By Aaron Kirchfeld and Fabio Benedetti-Valentini - Nov 8, 2011 10:10 PM GMT+0700
Banks are selling debt of southern European nations as investors punish companies with large holdings and regulators demand higher reserves to shoulder possible losses. The European Banking Authority is requiring lenders to boost capital by 106 billion euros after marking their government debt to market values. The trend may undermine European leaders’ efforts to lower borrowing costs for countries such as Greece and Italy, while generating larger writedowns and capital shortfalls.
“European regulators and leaders are shooting themselves in the foot because a big investor group for sovereign bonds has been taken out of the market,” said Otto Dichtl, a London-based credit analyst for financial companies at Knight Capital Europe Ltd. “The downward spiral will continue until policy makers find a back-up solution for the sovereigns.”
European banks cut their foreign lending to the Greek public sector to $37 billion as of June 30 from $52 billion at the end of 2010, according to the most recent data from the Bank for International Settlements. European banks’ lending to the Irish, Portuguese and Spanish public sectors also fell, according to Basel, Switzerland-based BIS.
Financial companies can reduce risk through writedowns, sales and hedges, as well as by letting bonds mature.
Greek bonds have dropped 42 percent since July, the most among 26 sovereign-debt markets tracked by Bloomberg/European Federation of Financial Analysts Societies indexes. Italian debt declined 8 percent and Portuguese securities 5 percent, the indexes show.
Italian benchmark yields climbed to a euro-era record yesterday on concern that the region’s third-largest economy will struggle to manage its debt as growth stagnates.
European banking stocks rose 2.4 percent today as investors awaited a vote on Italy’s budget that may show whether Prime Minister Silvio Berlusconi has enough support in parliament to stay in power. The Bloomberg Europe Banks and Financial Services Index, which tracks 46 stocks, has fallen 30 percent this year.
European leaders are demanding that banks raise capital to increase their resilience after firms represented by the Institute of International Finance agreed last month to accept a 50 percent loss on Greek sovereign holdings to help tackle the debt crisis. Policy makers also announced plans to boost the region’s rescue fund to 1 trillion euros.
The EBA examined how much capital the region’s biggest lenders would need to reach a core Tier 1 ratio of 9 percent by the middle of next year after marking their sovereign holdings to market, an exercise omitted during bank stress tests in July. Most major European countries’ sovereign debt was considered risk-free in the past.
‘Damp Squib’
“The recapitalization of European banks is also turning out to be a damp squib,” according to a Nov. 6 note from CreditSights Inc. “This does nothing to fix the main problem of restoring sovereigns’ risk-free status.”
Forcing Europe’s lenders to boost capital based on sovereign markdowns “will cause a number of serious problems,” the IIF, a Washington-based group representing more than 450 financial firms, warned in a letter to French President Nicolas Sarkozy before last week’s Group of 20 summit in Cannes, France.
“The market value of the debt of the countries most under scrutiny is likely to decline further as banks unload sovereign bonds,” according to the letter, signed by Managing Director Charles Dallara. “This is contrary to the goal of stabilizing and underpinning the outlook for sovereign debt in Europe.”
An EBA spokeswoman declined to comment.
MF Global
The impact of declining government bond prices spread to New York on Oct. 31, when MF Global Holdings Ltd. (MF), the holding company for the broker-dealer run by Jon S. Corzine, filed for bankruptcy protection after making a $6.3 billion bet with the firm’s money on European sovereign debt.
Moving away from the principle that European sovereign debt is risk free “will come back to haunt us,” Deutsche Bank AG Chief Executive Officer Josef Ackermann said in an interview on Nov. 6 with German ARD television. “That is a very dangerous development.”
Italian banks including Intesa Sanpaolo SpA, the country’s second-biggest, are backing a plan to sell government bonds to individual investors without commissions for a day.
The losses on Greek bonds and efforts to reduce sovereign- debt holdings have hurt banks’ third-quarter earnings.
Commerzbank, Germany’s second-biggest lender, reported a 687 million-euro loss on Nov. 4 after writing down the value of its Greek government debt and selling securities of southern European nations at a loss. Chief Financial Officer Eric Strutz said the Frankfurt-based firm booked a “three-digit-million” euro loss on Italian bond sales, without elaborating.
