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. Santander, which said in October it needs to plug a 5.2 billion-euro ($6.9 billion) capital gap, sold its Colombian unit last week to Chile’s Corpbanca for $1.16 billion. Deutsche Bank is weighing options including a sale of most of its asset-management unit, while KBC may dispose of businesses in Poland.
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.
“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.”
Hurting Profitability
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. Return on asset value at Frankfurt-based Deutsche Bank will shrink by almost 1 percentage point and at Santander by about 0.8 percentage point because of deleveraging, he said. The shrinking economy will help cut returns by an additional 2.5 percentage points, he added.
‘Cheaper Way’
For French banks BNP Paribas SA (BNP), Societe Generale (GLE) SA and Credit Agricole SA (ACA), return on equity may fall to between 7 percent and 9 percent in 2013, from 12 percent to 21 percent in 2007, according to Christophe Nijdam, an analyst at AlphaValue in Paris. The ratio may rise to between 10 percent and 12 percent by 2015, assuming the economy recovers by then, he said.
“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.”
For banks, selling assets has become a cheaper way to raise capital than selling new stock after their shares tumbled. The Bloomberg Europe Banks and Financial Services Index (BEBANKS) has slumped 33.5 percent this year, leaving bank stocks trading at an average of 63 percent of book value.
“Many of those banks are trading at 50 percent of their book value, so if you can sell an asset at more than that, it’s a cheaper way to raise capital,” said Symon Drake-Brockman, former chief executive officer of Royal Bank of Scotland Group Plc (RBS)’s global banking and markets in the Americas and now managing partner of private-equity firm Pemberton Capital Advisors LLP in London.
‘Adverse Selection’
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.”
Raising Capital
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.
‘Family Jewels’
“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.”
Santander completed the sale of its Brazilian insurance operations to Zurich Financial Services AG for $1.7 billion and sold a $958 million stake in Banco Santander Chile, the South American country’s biggest bank by assets. The Chilean bank’s net profit grew 45 percent (BSAN)between 2008 and 2010 and may increase by another 15 percent this year to about $970 million, according to analyst estimates compiled by Bloomberg. Santander said it will also sell a stake in its Brazilian banking unit.
The Spanish lender’s sale of its U.S. consumer-loan business to a group led by private-equity firm KKR & Co. may cut net profit for Santander’s shareholders by 150 million euros, according to an Oct. 28 estimate by Raoul Leonard, an analyst at RBS in London.
Bloomberg
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