The Wall Street Journal BUSINESS November 7, 2011
Old Debts Dog Europe's Banks Lenders Slower Than Their U.S. Counterparts to Shed Risky Mortgage Assets
By DAVID ENRICH and LAURA STEVENS
European banks are sitting on heaps of exotic mortgage products and other risky assets that predate the financial crisis, adding to pressure on lenders that also are holding large quantities of euro- zone government debt.
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Four years after instruments like "collateralized debt obligations" and "leveraged loans" became dirty words because of the massive losses they inflicted on holders, European banks still own tens of billions of euros of such assets. They also have sizable portfolios of U.S. commercial real-estate loans and subprime mortgages that could remain under pressure until the global economy recovers.
While the assets largely originated in the U.S. financial system, top American banks have moved faster than their European counterparts to rid themselves of the majority of such detritus.
Sixteen top European banks are holding a total of about ?386 billion ($532 billion) of potentially suspect credit-market and real-estate assets, according to a recent report by Credit Suisse analysts. That's more than the ?339 billion of Greek, Irish, Italian, Portuguese and Spanish government debt that those same banks were holding at the end of last year, according to European "stress test" data.
The banks are in the spotlight largely because of the political and financial turmoil racking the Continent. In the latest upheaval, Greece's prime minister agreed Sunday to step down as the country's main political parties announced plans for a unity government. Meanwhile, the future of Italian Prime Minister Silvio Berlusconi's government appeared increasingly uncertain as some members of his own party threatened to pull their support.
The old credit-market assets might turn out to be harmless for the banks. If real-estate markets hold steady or strengthen, for example, instruments made up of home loans could gain value and generate a steady stream of cash payments for their holders.
Still, the hefty holdings of debt from before the 2008 financial crisis compound the challenge facing the Continent's banks.
Many are holding tens of billions of euros of bonds issued by financially shaky countries. They are holding hundreds of billions more in loans to customers in those same countries, which are likely to go bad at an increasing clip if Europe's economy continues to struggle.
The situation is heightening fears that the banks lack enough capital to absorb potential losses and could require government support.
The banks generally have been holding the assets since before the financial crisis got under way four years ago, a time when real-estate assets in general had much higher prices. Some banks haven't fully written down these loans to reflect their current market values.
European banks, on average, have roughly halved their stockpiles of the legacy assets since 2007, the Credit Suisse analysts found. Meanwhile, the top three U.S. banks?Bank of America Corp., Citigroup Inc. and J.P. Morgan Chase & Co.?have slashed such assets by well over
80% over a similar period."There's been very much a pattern of just holding them," said Carla Antunes-Silva, head of European banks research at Credit Suisse. "It will be another drag" on the banks' capital and returns on equity.
Bank executives in Europe play down such concerns. They say they have reduced their exposures to risky assets and have enough capital to soak up any losses.
They add that investors seem preoccupied with the euro-zone mess and haven't been asking questions lately about the banks' lingering credit- market exposures.
"It's not at all a concern," said a top official at France's BNP Paribas SA, which is sitting on ?12.5 billion of asset-backed securities and collateralized debt obligations tied to real-estate markets. The assets are liquid and "priced very conservatively."
The assets could lose value due to a wave of selling by the banks. Last month, regulators instructed many European lenders to come up with a total of about ?106 billion in new capital by next summer. Bankers, analysts and other experts say that dumping leftover credit assets is likely to be an attractive method of finding the funds.
French banks in particular have pointed to such sales as a key part of their plan to address a cumulative ?8.8 billion capital shortfall.
If the banks sell the assets at a loss, it erodes their profits and can dent their capital bases. But if they don't sell them, they're stuck with assets that consume significant quantities of capital.
The large amount of structured-credit assets still on European banks' books "clearly heightens the importance of capital that banks need," said Kian Abouhossein, head of European banks research at J.P. Morgan. Until now, "they just haven't taken the hits."
Banks in the U.K., France and Germany are the biggest holders of such assets, even after chipping away at their exposures. The four biggest British banks reduced their holdings by more than half since 2007, while four French banks trimmed theirs by less than 30%.
Barclays PLC, for example, is sitting on about £17.9 billion as of Sept. 30, down from £23.9 billion at the start of the year. The assets, which landed on the giant U.K. bank's books before mid-2007, include collateralized debt obligations, composed of securities backed by assets like mortgages, commercial real-estate loans and leveraged loans that helped finance boom-era corporate buyout deals. Barclays executives say they have made good progress reducing their portfolio by selling assets or letting them mature.
At roughly ?28 billion, Crédit Agricole SA has the biggest portfolio of such assets among French banks, according to Credit Suisse. The bank's June 30 financial report includes ?8.6 billion of CDOs backed by U.S. residential mortgages.
On top of that, Crédit Agricole also has at least ?1 billion of U.S. mortgage-backed securities, some composed of subprime loans. With the U.S. real-estate market still hurting, further losses are possible in all these securities.
A Crédit Agricole spokeswoman declined to comment.
Legacy assets are also haunting Deutsche Bank AG. The Frankfurt-based bank is holding ?2.9 billion in U.S. residential mortgage assets, including subprime loans. It has an additional ?20.2 billion tied up in commercial mortgages and whole loans. The bank says it has hedged nearly all of its residential mortgage exposure.
Analysts at Mediobanca estimate that Deutsche's exposure to such assets amounts to more than 150% of its tangible equity?a key measure of its ability to absorb unexpected losses.
Deutsche Bank said it plans to let most of its legacy assets mature, so it won't face losses selling them at discounted prices.
Compared with European banks, U.S. lenders have moved faster to dump such assets. Citigroup, which required $45 billion of government aid in 2008, faced intense pressure from regulators to rid itself of risky assets, many linked to mortgages, that got the New York bank in trouble. Its stockpile of such assets was down by 86% to $45 billion at Sept. 30.
"It's a very cultural difference," said Mr. Abouhossein, the J.P. Morgan analyst. "In the U.S., you take the hits, raise equity, and move on?In Europe, it's more, 'Let's see more normalized pricing and then let's get rid of it.' "