of the securities and the current discounted price as a profit.

The banks can do so because they have already collected the full amount of the debt from investors and have to repay only the smaller amount.

A bank, for example, can buy back $10 billion of hybrid securities from investors at 70 cents on the dollar, or $7 billion. By doing so, the firm cuts the amount of debt on its balance sheet and books an extra $3 billion for its buffer of highest-quality capital, minus any taxes.

“This will be a key means by which European banks will generate significant core capital,” said Huw Richards, managing director of debt capital markets at JPMorgan Chase in London.

While the deals have passed regulatory muster, analysts worry that using cash, or liquidity, to buy complex debt instruments may leave banks at risk if the market volatility continues. For many financial firms, it remains prohibitively expensive to sell bonds in the current environment. So banks are relying on cash reserves to meet short-term financing needs, making it especially important for firms to remain liquid.

“Banks are having to use cash to exchange hybrid securities for equity,” said Lisa Hintz, a European bank risk analyst at Moody’s Analytics. “But they’re trading cash for equity, and liquidity is at a premium right now.”

Europe’s banks are scurrying to comply with new capital rules. In response to the crisis, the European Banking Authority announced plans in October to force firms to put aside extra funds to cover potential future losses. By June 2012, the region’s financial institutions will need to increase their core Tier 1 capital ratio — the strictest measure of a bank’s ability to resist financial shocks — to 9 percent of assets, up from the currently mandated level of 2 percent.

On paper, some of Europe’s biggest banks already meet the minimum requirements. But in this rapidly deteriorating environment, their capital could quickly evaporate.

Policy makers are also clamping down on the types of securities that can be used toward banks’ reserves in the future. In particular, authorities are assessing what hybrid investments will count as capital.

The Continent’s banks are struggling to meet the new rules. Regulators estimate European financial firms must raise a minimum of $142 billion by next summer. Greek banks alone have to come up with $40 billion.

With investors reluctant to pump more money into the Continent’s troubled financial sector, banks have turned aggressively to asset sales to increase their capital base. On Wednesday, Grupo Santander of Spain said it would sell its Colombian units to CorpBanca of Chile for $1.23 billion.

In total, European financial players are expected to sell or write down more than $1.8 trillion of loan assets over the next decade, according to the consulting firm PricewaterhouseCoopers. That compares with just $97 billion from 2003 to 2010.

The fire sale, however, has not been enough. Local politicians have raised objections to selling banking assets to foreign firms. And potential buyers, including leading private equity firms in the United States, are largely sitting on the sidelines in the hopes that asset values will continue to drop.

“Deals are taking longer to complete,” said Christopher Clark, a corporate finance partner at the accounting firm BDO in London. “Firms are taking more time to check their due diligence.”

To supplement the sales, banks are finding ways to restructure their debt in a bid to increase their capital levels. On Monday, Barclays said it was offering to buy back as much as $3.9 billion of securities at a discount of up to 30 percent. The bank said the deal would help meet regulatory limits on using hybrid securities toward the bank’s core Tier 1 capital, as well as bolstering its funding reserves.

Last week, the Lloyds Banking Group announced plans to exchange $7.7 billion of similar debt for new bonds. The firm, which is 41 percent owned by British taxpayers after a $27 billion bailout in 2008, asked investors for up to a 30 percent discount on the securities. Lloyds said the deal was in response to market volatility and would help improve the quality of its capital base.

The French banks BNP Paribas and Société Générale also have announced similar deals worth billions of dollars. The financial firms said they remain well capitalized, and the offer would allow investors to offload hard-to-sell assets at a price higher than current market values.

“This is totally new territory for banks,” said Peter Hahn, a banking professor at Cass Business School in London and a former managing director at Citigroup. “Firms are taking money from wherever they can find it as they restructure their capital base.”

The current owners of some hybrid securities are often eager to trade the investments for cash. The deals allow investors to dump underperforming securities, which in some cases are trading 50 percent below their face value.

But some institutional investors like pension funds and insurance companies, which typically hold bonds for long periods of time, say they are being shortchanged because of the large markdowns that banks are demanding.

In November, Santander announced plans to exchange $9 billion of so-called subordinated debt at a nearly 10 percent discount. It said the aim was to retire securities that no longer counted toward the new regulatory capital requirements. The deal also would allow bondholders to exchange their existing investments for debt that offers a higher interest rate.

Investors balked at the terms. So far, Santander has said only 24 percent of bondholders have agreed to the deal, and some questioned whether the bank was offering a good deal.

