Click for full photo gallery: Capital Holes In European Banks
The myriad ways banks can improve their capital positions boil down to two basics: selling assets or growing profits. In the face of a likely recession in the eurozone, the latter seems unlikely, which makes the former crucial in the months ahead.
That was cast into stark relief Thursday, when the European Banking Authority released an update on its evaluation of the region��s capital needs. European banks need to raise �114.7 ($153.2 billion) to fill their capital shortfall, the EBA said. The biggest capital infusions, not surprisingly, are needed for banks based in Greece (�30B), Spain (�26.2) and Italy (�15.3B), but the EBA figures that banks in Germany (�13.1B) and France (�15.3B) also have gaping holes to fill in order to get to a 9% Tier 1 capital ratio by June 2012.
The EBA is recommending that “national supervisory authorities should require the banks to strengthen their capital positions by building up an exceptional and temporary capital buffer against sovereign debt exposures to reflect market prices as at the end of September.
“In addition, banks will be required to establish an exceptional and temporary buffer such that the Core Tier 1 capital ratio reaches a level of 9% by the end of June 2012. The amount of any capital shortfall identified is based on September 2011 figures and the amount of the sovereign capital buffer will not be revised. Sales of sovereign bonds will not alleviate the buffer requirement to be achieved by June 2012. ”
The buffers, the EBA says, “
are explicitly not designed to cover losses in sovereigns but to provide a reassurance to markets about the banks�� ability to withstand a range of shocks and still maintain adequate capital. The sovereign capital buffer is a one-off measure and, once the ! deployme nt of the new EFSF��s capacity becomes effective in addressing the sovereign debt crisis by lifting sovereign bond valuations from today��s distressed prices, the EBA will reassess the ongoing need for and size of capital buffers against banks�� sovereign exposures.”
To date, promises of strict austerity programs have been the primary way for debt-addled countries like Greece and most recently Italy to generate support for bailout loans from stronger neighbors France and Germany. Those austerity programs will sap growth, not boost it though, so growing their way out of the crisis as a way to shore up capital is at best a pipe dream for pressured European banks.
That leaves asset sales, and the Great European Deleveraging of 2012 is a theme many strategists have been talking about in recent weeks.
Part of the issue, according to a Nov. 7 note from Nomura strategist Jens Nordvig, is the risk that European banks may not be able to sell the assets that have gotten them in trouble. While banks have certainly been looking to cut exposure to sovereign debt, getting out of the bonds of the country where they are domiciled is a tricky game. That means at least a chunk of the deleveraging is likely to come from cross-border holdings, which is no small pie given that Europe��s banks hold nearly $2 trillion in U.S. assets and more than $1.5 trillion in the U.K. that could easily be reclassified as non-core given the current landscape.
Of course, under the current conditions, raising capital can only go so far. ��Everything the EU and eurozone are doing is necessary, but not sufficient,�� says Barclays Capital��s Ajay Rajadhyaksha. Until the underlying assets (sovereign debt) are stabilized, raising all the capital in the world will not be sufficient.
While politicians sort out the details of efforts to stabilize the sovereign picture �C including at this weekend��s EU summit — Barclays Capital estimates the European deleveraging could amount to as much as 10% of cross-bo! rder eur ozone bank assets (anywhere from �500 billion to �3 trillion). Barry Knapp, head of the firm��s U.S. equity strategy, thinks the deleveraging could produce some headwinds for the market in early 2012 as ongoing and potential divestitures keep a lid on the prices of certain assets.
Many of the banks where the EBA sees shortfalls have already announced plans aimed at deleveraging or cost-cutting to boost capital. Germany��s Deutsche Bank (�3.2 billion shortfall) is rolling off certain portfolios and could sell its U.S. asset management operations, according to Citigroup bank analyst Keith Horowitz, while France��s BNP Paribas (�1.5 billion) and Soci��t�� G��n��rale (�2.1 billion) have both announced plans to significantly take down leverage.
The European bank that has the biggest capital shortfall, according to the EBA, is Spain’s Banco Santander, which needs to plug a �15.3 billion capital hole.
An important point to mention, Horowitz said in a Nov. 29 note after meeting with senior executives from major U.S. and European banks in London, is that there are numerous opportunities that arise in such a deleveraging scenario. For one thing, if European banks pull back from certain market-making activities, the remaining players could pick up share, Horowitz says, citing Goldman Sachs as one potential winner given its ��strong trading technology�� and [the benefit of ] greater asset turnover amid deleveraging.��
Other potential winners, in Horowitz��s view: JPMorgan Chase in the U.S. and Barclays, HSBC and Standard Chartered in Europe.
(Update: As a reader pointed out via e-mail, this story did not mention the ECB’s decision Thursday to offer European banks unlimited cash under new three-year loan programs, and loosen collateral rules. While these are important moves from a liquidity standpoint, it is nothing more than a move that buys time for the ongoing efforts toward a workable solution for the debt crisis. The ECB is not giving the banks money, and thus not f! illing t he capital hole this story discussed.)
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