Creating Supply
Strutz, on a conference call with analysts that day, blamed regulators for worsening the situation by including mark-to- market rules in the stress tests, effectively encouraging banks to sell sovereign bonds.
“It’s a little bit strange to see that the regulators are actually fueling the whole debate by going into the other direction of creating more supply in the market,” said Strutz. “If you have a mark-to-market, all banks will further sell down their sovereign bonds, because in the end, you need -- whether implicit or explicit -- you need higher capital for that.”
While Commerzbank doesn’t want “a fire sale,” it’s willing to take “a small loss” to free up capital as the lender further reduces sovereign holdings, he said.
Reiner Rossmann, a Commerzbank spokesman, declined to comment beyond Strutz’s statements.
Losses on Debt
Third-quarter profit at BNP Paribas (BNP) fell 72 percent because of a 2.26 billion-euro writedown on Greek sovereign debt and losses from selling European government bonds, the Paris-based bank said on Nov. 3.
BNP Paribas, the largest foreign holder of Italy’s bonds, reduced that nation’s debt in its banking book by 8.3 billion euros between the end of June and the end of October, according to a Nov. 3 presentation. Chief Executive Officer Baudouin Prot said on a conference call with reporters the same day that the Italian bonds were “sold in full on the markets” and not to the European Central Bank.
BNP Paribas said it cut the total sovereign debt in its banking book by 23 percent to 81.5 billion euros.
“We very much reduced our exposure to sovereign debt,” Prot said in a Nov. 3 Bloomberg Television interview. “We incurred losses for that.”
Isabelle Wolff, a spokeswoman for BNP Paribas, declined to elaborate.
ECB Purchases
Societe Generale (GLE) SA, France’s second-largest bank, today reported a 31 percent decline in third-quarter profit because of a writedown on Greek sovereign bonds and lower trading revenue. The Paris-based firm also booked 87 million euros of fixed- income losses from sovereign risks tied to Italy, Spain, Portugal, Ireland and Greece, it said. Societe Generale cut its banking-book sovereign holdings on the five countries to 3.4 billion euros at the end of October from 5.6 billion euros in June.
“You can’t really blame BNP or other European banks for selling sovereign debt,” said Christophe Nijdam, an AlphaValue bank analyst in Paris. “The European rescue fund hasn’t enough financial firepower, we still don’t have a rescue fund equipped to make sizeable purchases on the secondary market. As a banker, you don’t want to wait to see what happens for Italy and Spain.”
While it’s difficult to determine who’s buying the bonds, Knight Capital’s Dichtl said that beyond purchases by the ECB, some Greek government bonds may be bought by hedge funds or distressed-asset investors and Italian debt is still being purchased by asset managers and pension funds.
‘Disentangle the Links’
Of about 355 billion euros in outstanding Greek debt, about 127 billion euros is held by the European Union, the International Monetary Fund and the ECB, while about 90 billion euros is held by European banks, led by Greek lenders, according to estimates by Open Europe, a research group based in London and Brussels. About 80 billion euros is held by foreign non- banks such as hedge funds and insurers. Data is scarce, making estimates difficult, according to Raoul Ruparel, an economic analyst at Open Europe.
In the past, domestic banks in countries such as Greece and Ireland “filled the gap” when foreign demand for their nations’ bonds slipped, said Alberto Gallo, head of European credit strategy at Edinburgh-based RBS.
“The question is how to disentangle the link between banks and sovereigns,” said Gallo, who described the situation as a Catch-22, referring to Joseph Heller’s 1961 novel that describes the no-win situation faced by a World War II pilot trying to avoid duty. “If you do, you have a risk of accelerated de- leveraging. If you don’t, you end up with a bank system very correlated with sovereign bonds and vulnerable to shocks.”
To contact the reporters on this story: Aaron Kirchfeld in Frankfurt at akirchfeld@bloomberg.net; Fabio Benedetti-Valentini at fabiobv@bloomberg.net
To contact the editors responsible for this story: Frank Connelly at fconnelly@bloomberg.net; Edward Evans at eevans3@bloomberg.net
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