“Investors need an incentive to accept these offers,” said Georg Grodzki, head of credit research at British pension and insurance provider Legal General.

“A low take-up usually means investors believe bond issuers want to retain the benefits for themselves.”

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Europe Finds Slope Ahead Is Growing Ever Steeper

Greece, Ireland, Portugal and Spain are already in downturns or fighting to escape them, as high unemployment and austerity measures bite. But in the past few weeks, Germany and France, the Continent’s powerhouses, have also started to falter, hurt as struggling banks tighten their lending and orders for business from the indebted countries of Europe ebb.

“The sovereign debt crisis is like a fungus on the economy,” said Jörg Krämer, the chief economist at Commerzbank, who last week joined the growing crowd of analysts who are now predicting that Europe is headed for a recession. “I thought it would be just a slowdown, as is not unusual after a recovery. But I have changed my mind.”

The euro zone economy has already slowed to essentially no growth. It could stay in a slump, many economists say, at least through next spring. If that happens, tax revenues are likely to fall and unemployment is expected to rise, making it even more difficult for Europe to deal with the sovereign debt crisis and protect its shaky banks.

Worse, emerging markets that are important customers for European exports, like China and Brazil, are tightening credit to prevent their economies from overheating. The United States, another main market, is stuck in its own economic rut.

In a sign of how quickly the ground is shifting, the European Central Bank on Thursday could well lower interest rates — just a few months after it started raising them in what is now seen by many as a misguided effort to stem incipient inflation.

Distress is increasingly evident across Europe. Philippe Leydier had been feeling more upbeat about his business until this summer, when orders for his French company’s corrugated boxes suddenly began to slide. Orders fell further last month as auto parts makers, electrical engineering firms, farmers and other industries reduced production.

“The euro crisis and the financial crisis linked to the debt of European countries is serious,” said Mr. Leydier, whose box and paper manufacturing business in Lyon, Emin Leydier, often provides an early signal of seismic shifts in economic activity. “European governments need to find a solution — and fast.”

In Italy, which has the euro zone’s third-largest economy, after those of Germany and France, a €45 billion, or $60 billion, austerity program has many worried about a recession. Paolo Bastianello, the managing director of Marly’s, a clothing retailer, has also seen his hopes fade.

At the start of the year, Mr. Bastianello was more optimistic that Europe might escape its troubles and that Italy’s dysfunctional government would seriously tackle the country’s problems. “But the turbulence of the markets and the uncertainty about this abnormal mass of public debt just scare people away from buying,” he said.

Not everyone is so pessimistic, especially in Germany. But even there, indicators are pointing to slower growth.

German executives say sales remain healthy, at least so far. “We don’t see any impact on our business,” said Roland Busch, a member of the management board of Siemens, the electronics and engineering giant based in Munich.

“The economy is cooling down but not more than that,” said Mr. Busch, who oversees a unit that supplies traffic-control systems, street cars and other products for public works.

Expecting demand for urban infrastructure improvements to grow, Siemens plans to add about 150 people over the next two years to the 850 employees at its complex in Sacramento, California, that makes light-rail cars.

Bucking the trend almost everywhere else in the developed world, unemployment in Germany continues to fall, and there are shortages of skilled workers in several key sectors.

“We know Germany is an exception,” said Jörg Köther, a spokesman for the IG Metall union.

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Asmussen Nominated to European Central Bank Post

FRANKFURT — Germany moved swiftly to install a guardian of its interests in the European Central Bank Saturday, nominating a top technocrat to replace a senior bank official whose unexpected resignation Friday hinted at divisions over the conduct of monetary policy.

The selection of Jörg Asmussen, 44, a deputy finance minister and career bureaucrat, announced at the meeting of Group of 7 countries in Marseille, France, appeared designed to reassure a German public increasingly concerned about the extraordinary lengths that the central bank has gone to support ailing countries like Greece and Spain.

Internal divisions at the European Central Bank spilled into the open Friday after Jürgen Stark, the bank’s de facto chief economist, said he would resign his seat on the six-member executive board, which manages bank operations and plays a leading role in setting monetary policy.

In a measure of the acute doubts about Europe’s ability to contain the sovereign debt crisis, Mr. Stark’s resignation was enough to spark stock declines in Europe and the United States. Mr. Stark’s resignation also threatened to further strain European unity and undermine German support for measures to keep Greece from defaulting.

Mr. Stark is an opponent of the E.C.B.’s purchases of bonds from ailing countries to hold down their borrowing costs, and many Germans share his concerns. His resignation “makes the European bailout scheme more unpopular among German voters which lowers the long-term credibility of the bailout policy among investors,” Jörg Krämer, chief economist at Commerzbank, said in a research note Saturday.

