The Journey Towards Financial Stability
Germany’s Commerzbank has announced its determination to avoid relying on state bailouts, as European banks scramble to find solutions to fill a €115 billion resources gap and safeguard the market.
While most banks claim to have found ways to address the deficiency, a few are currently working privately to resolve the issue.
The risks associated with declining profits caused by a weakened eurozone economy, increased losses on Greek government bonds, and lack of investor appetite for bank equity mean that the possibility of state assistance cannot be ruled out, especially for Commerzbank and Italy’s Banca Monte dei Paschi di Siena BMPS.MI.
Regulatory Requirements and Deadlines
In an effort to provide a larger capital cushion and protect taxpayers from a repeat of the 2008 crisis, European financial regulators have imposed a requirement for banks to hold a core funding level of at least 9 percent by the end of June. Additionally, these banks must fill any shortfall in capital.
By Friday, thirty-one banks are expected to present their plans for raising additional capital to their national regulatory authorities.
Commerzbank and Monte dei Paschi (MPS) will have to assess how the European Financial Authority will scrutinize the assumptions underlying their plans.
Commerzbank, Germany’s second-largest lender, needs to find €5.3 billion. On Thursday, it announced that it had already reserved €3 billion and expects to reduce the need for an additional €3.3 billion. This announcement caused its shares to surge by 14 percent, as analysts had feared it would require state assistance.
CEO Martin Blessing emphasized that this strategy is contingent on no further deterioration in the macroeconomic environment, especially no further escalation of the sovereign debt crisis.
Uncertainties Surrounding MPS
Faced with a requirement of €3.3 billion, Banca Monte dei Paschi di Siena may need to turn to shareholders or the government for at least half of that amount.
The bank plans to sell assets, form joint ventures, reduce its holdings, and issue convertible notes to strengthen its capital. However, doubts remain about its ability to achieve €1 billion in asset sales by June. Thus, it might need to seek investment from external sources. There are suggestions that it may require state assistance, as the organization overseeing the bank is financially strained.
“They are in a very delicate situation. It’s really hard to see where they can raise that much capital,” commented Frederic Teschner, a banking expert at Natixis in Paris. “The organization does not want a capital increase that it cannot subscribe to because it would lose control.”
A Global Issue
Portugal’s Millennium bcp is exploring all options to find the €2.1 billion it needs and may consider attracting external investors. Portugal’s banks can also tap into an international aid program for the €7 billion they require.
Spain’s Bankia and Popular have declared that they can meet their respective shortfalls of €1.3 billion and €2.6 billion without state aid.
Bankia plans to convert preference shares to fulfill its need. However, if Spain instructs its banks to set aside more capital to cover potential losses on property loans, Bankia may find itself needing to reserve an additional €5 billion.
Exploring All Possible Solutions
Banks have various means at their disposal to raise the required capital. They can retain profits, reduce loans to customers, convert hybrid debt into equity, repurchase their own bonds, sell assets, and cut dividends or staff salaries.
Banks must present their plans to their national regulatory authorities, who will review and approve them before forwarding them to the European Banking Authority (EBA). The EBA board will then evaluate the plans in early February.
Commerzbank should, in theory, surpass the required capital level. However, in practice, it might fall short by a few hundred million euros, according to Andrew Lim, an analyst at Espirito Santo. This raises questions about the level of flexibility the EBA and investors will allow Commerzbank and other banks.
Commerzbank’s Strategy for Success
Commerzbank’s plan includes reducing riskier asset holdings by an additional €17 billion, retaining more of its profits, and refraining from expanding its business outside of Germany and Poland.
The bank also intends to pay its employees in shares instead of cash, which could free up €250 million in regulatory capital.
The primary objective is to shrink the balance sheet to less than €600 billion by 2014, down from approximately €739 billion at the end of 2011.
UniCredit, Italy’s largest bank, is currently in the middle of a rights issue to raise €7.5 billion in much-needed capital. Despite facing challenges, such as investor caution, this underwritten deal will secure the funds required. However, it serves as a reminder that smaller competitors might find it harder to comply with similar requirements.
Santander, which had the largest capital deficit of any bank, recently announced that it has already raised the €15.3 billion it needed through a combination of converting hybrid debt and preferred shares, retaining profits, selling assets, and other measures.
