European banks, under pressure from regulators to bolstercapital, are selling some of their fastest-growing businesses tocompetitors from outside the region — at the expense of futureprofit and economic growth.

Spain's Banco Santander SA, Belgium's KBC Groep NV and Germany'sDeutsche Bank AG are accelerating plans to exit profitableoperations outside their home markets. Santander, which said inOctober it needs to plug a 5.2 billion-euro ($6.9 billion) capitalgap, sold its Colombian unit last week to Chile's Corpbanca for$1.16 billion. Deutsche Bank is weighing options including a saleof most of its asset-management unit, while KBC may dispose ofbusinesses in Poland.

Such sales risk hurting long-term profit, just as Europe entersrecession, investors say. It's the unintended consequence of thedecision by European regulators to make banks increase core capitalto 9 percent by June instead of 2019. Unwilling to raise equitybecause their share prices are too low, lenders are sellingprofitable assets because they're struggling to find buyers willingto pay enough for their troubled loans to avoid a loss that woulderode capital. Investors say the sales risk leaving banks focusedon a stagnant economy and deprive them of economic growth fromoutside the region.

“These are the most profitable parts of their business,” saidAzad Zangana, European economist at London-based Schroders Plc, the200-year-old British asset manager, citing Spanish and Portuguesebanks selling assets in Latin America. “They're being forced byregulators to sell them off. You begin to become a less profitableorganization. Your business model stops working if you're beingforced to lend only to an economy that's going through a very deeprecession.”

The divestitures are likely to hurt banks' profitability incoming years, analysts say. Shrinkage will cut their return on netasset value by 1.5 percentage points on average, according to aDec. 6 report by Huw van Steenis, a Morgan Stanley analyst inLondon. Return on asset value at Frankfurt-based Deutsche Bank willshrink by almost 1 percentage point and at Santander by about 0.8percentage point because of deleveraging, he said. The shrinkingeconomy will help cut returns by an additional 2.5 percentagepoints, he added.

For French banks BNP Paribas SA, Societe Generale SA and CreditAgricole SA, return on equity may fall to between 7 percent and 9percent in 2013, from 12 percent to 21 percent in 2007, accordingto Christophe Nijdam, an analyst at AlphaValue in Paris. The ratiomay rise to between 10 percent and 12 percent by 2015, assuming theeconomy recovers by then, he said.

“There's nothing wrong in theory about selling the crownjewels,” Nijdam said. “It's always a question of price. Europeanbanks will be less profitable — but less risky.”

For banks, selling assets has become a cheaper way to raisecapital than selling new stock after their shares tumbled. TheBloomberg Europe Banks and Financial Services Index has slumped33.5 percent this year, leaving bank stocks trading at an averageof 63 percent of book value.

“Many of those banks are trading at 50 percent of their bookvalue, so if you can sell an asset at more than that, it's acheaper way to raise capital,” said Symon Drake-Brockman, formerchief executive officer of Royal Bank of Scotland Group Plc'sglobal banking and markets in the Americas and now managing partnerof private-equity firm Pemberton Capital Advisors LLP inLondon.

'Adverse Selection'

Banks across Europe have pledged to cut more than 950 billioneuros of assets over the next two years, according to data compiledby Bloomberg. About two-thirds of that will come from sales ofprofitable units and performing loans, said van Steenis. Sales ofdistressed assets and souring loans will account for just 4percent, or about 100 billion euros, he said.

“European banks are likely to sell good, performing assets toforeign banks and investors,” he said in an interview. “Thequestion is: When are you getting to the point of adverseselection? When you're selling the good assets and you're keepingthe more risky assets. There is a risk we're moving in thatdirection.”

Buyers, for the most part private-equity and hedge funds, areoffering too steep discounts for underperforming assets. For banks,a fire sale would trigger losses they can ill afford at a time whenthey're required to boost capital.

“Lenders are selling more liquid assets so they can get a pricethat avoids additional capital losses,” said Joseph Swanson,co-head of restructuring at Houlihan Lokey in London.“Unfortunately, this strategy can result in lower asset quality andincreased earnings volatility.”

Regulators are forcing European banks to raise capital as theregion's sovereign-debt crisis worsens. The European BankingAuthority last week ordered the region's financial firms to raise114.7 billion euros of additional capital. The EBA, whichco-ordinates the work of the region's 27 national regulators, toldlenders to bolster their core Tier 1 capital ratios to more than 9percent of risk-weighted assets by the middle of 2012.

Faced with a potential credit crunch, the regulator told banksto raise the money from investors, retained earnings and lowerbonuses. Failing that, companies may sell assets, provided thedisposals don't limit overall lending to the European Union's“real” economy, the EBA said in a Dec. 8 statement.

