Financial Institutions 2013 – A Global Analysis

By M. Isi Eromosele

Since 2007, the reduction in bank leverage has been largely achieved through retained earnings and capital raisings. The fall in equity valuations and consequential negative impact on equity raising has shifted focus to the asset side of bank balance sheets.

Pressure on banks to deleverage is increasing as they seek to address capital and funding

requirements imposed by regulators, meet the requirements of the market and, in certain cases, achieve imposed restructuring deadlines.

It is widely believed that asset deleveraging across the global banking sector will increase substantially in 2013 and that European banks, for example, have identified over 1 trillion Euros in asset deleveraging.

Amongst investors, there is a widespread expectation that significant asset portfolio sales may take place in 2013 at fire sale prices. This expectation may or may not turn out to be correct.

At Oseme Finance, we believe rapid and price insensitive deleveraging on a widespread basis is unlikely. There are several reasons why deleveraging through asset sales by European and other global banks will occur in a much more staggered and orderly manner over an extended time frame than many expect. These include:

Continuation of well established deleveraging process

Deleveraging through asset sales is not new with many banks undertaking significant deleveraging. The deleveraging trend will continue with new asset classes becoming relevant but increased volumes of assets identified for deleveraging will likely be incremental to a well-established process, not a step-change.

Asset sales are a less attractive form of deleveraging

Asset deleveraging can occur via several means: write-off, disposal, redemption or refinancing. Given the capital benefit of run-down over divestment, expect the majority of assets to be reduced by refinancing or redemption.

Funding pressures

Whilst a reduction in U.S. dollar funded assets remains a priority for those European banks finding access to U.S. dollar funding markets difficult, immediate term funding pressure has reduced as the European Central Bank (ECB) has expanded provision of term liquidity to banks.

ECB funding reliance is not sustainable and will need to be addressed through deleveraging but only over time. In addition, innovations in secured funding give banks increased flexibility to hold funded assets to maturity rather than incur losses immediately.

Regulatory pressures

Regulatory pressure to meet capital ratios will only be aided by certain forms of deleveraging. With the exception of certain high RWA and other marked-to-market trading book assets, large scale deleveraging through asset sales is unlikely to be capital accretive, making it a less attractive strategy for banks required to meet substantial new capital requirements under the Basel 3 or EBA frameworks.

Interaction of deleveraging with alternative capital relief measures

Deleveraging is only one tool to achieve capital objectives. The relative attractions of alternatives such as canceling dividends, equity raising or liability management will have a significant bearing on the volumes and pricing levels of asset sales.

Substitutability of portfolios identified for deleveraging

Non-core assets identified for deleveraging that prove difficult to sell could be supplemented by other assets identified for their salability rather than their profitability.

Separating platforms from portfolios

A substantial business element of certain loan portfolios may reduce buyer appetite but may be difficult to divorce from a portfolio sale due to, for example, goodwill destruction or stranded costs.

Bank deleveraging through asset sales are likely to continue in 2013, at an increased but managed pace, as banks continue to use deleveraging as a tool to address capital and funding pressures and restructure business models to ensure adequate shareholder returns.

In an environment where many banks are simultaneously seeking to reduce balance sheets, asset deleveraging processes will need to be carefully constructed. Two key elements to improving execution are 1. definition of the sale portfolio perimeter and sale structure; and 2. the sale process.

The sale portfolio perimeter definition and sale structure will have a material impact on buyer appetite. Sale portfolio sizes will need to be kept small, despite significant deleveraging requirements, due to buyer funding availability and the reduced attractiveness of portfolios that are too diversified to buyers.

Portfolio tailoring is essential to minimize cherry picking. Structured sales (e.g. tranching) may be required to attract a wider investor base. Sale strategies should evolve in response to buyer interest, competing processes and changing market conditions.

A series of narrow auctions or bilateral discussions may be better than a failed process polluting further deleveraging initiatives.

For acquirers of assets, the key challenges faced in 2013 will be

1. identifying and accessing available opportunities

2. differentiating interest with sellers likely to be inundated by often opportunistic interest

3. acquiring assets that meet pricing and return expectations

Buyers must identify opportunities early and demonstrate credibility. For banks with substantial deleveraging objectives, it may not be necessary for buyers to wait for a formal sale process.

Given the substantial deleveraging task for certain banks, reverse enquiries may be well received. Importantly, a detailed understanding of seller objectives, time pressures, pricing constraints and alternative strategies may assist buyer positioning, through highlighting such attributes as transaction track record, due diligence efficiency and access to financing.

As the focus of asset sales moves from bank trading books to whole loans and loan portfolios, banks face a greater disparity between carrying value and realizable value. As pressure on banks to deliver increases, pricing expectations may fall but buyers may find that they also need to adjust return expectations.

Increasing innovation and detailed understanding and insight are required in an environment where funded buyers are few and resource constrained. Further innovation is expected and needed in areas such as financing, facilitating buyers into new asset classes and the way portfolios or businesses are presented to the market.

In an increasingly volatile and complex banking environment, a mutual understanding of objectives and drivers between buyers and sellers becomes less straightforward but even more necessary to ensure an efficient transfer of assets.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

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