European banks, assuring investors they can weather thesovereign debt crisis by selling assets and reducing lending, maynot be able to raise money fast enough to prevent government-forcedrecapitalizations.

Banks in France, the U.K., Ireland, Germany and Spain haveannounced plans to shrink by about 775 billion euros ($1.06trillion) in the next two years to reduce short-term funding needsand comply with tougher regulatory capital requirements, accordingto data compiled by Bloomberg. Morgan Stanley predicts that amountcould reach 2 trillion euros across Europe by the end of next yearas banks curb lending and sell loans and entire businesses. A lackof buyers and the losses lenders face on loan sales are makingthose targets unrealistic.

“Asset sales are impractical in the current environment,” saidSimon Maughan, head of sales and distribution at MF Global UK Ltd.in London. “Every bank is selling, and no bank is buying. It justwon't work. Beyond that, the magnitude of the cuts the banks aretalking about is nowhere near the likely required amount ofdeleveraging. They need to reduce hundreds of billions more toadjust to the new world order. There has to be arecapitalization.”

Boosting Capital

European Union leaders are seeking to boost bank capital asinvestors prove reluctant to provide short-term funding, in partbecause of concerns that lenders face more writedowns of sovereigndebt from Greece and other southern European nations. They mayrequire that banks increase core capital to 9 percent ofrisk-weighted assets from 5 percent within six months, seven yearsahead of the target set by the Basel Committee on BankingSupervision, according to a person with knowledge of the plans.

Banks in Europe may need 100 billion euros to 230 billion eurosof additional capital to meet the requirements, according toestimates by Morgan Stanley and JPMorgan Chase & Co. Those thatcan't raise cash through share sales would be required to takecapital from their governments or the EU and may face curbs onpaying bonuses and dividends, European Commission President JoseBarroso said Oct. 12.

European leaders will consider the plans at a meeting inBrussels Oct. 23.

Ackermann, Botin

Banks, whose shares as measured by the 46-member BloombergEurope Banks and Financial Services Index have fallen 30 percentthis year, oppose the plan partly because it would dilute the valueof existing shares. In addition, Deutsche Bank AG's Chief ExecutiveOfficer Josef Ackermann and Banco Santander SA Chairman EmilioBotin say capital injections won't address the real problem, whichis sovereign debt.

“Since private investors will certainly not be providing thefunds for such a recapitalization, governments would ultimatelyhave to raise such funds themselves, thus only exacerbating theirdebt situation,” Ackermann, who's also chairman of theWashington-based Institute of International Finance, said at aconference in Berlin on Oct. 13.

Avoiding government aid may require reducing balance sheets, hesaid. Such shrinkage would help lenders meet revised capitalratios.

The EU proposals “will produce a contraction of credit sincemany institutions will opt to reduce their balances,” Botin said ina speech at Santander's headquarters outside Madrid yesterday.

Shares Rise

The Stoxx Europe 600 Index added 1.07 percent at 11:50 a.m. inLondon and the euro strengthened 0.7 percent to $1.3847 today amidspeculation leaders will stem the region's debt crisis. Analystspartly attributed stock gains to a Guardian newspaper report thatsaid Germany and France agreed to boost the region's rescue fund to2 trillion euros, even after a person with direct knowledge toldBloomberg News no deal has been reached. Moody's Investors Servicecut Spain's credit rating yesterday for the third time in 13months.

French lenders BNP Paribas SA, Credit Agricole SA and SocieteGenerale SA, whose share prices have fallen 35 percent, 47 percentand 51 percent respectively this year, were the latest to announceasset reductions after investors shunned their stocks in August onspeculation France was facing a credit-rating downgrade andconcerns that the banks were too reliant on short-term funding.

BNP Cuts Assets

BNP Paribas, France's largest bank, said on Sept. 14 it willreduce risk-weighted assets by about 70 billion euros by the end ofnext year. This amounts to about 200 billion euros in gross assets,or about 10 percent of the lender's balance sheet, according toestimates by Christophe Nijdam, a Paris-based AlphaValue analyst.It will include sales of investment-banking operations outsideEurope, the bank said.

Societe Generale, the country's third-largest lender by assets,said this month it will cut as much as 80 billion euros inrisk-weighted assets by 2013, including 40 billion euros throughasset disposals. This will decrease funding needs by as much as 95billion euros, the bank said. The reduction amounts to about 150billion euros in gross assets, said Nijdam.

Credit Agricole said it would cut as much as 52 billion euros infunding needs by the end of 2012, which equals about 30 billioneuros in gross assets, according to Nijdam.

'On a Diet'

“French banks had three years to downsize their balance sheet,and they've done little,” Nijdam said in an interview. “Today theydon't have the choice. They were so attacked this summer over theirliquidity needs that the French regulator pressed them to go on adiet. And they want to avoid equity injections that would feel verypunitive for their existing shareholders.”

BNP Paribas had 1.93 trillion euros of gross assets as of June30, compared with 2.08 trillion euros on Dec. 31, 2008, beforepurchasing Fortis's Belgium and Luxembourg assets in 2009. SocieteGenerale had 1.16 trillion euros in assets in June, up from 1.13billion euros at the end of 2008. Both banks say they can meet newBasel capital requirements.

“We've got a perfectly precise route plan to reach the level ofshareholders' equity corresponding to the new rules,” BNP ParibasCEO Baudouin Prot said Sept. 21 on France's Radio Classique. CarineLauru, a spokeswoman for Paris-based BNP Paribas, said the bankwould be able to comply with Basel capital requirements six yearsahead of schedule.

