Monday, December 26, 2011

Looting of the Irish expands to looting of the Eurozone

This blog has frequently looked at the issue of regulators requiring insolvent financial institutions to increase their book capital ratios.  A subset of this policy is the requirement that insolvent financial institutions shrink their balance sheets at the same time as these institutions are required to maintain high capital ratios.

One hundred percent of the time this capital ratio policy results in the financial institution selling its bests assets at a discount.  It also does absolutely nothing to address the bad debt that is on the financial institution's balance sheet and that is causing them to be insolvent in the first place.

Why does this regulatory capital ratio policy always end up with the best assets being sold at a discount?

The buyers know several facts that reduce the selling bank's leverage in the negotiation.
  • The selling financial institutions cannot raise capital from the equity markets because no one can assess their risk or solvency;
  • The selling financial institutions have a limited time in which to achieve the target capital ratio -- frequently, the regulators publish a deadline; 
  • The amount of assets that the financial institutions must sell is large relative to the capacity of the buyers to acquire - in Europe, banks are trying to shed 3 trillion euros of assets; and
  • The selling financial institutions must sell their best assets because recognizing the losses on their bad assets would decrease their book capital levels and move them away from the regulators' targeted capital ratios.

The end result is that the regulators effectively required their banks to sell their best assets at a discount.

I call this "looting" because the taxpayer has been called on to bailout these financial institutions in the past and, unless ultra transparency is adopted, be required to bailout these financial institutions in the future.  When the taxpayer needs to step up for the future bailout, the size of this bailout is increased by the discount the banks realized when selling their best assets.

The NY Times ran an article that gives some idea of how attractive looting the Eurozone financial system is.
As Europe struggles with its debt crisis, American businesses and financial firms are swooping in amid the distress, making loans and snapping up assets owned by banks there — from the mortgage on a luxury hotel in Miami Beach to the tallest office building in Dublin.
The sales are being spurred on because European banks are scrambling to raise capital and shrink their balance sheets, often under orders from regulators. European financial institutions will unload up to $3 trillion in assets over the next 18 months, according to an estimate from Huw van Steenis, an analyst with Morgan Stanley....
At Kohlberg Kravis, Nathaniel M. Zilkha, co-head of the special situations group, is expanding his London team to eight, from two, and hoping to take advantage of opportunities in Europe. The firm is even considering potential investments in the country where the crisis began, Greece, despite headlines warning of a default by Athens or the possibility that Greece may withdraw from the euro zone. 
“If no one is willing to turn over the rocks, that’s when you can make extraordinary investments,” Mr. Zilkha said. “The market dislocation in Greece is creating significant opportunities that wouldn’t be otherwise available.” 
Besides Greece, Kohlberg Kravis bankers have also been looking for deals in Spain and Portugal, where private companies are having a similarly hard time winning new credit or extending existing loans.... 
Experts expect these kinds of sales to jump as European banks race to meet the June deadline imposed by the European Banking Authority to raise more than 114 billion euros in fresh capital. Financial institutions also have to increase their Tier 1 capital ratio — the strictest yardstick of a bank’s ability to absorb financial blows — to 9 percent of assets. 
Banks get a twofold benefit from unloading assets like real estate loans and other holdings; not only do they have more cash, but there are fewer assets they must hold capital against in case of losses, thereby quickly bolstering Tier 1 levels...
Inside his firm, Stephen A. Schwarzman, the chief executive of the Blackstone Group, recently cited the $3 trillion estimate of how much European banks will have to unload, and this summer he told investors that Europe was back on Blackstone’s radar after being absent for several years. 
“As people become increasingly negative on the environment there, we think we are buying good companies at very good values,” he said.

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