Mr. Asmussen’s background suggests he will carry on the German economics tradition, with its focus on price stability. Mr. Asmussen studied economics at the University of Bonn, where he was a protégé of Axel Weber, who later became president of the Bundesbank before resigning earlier this year — like Mr. Stark, in protest over the E.C.B.’s intervention in bond markets.

Mr. Asmussen is close to Jens Weidmann, who succeeded Mr. Weber as president of the Bundesbank. Mr. Weidmann also studied under Mr. Weber, and is known to be among the minority on the E.C.B.’s policy-making governing council who oppose what critics regard as the bank’s improper interference in government fiscal policy.

Mr. Asmussen and Mr. Weidmann are likely to form a united front on the central bank’s governing council. But, along with two or three other council members who opposed the bond purchases, Mr. Asmussen will represent a minority view.

Mr. Asmussen’s appointment must be ratified by other European leaders, but is a foregone conclusion.

Jack Ewing reported from Frankfurt, and Liz Alderman from Marseille.

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E.C.B. Signals Interest Rate Increase in July

However, the euro fell against the dollar after Jean-Claude Trichet, the E.C.B. president, set up a conflict with the German government by rejecting any suggestion that creditors of Greece should be forced to share the burden of a rescue plan.

“We are not in favor of restructuring, haircuts and so forth,” Mr. Trichet said at a press conference following the E.C.B. governing council’s monthly meeting on monetary policy.

His statements were an implicit rebuke to Wolfgang Schäuble, the German finance minister, who said Wednesday that holders of Greek bonds should swap them for debt that the country would have longer to repay.

“President Trichet has gone on a collision course with the German government,” Jörg Krämer, chief economist at Commerzbank in Frankfurt, said in a note following the press conference.

The Bank of England, meanwhile, kept its main interest rate at a record low amid concerns that the country’s economy was still too weak to cope with higher borrowing costs.

In the 17-country euro zone, the E.C.B. has been more fixated on inflation, which has been pushed up by rising food and energy prices.

“Strong vigilance is warranted,” Mr. Trichet said. That language would indicate that a rate increase in July is probable, though the bank always leaves its options open. At the same time, E.C.B. economists slightly lowered their forecast for inflation next year, suggesting that the bank may feel less pressure to raise rates quickly.

On Thursday, the E.C.B. left its benchmark rate at 1.25 percent, after raising it in April from 1 percent, the first increase in two years. Inflation in the euro area was 2.7 percent in May. “When I compare inflation today to interest rates I see a negative number,” Mr. Trichet said.

The benchmark rate in Britain was left at 0.5 percent and the central bank also kept the size of its asset purchase plan unchanged at £200 billion, or about $328 billion.

The E.C.B. said it would continue its emergency support of euro area banks by continuing to grant them unlimited low-interest loans at least through September.

With Germany, Europe’s largest economy, growing so quickly that some economists fear overheating, the E.C.B. has been trying to nudge interest rates back to levels that would be normal in an upturn. But the bank faces a dilemma because the Greek debt crisis still threatens growth in the euro zone as a whole. Economies in Spain, Ireland and other so-called peripheral countries remain sluggish. Higher rates could make it harder for those countries to recover.

Mr. Trichet argued that the best way to help the European economy was to make sure that prices were contained. “It is good for all countries,” he said.

Questions about Greece dominated the E.C.B. press conference, but Mr. Trichet showed no sign of being willing to consider a Greek restructuring, unless it was completely voluntary on the part of creditors — a scenario that is difficult to imagine.

On the contrary, he implied that any restructuring of Greek debt might prompt the bank to stop accepting the country’s bonds as collateral, a move that could be fatal for some Greek banks that depend on cheap E.C.B. loans.

“It is difficult to see how this debate will be resolved,” said Marie Diron, senior economic advisor to Ernst Young, the consulting firm. “Someone, either the E.C.B. or the German government, needs to make some concessions to reach a compromise,” she said in a note. “And this needs to happen soon as time is running out for Greece to refinance its debt.”

Though it does not belong to the euro area, Britain also remains fragile economically. Consumer confidence worsened in April as more people claimed unemployment benefits and as wage increases lagged behind inflation, weighing on living standards. Spending cuts and tax increases that are part of the government’s austerity program made households even more reluctant to spend.

“The story of weak growth is still going to continue for a while,” said James Knightley, a senior economist in London for ING Financial Markets.

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