The bulk of the banks' deleveraging, which could reach 5trillion euros in the next three to five years, will come fromrunning off lending rather than selling assets because of the lackof buyers, according to Alberto Gallo, head of European creditstrategy at Royal Bank of Scotland Group Plc.

'Uncertainty Is High'

Potential buyers of bank assets such as insurance companiesdon't have the means to invest significantly, while others such asU.S. banks and sovereign wealth funds may be wary of makingacquisitions in Europe, Gallo said.

“Uncertainty is high, buyers are conservative, valuations lowand the pool of potential buyers is restricted because privateequity has limited access to leverage,” Malik Karim, CEO ofLondon-based Fenchurch Advisory Partners, which providescorporate-finance advice, said. “Selling your best business unitsmay be feasible at attractive prices, but banks will need to decidehow they will replace quality earnings, which underpin theirdividends, an equity story and share prices.”

U.K. and Irish banks have been shrinking their balance sheetswith mixed success since they were bailed out in the 2008 financialcrisis.

RBS Shrinks

Royal Bank of Scotland, which received 45.5 billion pounds ($71billion) in government funding, has cut about 1 trillion poundsfrom its balance sheet since 2008 to 1.4 trillion pounds at the endof the second half of 2011, said Sarah Small, a spokeswoman for thebank.

The sales include the European and Asian operations ofcommodities-trading business RBS Sempra to JPMorgan Chase for $1.7billion, credit-card payment unit WorldPay to private-equity buyersAdvent International Corp. and Bain Capital LLC for 1.7 billionpounds, and more than 300 branches to Santander for about the sameamount.

RBS plans to sell or wind down another 113 billion pounds, Smallsaid, including Churchill and Direct Line insurance units andaircraft-leasing operation RBS Aviation Capital.

“It's obviously not the best market, but there are certain typesof assets that will find buyers,” said Andrew Nason, a seniorbanker advising financial institutions at Societe Generale inLondon. “Banks may be able to sell custody assets andasset-management businesses, which have not been as badly affectedby the downturn.”

Lloyds's Sales

Lloyds Banking Group Plc, which received 20.3 billion pounds ina government bailout, said on June 30 it had cut 48 billion poundsfrom its balance sheet since 2009, taking it to 979 billion pounds.The U.K.'s biggest mortgage lender has attracted only one formalbidder, NBNK Investments Plc, for a sale of 632 branches. The 1.5billion-pound offer is 1 billion pounds short of the 2.5 billionpounds the bank had sought to raise. Lloyds plans to reducenon-core assets by at least an additional 72 billion pounds by theend of 2014, said Sarah Swailes, a bank spokeswoman.

Other European lenders also have found it difficult to sellassets. UniCredit SpA, Italy's biggest bank, in April abandoned aneffort to find a buyer for Pioneer Global Asset Management SpA. KBCGroep NV, Belgium's largest lender and insurer by market value,couldn't get regulatory approval in March to sell itsprivate-banking unit to India's Hinduja Group for 1.35 billioneuros. It announced a new buyer on Oct. 10 from the Middle East for1.05 billion euros.

German lender Commerzbank AG, which is to disclose anasset-reduction target next month, still needs to find a buyer forits Eurohypo mortgage unit to satisfy EU antitrust regulatorsfollowing its 2008 bailout.

Loan Portfolios

Banks also have had mixed success with loan portfolios, oftenselling at discounts. Bank of Ireland Plc said this week it hadagreed to sell 5 billion euros of U.S. and U.K. real- estate assetsat 9 percent below face value. Anglo Irish Bank Corp. and RBS saidthey are close to completing loan-book sales.

Other European banks have been unwilling to sell loans that arebooked at a higher value than what buyers, mostly private-equityfirms and hedge funds, are ready to pay, said Richard Thompson, apartner at PricewaterhouseCoopers LLP in London, which advisesbanks or buyers on those transactions.

“Selling loans reduces the size of the balance sheet, but quiteoften you're selling to a financial investor, who's asking for abig discount because its return requirement is greater than thereturn requirement of the bank holding the assets,” Thompson said.“This simple difference in cost of capital generates a loss.”

U.S. Buyers

Irish banks, which were ordered in March to offload about 70billion euros in assets by 2013, have been able to sell loans atlosses because they have been recapitalized, he said.

European banks have about 1.3 trillion euros of non-core loanson their balance sheets, PwC estimated in April. Lured by theprospect of buying those portfolios at discounts, U.S. hedge fundsand private-equity firms such as New York-based Apollo GlobalManagement LLC have raised about $7 billion for funds targetingEuropean distressed assets since 2009 and are seeking another $7billion, compared with about $400 million during the 2002recession, according to London-based researcher Preqin Ltd.

“The expectation when the financial crisis came about in 2008and 2009 was there would be lots of opportunities to choose from,”said Dilip Awtani, a managing director responsible for distressedinvestments in Europe at Los Angeles-based private-equity firmColony Capital LLC. “But that didn't materialize. There's a hugeprice gap currently. A lot of the banks in a position to default orfail didn't and are still around because the government supportedthem. We'll see whether banks have gotten realistic about thepricing it will take for them to lighten their books.”

Wholesale Funding

European banks need to cut more assets than they are announcingto wean themselves from their reliance on wholesale funding, MFGlobal's Maughan said. Of the 1.1 trillion euros in total fundingrequired by euro-zone banks through next September, about 60percent will come from the short-term money markets, Roger Francis,an analyst at Mizuho Securities Co. in London, said in a note toclients on Oct. 7.

“Banks think the funding costs will go back to the way they wereas if by magic,” Maughan said. “But they will not, not in mylifetime, because the implicit sovereign guarantee of banks'balance sheets is gone.”

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