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Monday, 14 November 2011

The European system banks: a story of new and old misfortunes

Today two of the 29 system banks in the world were prominently in the news. And unfortunately in both cases not because things were running smoothly.

The Financial Times ( writes on the plan of the Italian-based UniCredit Group to issue shares to the value of €7.5 bln and the reasons for the bank to do so. Here are the pertinent snips of this story: 

UniCredit unveils €7.5bn share sale to boost capital

UniCredit, Italy’s largest bank by assets and one of the more weakly capitalised of Europe’s big banks, has announced plans to boost its capital with a €7.5bn rights issue, while scaling back its investment banking business and slashing 6,200 staff.

The bank unveiled the shake-up as it reported a third-quarter net loss of €10.4bn caused by significant goodwill writedowns and Greek bond impairments. It will suspend dividend pay-outs this year.

It said the move would increase its tier one common equity to 9.3 per cent by 2012 bringing it in line with tougher Basel III capital rules. The European Banking Authority said last month the bank required €7.4bn in additional capital.

UniCredit, which operates across 22 European countries, was the only Italian lender to be named among the globally systemically important financial institutions, and has been at the eye ofthe sovereign debt storm buffeting Italy.
Shares in the bank have lost around half their value so far this year on concerns about its weak capital and its exposure to Italy where the debt crisis is squeezing funding and the economy is forecast to shrink next year. UniCredit owns €40bn worth of Italian sovereign debt, one of the highest exposures of any institution.

Alongside the cash call, the bank will slim down its investment banking business, including shutting its London-based Western European equity trading desks.
Over the next three years, it will refocus on retail banking its in core markets of Italy, Germany and Austria. It will also pull back to its most-profitable markets in central and eastern Europe, including Poland, Turkey, Russia and Croatia, and run down less profitable businesses in the region. In total, the bank will cut 6,200 jobs, including 12 per cent of its Italian workforce.

Going back to the stock exchanges in these challenging markets is the last thing a bank wants do. But I’m sure that UniCredit has no other options.

I really wonder what the huge writedown of €9.6 bln (Source: was all about, as the expression ‘goodwill’ doesn’t give you much extra information. I guess this write-down has to do with the total bond portfolio of UniCredit: not only the Greek bonds are under jeopardy, but also the €40 bln Italian bond portfolio might have been subject to substantial write-downs.

Not even to mention Spanish bonds; although Spain now profits from the fact that the focus of the financial markets is at Italy currently, the economic situation in Spain and the situation at the Spanish banks remains cause for concern.

I guess it is a wise decision to slim down the various investment banking businesses that are outside the core markets, or that are not successful enough in their own right. It is a shame, however, that 6200 jobs are lost during this action. But it might be the start of a new period where bad assets have mostly been written off and where an injection with core tier one capital leads to a stronger and better capitalized bank, with less bad assets on the balance sheet. In other words: it could be a new beginning for the biggest Italian bank.

And let me speak some words of warning; the fact that UniCredit has to write-off for €9.6 bln on their assets, should be a sinister warning that substantial write-offs might follow at other (system) banks. The fact that banks don’t trust each other currently, tells probably something about the quality and marked-to-market value of their own assets. So be prepared…

The Dutch financial newspaper Het Financieele Dagblad ( writes on an older story that emerged today, during the parliamentary hearings of banking officials that are taking place in The Hague since two weeks.

The CEO of ING Direct reported to the parliamentary commission on a serious calculation error that cost the bank €5 bln in 2008. Here are the pertinent snips of this story:

ING made a serious mistake at the beginning of 2008, when it returned €5 bln to its shareholders. The largest financial institution of The Netherlands didn’t take into consideration that additional buffer capital is demanded, when investments receive a downgrade of their credit rating. 

This was stated to the Parliamentary Investigation Commission De Wit on Monday. by Dick Harryvan, at the time CEO of ING Direct. ‘We didn’t take into account that a rating downgrade on investments forced the bank to keep larger buffers’, according to Harryvan. ING should have reckoned with an increase of the buffer demands by €10 bln, and that didn´t happen.

Instead, the bank returned money to its shareholders, as it seemed initially that the bank had more buffer capital than strictly necessary, thanks to new regulations. The ING feared that so much excess capital (as the capital buffer was seen in those days) would increase the possibility of a hostile takeover; just like happened with ABN AMRO earlier.

A half year later ING Group had to request for state support, especially because the bonds that subsidiary ING Direct had purchased in the US had declined strongly in value. On top of that these bonds received a lower credit rating, making the legal buffer demands increase. Harryvan pointed out that ING was informed by local supervisor OTS in the early summer that its losses on the portfolio would be moderate.

The state support was not unfavourable to the Dutch goverment, according to Harryvan. The government makes currently an estimated profit of €1 bln on the guarantees that have been issued on a portfolio of American Alt-A mortgages, held by ING Direct.

Harryvan calculated that the Dutch state only looses when in the US the housing prices drop by another 20% and an additional 20% cannot afford their mortgage burden anymore. The state earned €4 bln on all combined ING rescue actions, which was twice as much as other governments made in yields while saving their banks, according to Harryvan.

That ING bank made a serious miscalculation, when returning € 5 bln to its shareholders, can be forgiven, if we look back at the frantic years before the 2008 Bear Stearns crash. The ABN AMRO had been the target of a hostile bidding spree between Barclays and the troika of Santander, RBS and Fortis Bank and the now largest Dutch bank didn´t want the same to happen.

However, you get the ominous impression from this witness´ story that ING Direct had been clueless on what it had actually bought with the Alt-A mortgages portfolio. The statement that ´supervisor OTS had said that losses would be moderate´ is not an explanation of a bank that is ´on top of things´ with its investments. To be frank, it sounds more like: ´Mum, I bought this bike from Johnny, because Johnny said that it was good and that €150 was a fair price´.

And the statements in red are statements of someone that is clueless on the impact of an €18 bln state guarantee on a small country, like The Netherlands. 

The blubberer´s story that The Netherlands made a large €4 bln profit on all combined ING Rescue actions and an estimated profit of €1 bln on the Alt-A mortgage portfolio alone might be true in itself. But it misses the point spectacularly that a government SHOULD NOT BE FORCED TO SPECULATE with its taxpayer´s money. 

And now the Dutch government IS speculating, while waiting how the Alt-A portfolio matures. In theory all Dutch citizens are on the hook for €1000 for this portfolio alone, only because people – supposed to be experts – didn’t know what they were dealing with. And that’s worrisome.

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