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The largest banks of Europe have started setting their houses in order and are doing so at a furious pace. As regulatory pressure increases and buyers compete for bad assets, the complexion of the continent’s banking space is changing. This surge in deal making could deliver a much-needed economic boost. This is because it would leave banks with funds which could then be used to step up lending.

Spurt in Deal Making

The disposal of unwanted assets and poor investments in companies which are to be sold off or closed down has undergone a significant increase. Such deal making has been led by Barclays PLC (BCS - Analyst Report), Credit Suisse Group AG (CS - Snapshot Report) and Milan-based UniCredit SpA.

According to Bloomberg, unwanted assets to be disposed of have increased by 65% since the end of last year to $1.72 trillion. Analysts are of the view that the number of deals taking place, across markets and asset classes, is unprecedented. There are two major reasons for such deals taking place. Firstly, there is pressure on banks to turn over better profits. Secondly, regulatory pressure on the banking industry has increased.

Regulatory Pressure

Former deputy governor of the Bank of England, Paul Tucker said: “Stronger banks will be good for credit in Europe.” Speaking during an interview in Salzburg, he added: “Weak banks don’t lend.”

New and more stringent regulations have diminished the lure of certain bond businesses. At the same time, regulators have forced lenders to declare that bad loans will not be repaid. Selling off inefficient operations and bad debts provides banks with more funds which can be used to step up lending.

This could come as a boon to nations in Europe whose economies have stagnated for nearly six years. The stagnation occurred due to a sovereign debt crisis contagion, itself a result of a large number of banking bailouts and clampdown on credit.

ECB’s Stress Tests

Italy’s largest bank UniCredit has already taken steps to account for the number of unwanted loans it will rid itself off. Other banks are expected to do the same as ECB conducts a review of the financial health of banks.

The ECB has decided to create a unified watchdog for all Eurozone banks before the end of the year. Ahead of its assumption of formal control on Nov 4 this year, the ECB is carrying out an exhaustive evaluation of the health of banks in the economic union.

Real Estate Loan Sales Rise

Years before this phenomenon gathered strength, investors were looking to buy such assets. However, banks were unwilling to sell, until now, when funds and other private-equity companies are willing to pay higher amounts. According to Cushman and Wakefield, buyers are now willing to pay more during real estate loan auctions.

The New York-based real estate broker said during the first half of the year, banks sold $54 billion (40.9 billion euros) worth of European loans linked to property. This is in excess of seven times that of those sold during the first six months of last year. The firm projects sales to be around 40 billion euros next year.

Banks to Benefit

The simple truth is that the longer banks keep unwanted assets on their books the more detrimental it is for them. This is because their cost of funding increases and they end up charging higher sums for loans.

This is why the faster banks rid themselves of these assets, the faster they will be able to boost profits. Of the 12 organizations that post earnings for assets that they intend to sell, these holdings resulted in pretax losses of around $7 billion during the first six months of the year. This includes the like of Copenhagen based Danske Bank A/S and Deutsche Bank AG (DB - Analyst Report).

However, record low interest rates maintained by central banks have increased investors’ appetite for debt available at discounted prices. This is because such a policy stance has reduced returns available from other avenues. The rise in investor demand will allow The Royal Bank of Scotland Group plc (RBS - Snapshot Report) to reduce the cost of disposing off assets by 1.5 billion pounds.

In Conclusion

Regulatory pressure and the need for banks to return better profits have led to a phenomenon which may prove to be beneficial at several levels. On one hand, regulators will witness the desired improvement in the quality of banking assets. Secondly, this will lead to better returns for banks. Moreover, the economy as a whole will receive a much needed boost as more funds become available for fresh loans.

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