Bloomberg is
reporting on what looks like a brazen con being pulled on taxpayers by eurozone banks and governments. It goes like this: During
the recent credit bubble the PIIGS country banks created and then sold a
bunch of low-quality mortgage bonds. Now they're buying them up at big
discounts to the original price, booking a profit on the trade, and using
those securities as collateral for low-interest-rate loans from the European
Central Bank.
European
Banks Bolster Capital With Shunned Bonds: Mortgages
Spanish and
Portuguese banks are leading European lenders in buying back their own
mortgage- backed securities at distressed prices to bolster capital and
stockpile eligible collateral for European Central Bank loans.
Banco Bilbao Vizcaya Argentaria SA (BBVA), Banco Comercial Portugues SA (BCP)
and other lenders this year repurchased 6.6 billion euros ($8.4 billion) of
asset-backed bonds they issued, more than double the level for all of 2011,
according to data compiled by Deutsche Bank AG. Banks buy the debt, packages
of loans in which they kept subordinated portions, for less than face value,
and book a capital gain similar to the discount.
The purchases
follow European Banking Authority demands that banks raise 114.7 billion
euros by last week after the sharp fall in the value of bonds issued by
governments in the 17-member shared currency. The deals are poised to
accelerate after the ECB last month reduced the minimum ratings it will
accept for mortgage securities offered as collateral for cheap loans, adding
incentive to lenders to buy back debt and pledge it with the Frankfurt-based
institution.
"Compliance
with the EBA rules has been the main reason of all buybacks we are seeing so
far, but there will be more deals since the ECB will take more of that
paper," said Frank Erik Meijer, head of asset-backed securities at The
Hague-based Aegon Asset Management, which oversees
220 billion euros of assets. "Lenders with little or no other sources to
raise capital and funding can turn to this strategy."
Northern Rock
The bigger
the discount the mortgage debt is trading at the larger the incentive for
banks to repurchase their own deals because that translates into greater
capital gains.
U.K. lender
Northern Rock Asset Management Plc last month
offered to buy back bonds issued under its Granite program as some were
trading at 58 percent of face value. They've risen to 69 percent of face
value after the Newcastle-based lender bailed out by the U.K government said
it would offer 64 percent to 77 percent of par.
Incentives
are greatest for Spanish and Portuguese lenders, where yields over benchmark
rates for mortgage-backed securities are as much as 17 times higher than
comparable notes pooling home loans in the U.K. Eleven Spanish banks and four
Portuguese lenders have put out tenders to repurchase some of their
securitizations, according to Barclays Plc data.
Few
Alternatives
European
lenders have few alternatives to raise capital as demand for shares of
financial companies has plummeted amid the crisis over the common currency.
Sales of
stock from European financial institutions fell 71 percent to 2.7 billion
euros, data compiled by Bloomberg show, as Europe's sovereign debt crisis has
spread from Greece to Spain, roiling credit and equity markets. The Bloomberg
Europe Banks and Financial Services Index (BEBANKS) declined more than 28
percent in the last year.
Shares have
fallen even as the European Central Bank pumped 1 trillion euros of
three-year loans, known as the LTRO program, into the system since December,
making it easier for them to fund such transactions. ECB provides the secured
loans at a rate of 1 percent.
"LTRO
money has made it easier for banks, especially from peripheral countries, to
use funding to raise capital at a moment when other possibilities such as
sale of stock or asset sales are virtually closed," said Conor O'Toole, the London- based asset-backed securities
analyst at Deutsche Bank. "Even as buybacks are at record levels so far
this year, we expect a second round of tenders."
Rating
Changes
Last month,
the ECB, which demands residential mortgage- backed securities to be graded
by at least two credit rating companies, said it will allow a second ranking
as low as the least investment grade, six steps below the prior requirement.
The central bank also widened the range of asset-backed securities it accepts
as collateral.
Banks can
pledge between 40 and 50 billion euros of bonds, which were not eligible due
to rating cuts, said Bank of America Merrill Lynch analysts including
Alexander Batchvarov.
Securitizations
pool assets ranging from corporate loans to mortgages and slice them into
securities of varying risk. The transactions remain on the originator's
balance sheet when it retains the riskiest slices.
Bilbao,
Spain-based BBVA bought back 638.2 million euros of bonds backed by
mortgages, consumer and company loans in a deal allowing it to record a 250
million euro capital gain, according to a June 28 regulatory filing. Banco Comercial Portugues offered to buy back as much as 300 million
euros of bonds it issued between 2003 and 2007 mostly under its Magellan
program backed by residential mortgages.
Some thoughts
Stripped of
all the terminology, this scam comes down to European governments investing
taxpayer funds in risky mortgage bonds -- in order to prop up banks that made
a lot of ill-considered loans in order to generate big year-end bonuses. This
may be legal, strictly speaking, but it's definitely not moral, and to the extent
that European taxpayers figure out what's happening, the result should be,
um, noisy.
It's also
interesting that the banks admit that they have no other source of cash. The
markets at long last appear to have recognized that most big European (and American
for that matter) banks are stuffed so full of bad paper and on the hook for
so many billions in derivatives that they're terrible bets. Now only
governments with docile citizens are left to keep the zombie banks animated.
This game,
like many others in today's global financial system, can go on as long as the
currencies the central banks are creating remain viable. Once euros and/or
dollars lose their attractiveness as a store of value, the end will come
quickly.
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