'Family Jewels'

“The family jewels are being sold,” Richard Mattione, aportfolio manager at Boston-based Grantham, Mayo, Van Otterloo& Co., wrote in a report this month. “A big chunk of privatesector loans can't be reduced because they involve property thatwill be inactive for years, perhaps a decade. So, once banks trimtheir healthiest borrowers, and perhaps reduce their overseasexposures, they quickly run into the need to cut loans to small andmedium enterprises, providing another negative impulse to Europeangrowth.”

Santander completed the sale of its Brazilian insuranceoperations to Zurich Financial Services AG for $1.7 billion andsold a $958 million stake in Banco Santander Chile, the SouthAmerican country's biggest bank by assets. The Chilean bank's netprofit grew 45 percent between 2008 and 2010 and may increase byanother 15 percent this year to about $970 million, according toanalyst estimates compiled by Bloomberg. Santander said it willalso sell a stake in its Brazilian banking unit.

The Spanish lender's sale of its U.S. consumer-loan business toa group led by private-equity firm KKR & Co. may cut net profitfor Santander's shareholders by 150 million euros, according to anOct. 28 estimate by Raoul Leonard, an analyst at RBS in London.

“That may only equate to 2 percent of Santander's group netattributable profit for 2010, but assuming multiple asset sales maybe in the pipeline, this could lead to a meaningful negative dragon” earnings, Leonard wrote.

A spokeswoman for Santander, who asked not to be identified byname in line with company policy, declined to comment.

KBC, the Belgian bank that received a 7 billion-euro governmentbailout, said in July it would sell Towarzystwo Ubezpieczen iReasekuracji Warta SA, Poland's second-largest insurer, and its 80percent stake in Polish bank Kredyt Bank SA.

The sale of Kredyt Bank, whose net income rose 9.5 percent to60.8 million zloty ($17.6 million) in the third quarter, willreduce KBC's return on equity to 17.3 percent from 18.9 percent,according to Benoit Petrarque, an analyst at Kepler Capital Marketsin Amsterdam.

'Two Sides'

If the disposal isn't big enough to help meet the 9 percentcapital target, the bank could sell its Czech unit as well,Petrarque said. The sale of the Czech division would boost corecapital to 10.5 percent at the cost of reducing return on equity toabout 11 percent, he estimated. KBC said in July it would retainfull ownership of Czech banking unit CSOB AS, its most profitablebusiness in Eastern Europe.

“When you sell an asset, there are always two sides of thecoin,” Stephane Leunens, a spokesman for KBC, said in a telephoneinterview. “We focus on de-risking the company while trying togenerate sufficient growth in our core markets.”

Philippe Bodereau, head of European credit research at PacificInvestment Management Co. in London, said in a telephone interviewthat European banks are becoming “slimmer, less global” and “moreutility-like.” They will be “better credit investments than equityinvestments,” he said.

Deutsche Bank, which needs to plug a 3.2 billion-euro capitalshortfall by the middle of next year, said last month it isreviewing all options, including a sale, for most of itsasset-management unit, a business that CEO Josef Ackermann built upover the last decade to help mitigate the bank's reliance oninvestment banking.

The review focuses on “how recent regulatory changes andassociated costs” are affecting the business, Deutsche Bank said inthe Nov. 22 statement. The disposal would exclude the DWS mutualfund unit in Germany, Europe and Asia, which the bank said was “acore part” of its offering to consumers. The review will beconducted “thoroughly and carefully” said Deutsche Bank spokesmanKlaus Winker, declining further comment.

Banco Espirito Santo SA, Portugal's largest publicly tradedlender, sold its stake in Brazil's Banco Bradesco SA for about $1billion and part of its stake in Denmark's Saxo Bank A/S this year.Banco Comercial Portugues SA, the country's second-biggest bank bymarket value, is considering options for Bank Millennium SA,Poland's seventh-largest lender, including a sale. The Porto-basedlender needs to raise 1.7 billion euros to meet regulatorytargets.

Banco Comercial

The Bradesco sale doesn't affect the operation's performance inBrazil and the bank's loan portfolio in that country is growing,Paulo Padrao, a spokesman for Espirito Santo said. Banco Comercialaims to “extract the maximum value” out of operations in Centraland Eastern Europe, Erik Burns, a spokesman for the bank, said.

ING Groep NV, the Netherlands's biggest financial-services firm,agreed in July to sell most of its Latin American insurance unitfor about 2.6 billion euros to a group led by Grupo de InversionesSuramericana SA, a Colombian investment firm.

“If they raise capital by selling crown jewels, the market willreward them in the short term because they'll meet the regulator'stimeframe,” said Will James, who runs the 632 million-pound SLIEuropean Equity Income Fund at Edinburgh-based Standard Life Plc.“That begs the longer-term question: How do you grow in anenvironment where customers are unwilling to borrow. That's themissing piece from the puzzle. In a low- growth or no-growthenvironment, banks that have sold good assets will continue tostruggle.”

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