The Big Crackdown by Europe's Banks

Lenders are forcing companies to shape up

It looked like another politically motivated bailout. In early July, German engineering group Babcock Borsig was skittering towards bankruptcy. So politicians from North Rhine Westphalia, Babcock's home state, persuaded German Chancellor Gerhard Schröder to offer government guarantees on some $400 million in fresh loans--provided Babcock's banks would pony up $800 million in capital. But on July 8, something extraordinary happened. "We rejected the plan because we thought Babcock Borsig could not be restructured successfully," says Wolfgang Hartmann, chief risk officer at Commerzbank, which has up to $200 million in outstanding loans to Babcock. "We need to strengthen our share price," says Hartmann bluntly. "And we won't do that by lending more money to weak companies."

The Old World's bankers are learning to say no--and Europe Inc. is scared to death. French banks have forced Jean-Marie Messier out of Vivendi Universal (V ) as a condition of saving the company. German banks, led by mighty Deutsche Bank (DB ), have dismantled the debt-burdened Kirch media group. And in Italy, a coterie of banks demanded that Fiat Group slash its debt by selling assets and commit to a spin-off of flagship Fiat Auto before signing off on a $3 billion debt restructuring. The promise to exit from the auto business by 2005 was not revealed publicly. But bankers confirm that the sale is nonnegotiable--a silent eclipse of power for Fiat patriarch Gianni Agnelli. "We were aware that if Fiat fell, we would fall, too," says one banker involved in the talks.

The get-tough approach of these lenders signals a dramatic transformation in the once-cozy relationship that flourished for decades between Europe's top companies and their house banks. "We are on the verge of a major restructuring of the banking sector, which is changing attitudes and behavior," says Stephane Garelli, professor at IMD International Business School in Lausanne.

There's a lot to change. The European habit of lending to risky creditors worked as long as bank shareholders remained quiescent and lenders operated mainly within their own borders. An inbred culture of cross-shareholdings between banks and industry prompted friendly bailouts that defied free-market logic. Politicians easily cajoled bankers into handing out fresh loans to poorly managed companies to save jobs. Failed German media mogul Leo Kirch, for example, nurtured strong ties to Bavarian politicians and wrested $1.9 billion in fresh loans from state-controlled banks just months before his bankruptcy.

Now, the bill is due. With the advent of the euro, it's much easier for investors to compare bank results across the Continent. "Banks are coming under increasing competition for capital from rivals in other countries, which is forcing them to put more emphasis on returns," says Keith Pond, a lecturer in banking and economics at Loughborough University in Britain. Add in sluggish growth and the steep decline of markets, which increase the pressure on margins, and the need for action is compelling. "Banks [must be] much tougher on corporate clients than they would be in the past, when they could use buoyant revenues from retail and private banking to subsidize corporate lending," says IMD's Garelli.

If this bank revolution continues, it could score gains where the shareholder-rights movement has failed. Supervisory boards of Europe's industrial companies are often packed with friends and allies who rarely sanction management, and hostile takeovers are still rare. But banks that have lent billions or hold sizable equity stakes have the leverage that outside investors are only just starting to acquire.

As the banks get tough, each is getting tough in its own way. In Germany, the approach seems the most brutal. Germany has chalked up five megabankruptcies in the past year, from Kirch's spectacular $10 billion collapse in March to jetmaker Fairchild Dornier Corp.'s April insolvency--all triggered by banks that said "no" to clients on the brink (table). "Increasingly, German bankers are saying that you shouldn't throw good money after bad," says one top banker.

The Germans have learned from the case of construction giant Philipp Holzmann, which the banks, under pressure from Schröder, rescued with fresh credits in 1999. Holzmann collapsed this year, unable to pay $1 billion in debt. That failure sealed Babcock Borsig's doom. "A year ago, we think we would have been able to save Babcock Borsig," says a spokesman for Wolfgang Clement, Prime Minister of North Rhine Westphalia, who brokered the rescue talks. "But the banks are taking a more hard-nosed approach."

That approach can include intervening to shake up management before the ultimate disaster strikes. The three largest lenders to French media-and-utilities giant Vivendi Universal precipitated the July 2 dismissal of Messier, fearing any additional management mistakes could provoke a financial meltdown. Pressure was mounting on the embattled CEO as the July due date for $1.8 billion in short-term loans approached. When Chief Financial Officer Guillaume Hannezo on June 27 called urgently on the company's French and German bankers for fresh credits, Vivendi's lenders snubbed him. Twenty-four hours later, they spurned a personal entreaty by Messier, effectively ending his reign.

Now, Société Générale, BNP Paribas, and Deutsche Bank--Vivendi's key lenders--are ready to support Jean-Rene Fourtou, Vivendi's new boss, provided he listens carefully to the banks' advice on restructuring. Fourtou won't be the only executive getting an earful. Says a senior officer at Credit Lyonnais: "We are in a situation where banks are going to be much more involved in companies. We've all got big loans to Vivendi, Alcatel, and France Télécom, and we are going to see pressure on them to sell assets and restructure debt."

The pressure is also fast mounting in Italy, where Fiat is now effectively a ward of its three largest lenders, Sanpaolo IMI, IntesaBci, and Banca di Roma. "I'm only sorry we arrived so late," says a banker involved in the emergency restructuring. "Fiat should have been prevented from doing deals that ballooned debt over the past year. Its gross debt was unbearable."

The banks' restructuring of $3 billion in short-term Fiat obligations requires a mandatory rights issue after three years if things go awry, which would hand control of Italy's leading industrial company to the banks. "Gianni Agnelli ran the company more for his ego than for shareholders," says another banker involved in the talks. "He squandered shareholder equity for a long time." If Italy's most powerful industrialist is forced to play by new rules, then the Continent's once-docile bankers may yet trigger a dramatic overhaul of Europe Inc.

By Gail Edmondson in Rome, with John Rossant in Paris and David Fairlamb in Frankfurt

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