Why European Banks Are Sacrificing Growth

Amid the crisis, lenders are selling some of their best businesses to raise money

Under pressure from regulators to bolster capital, European banks are selling some of their fastest-growing businesses to competitors from outside the region. The sales may leave them better able to withstand financial stress—and less able to boost future profits. Spain’s Banco Santander, which said in October it needs an additional €5.2 billion ($6.9 billion) to meet capital requirements, sold its Colombian unit in December to Chile’s Corpbanca for $1.16 billion. Germany’s Deutsche Bank is weighing options including the sale of most of its asset management unit, while Belgium’s KBC Groep may dispose of businesses in Poland.

Such sales are an unintended consequence of the decision by European regulators to make banks increase capital—a buffer that protects against credit losses—to help them survive the worsening sovereign-debt crisis. The European Banking Authority on Dec. 8 ordered the region’s financial companies to raise €114.7 billion of additional capital by the middle of 2012.

To reduce their reliance on the markets for funding, banks across Europe have pledged to cut assets by more than €950 billion over the next two years, according to data compiled by Bloomberg. About two-thirds of that will come from sales of profitable units and performing loans, says Huw van Steenis, a Morgan Stanley analyst in London. While it may be hard to get premium prices for those businesses in a crisis, other options for raising money are even less appealing. Lenders don’t want to issue additional shares because their stock prices are too low: The Bloomberg Europe Banks and Financial Services Index is down 33.5 percent this year. Selling troubled loans is also problematic. If the banks accept the low prices investors are willing to pay, the lenders would have to record losses on the loans, and those losses would erode their capital. As a result, distressed assets and souring loans will account for just 4 percent of asset reductions over the next two years, according to van Steenis.

That leaves selling entire business units outside of their domestic markets. These are the most profitable parts of their business,” says Azad Zangana, European economist at London-based Schroders, citing Spanish and Portuguese banks selling assets in Latin America. “You begin to become a less profitable organization. Your business model stops working if you’re being forced to lend only to an economy that’s going through a very deep recession.”

By shedding some of their best assets, the sales may make banks less stable. “Lenders are selling more liquid assets so they can get a price that avoids additional capital losses,” says Joseph Swanson, co-head of restructuring at Houlihan Lokey in London. “Unfortunately, this strategy can result in lower asset quality and increased earnings volatility.”

Santander completed the sale of its Brazilian insurance operations to Zurich Financial Services for $1.7 billion in October. The Spanish bank also sold a $958 million stake in Banco Santander Chile, the South American country’s biggest bank by assets. The Chilean bank’s net profit grew 45 percent between 2008 and 2010 and may increase 15 percent this year, to about $970 million, according to analyst estimates compiled by Bloomberg. Santander said it will also sell a stake in its Brazilian banking unit. The Spanish lender’s planned sale of part of its U.S. consumer loan business to a group led by KKR may cut net profit for Santander’s shareholders by €150 million, according to an Oct. 28 estimate by Raoul Leonard, an analyst at Royal Bank of Scotland Group in London. “Assuming multiple asset sales may be in the pipeline, this could lead to a meaningful negative drag” on earnings, Leonard wrote. A spokeswoman for Santander declined to comment.

KBC, the Belgian bank that received a €7 billion government bailout, said in July that it would sell Poland’s second-largest insurer and its 80 percent stake in Poland’s Kredyt Bank. “When you sell an asset, there are always two sides of the coin,” says Stephane Leunens, a spokesman for KBC. “We focus on de-risking the company while trying to generate sufficient growth in our core markets.” Deutsche Bank, which needs to plug a €3.2 billion capital shortfall by the middle of next year, said last month it may sell most of its asset management unit, a business that Chief Executive Officer Josef Ackermann built up over the last decade to help reduce the bank’s reliance on investment banking. The asset management business’s third-quarter pretax earnings more than doubled to €186 million, or 20 percent of the bank’s total profit.

Analysts say the banks are in a bind. “If they raise capital by selling crown jewels, the market will reward them in the short term because they’ll meet the regulator’s time frame,” says Will James, who runs the SLI European Equity Income Fund at Standard Life in Edinburgh. The longer-term question, he adds, is “How do you grow in an environment where customers are unwilling to borrow? That’s the missing piece from the puzzle. In a low-growth or no-growth environment, banks that have sold good assets will continue to struggle.”


    The bottom line: To meet capital requirements, European banks may eliminate more than €950 billion of assets, including some of their best businesses.

    Before it's here, it's on the Bloomberg Terminal.