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Regulatory Black Hole Puts Banks Off Deals

Regulatory uncertainty is putting large banks off buying the assets of smaller rivals, complicating the sector's restructuring and giving hedge funds and private equity a golden opportunity to swoop in.

Regulatory uncertainty is putting large banks off buying the assets of smaller rivals, complicating the sector's restructuring and giving hedge funds and private equity a golden opportunity to swoop in.

Banks are facing a regulatory crackdown in the wake of the financial crisis, with national regulators increasingly opting to go it alone with stricter rules, creating confusion for lenders trying to calculate the merits of buying a rival's assets and for fund managers running the slide rule over bank stocks.

"The regulatory environment is such that you are seeing increasing capital standards for banks, but we don't know yet where they are going to," said Niall Gallagher, manager of the GAM Star Continental Europe Equity fund.

"There's a lot of investor angst out there at the moment, and unless you have a crystal clear view, it is very hard to invest in these stocks."

Despite hundreds of billions of euros' worth of loans for sale in Europe, senior bankers complain that they can't get some deals past their credit committees because there is uncertainty over how much capital they would need to hold after the acquisition.

"We are looking at assets. But the regulatory uncertainty is making us wary," said one senior U.S. banker.

With investors reluctant to plough more money into bank shares, lenders are under huge pressure to shrink their bloated loan books - by running them down or selling them - to meet tougher capital requirements.

Europe's banks, including Royal Bank of Scotland, Lloyds, Commerzbank and others in Ireland, France, Spain and beyond, have shed hundreds of billions of euros since 2008 but still have further to go than their U.S. rivals because they grew so much during the boom.

The IMF has estimated banks will shrink by $2.8 trillion, but in an extreme scenario that could reach $4.5 trillion as firms rid themselves of unwanted loans and "rightsize" for a lower growth environment.

With their loan books still bloated, European banks are capping new lending to shore up capital.

Weak credit growth has already hit the European economy hard, with the IMF warning earlier this year that deleveraging would squeeze credit availability in the euro area by 1.7 percent over the next two years.

PricewaterhouseCoopers (PwC) has estimated that European banks have more than 2.5 trillion euros of non-core loans, or about 6 percent of their assets. It has estimated about 500 billion euros of those loans will trade in the next decade.

Banks are only four years into what is expected to be a 10-year process of cutting assets. Next year could surpass 2012 as the peak for asset sales.

Richard Thompson, European portfolio advisory group partner at PwC, expects a record 60 billion euros of loans will be sold next year up from an estimated 50 billion this year and 36 billion euros in 2011.

"It's the opportunity to acquire customers at a relatively cheap price. Some banks will emerge as buyers when they see assets at relatively competitive prices. But a lot of banks are being very cautious on capital," said Thompson.

With U.S. banks facing tough regulatory hurdles on acquisitions in the aftermath of the financial crisis, Canadian, Japanese and Australian banks, which emerged largely unscathed from the credit crunch, are the most obvious trade buyers.

Japan's Mitsubishi UFJ Financial Group bought U.S. bank Pacific Capital Bancorp for $1.5 billion in February this year, while Sumitomo Mitsui Financial bought Royal Bank of Scotland's aircraft leasing business for $7.3 billion in the summer.

More recently, private equity houses have been the buyers, with Apollo Global Management acquiring a 1.47 billion pound book of troubled Irish property loans at a 90 percent discount from Britain's LLoyds.

Spanish lender Popular this month finalised the sale of a 1.14 billion euro portfolio of distressed consumer loans to Nordic distressed debt group Lindorff and private equity firm AnaCap, a source told Reuters.

One international investor said a stricter, more uniform approach to dealing with banks' bad debts across Europe would trigger more asset sales, particularly in Spain, which recently created a so-called "bad bank" to take over the soured assets of some banks.

"We have been in very, very regular communication with banks in Spain. Our inclination is it is a bit early to do things there," said the investor, who requested anonymity.

"They (the Spanish) haven't really worked through the good bank/bad bank scenario, and there really hasn't been crystallised yet the framework for pan-European banking regulation."


Confusion over financial regulation is set to continue as efforts to introduce universal standards for banks go awry.

Both the United States and Europe, the world's two largest banking markets, are delaying the introduction of tougher global capital rules for banks, the so-called Basel III accords, which were meant to start rolling out on Jan. 1, 2013.

While the biggest European and U.S. banks already comply with Basel III's minimum requirements, investors are worried that a delay in introducing the new regime will encourage some regulators to devise their own firewalls, leading to a series of escalating responses.

"If you always go for more capital, more safety, more everything, then you get into a position where you stop shoplifting by not having any shops," said Robert Hingley, director of investment at the Association of British Insurers, which represents some of the UK's largest investors.

The U.S. Federal Reserve has proposed raising the capital requirements on foreign banks to ensure they are in line with domestic lenders.

The Bank of England, meanwhile, signalled last month that UK banks still needed to raise tens of billion of pounds in additional capital as many of them had underestimated the cost of loans going sour and future fines for misconduct.

Despite the problems in getting it off the ground, there are also fears that Basel III will not be the final word.

The current accord relies heavily on banks using in-house models to assess risks and capital. But with investors increasingly wary of the wide variety of methods used, the committee that oversaw Basel III is probing these in-house models and will report back next year with its findings.

"We don't know whether Basel III is it, or whether we'll have Basel IV or V," said Gallagher.

Copyright 2012 by Reuters. All rights reserved.

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