The ongoing market turmoil in the U.S. has sent shockwaves through global capital markets and is forcing European governments to act decisively to avert similar bank failures.
Last week, regulators stepped up efforts to shore up banking regulations as governments from Iceland to Germany moved to bail out troubled financial institutions. The most prominent rescue involved the Brussels- and Amsterdam-based banking giant Fortis, which over the weekend received a capital injection of €11.2 billion ($16.1 billion) from the Dutch, Belgian, and Luxembourg governments in exchange for a minority stake. That action was quickly followed by the British government's seizure of lender Bradford & Bingley and its roughly £50 billion ($90.12 billion) mortgage portfolio.
More recently, the Irish government announced Sept. 30 it would guarantee deposits and debts at six financial institutions, while the German government announced a day earlier it would join a consortium of banks in providing credit guarantees amounting to €35 billion ($52.2 billion) to Hypo Real Estate, one of Germany's largest lenders. Franco-Belgian bank Dexia also received a €6.4 billion government bailout this week.
This recent flurry of activity across Europe not only underscores the wide impact of global credit problems, but also highlights the lack of coordination in the European approach to the crisis.
The government of U.K. Prime Minister Gordon Brown warned about the Irish government's intervention. According to Brown, the deposit guarantee was capable of distorting competition given that the guarantees applied only to Irish, and not foreign, banks operating in the republic. Furthermore, the European Union Commissioner for Competition, Neelie Kroes, also cautioned governments about intervening and criticized Germany's rescue of WestLb, a German banking group that earlier this year received bailout money and was required to restructure.
For a decade, European regulators have worked to abolish national government support for local corporations in order to guarantee free competition across the EU. Currently, the European approach is primarily national and ad hoc, with European member states moving to save their own financial institutions. The recent events raise the question whether it is necessary to have a coordinated European approach. Suggestions for a pan-European fund to support the financial sector received opposition from Germany, but had initial support from the Netherlands, France, and other markets.
The potential impact of the credit crisis on European companies came into sharp focus following the U.S. government's takeover of mortgage giants Fannie Mae and Freddie Mac. After those seizures, European Internal Market Commissioner Charlie McCreevy told a gathering of governance professionals on Sept. 9 that more needed to be done to ensure effective governance, particularly with respect to transparency and risk management. It was also necessary for EU regulators to increase cooperation, he said, given that it is not enough to have a national focus when financial markets are integrated at the EU level and sometimes even globally.
The effect of an illiquid environment on Europe's financial sector could be worse than that evidenced in the U.S., some analysts contend. Economists at Citigroup warned in a report this week that European banks, with lower profits and interest margins than those in the U.S., have "less cushion to absorb financial strains and losses," Bloomberg News reported. That is pushing regulators and others in Brussels to strengthen oversight of the financial sector. On Oct. 1, McCreevy announced a draft proposal to give local regulators more authority over a lender's foreign operations.
The draft proposal seeks higher capital standards for the securities built out of loans or other assets, referred to as structured finance, which lie at the heart of the market turmoil. Lenders also would get stricter limits on the size of any individual risk they take on, even if it is from another bank. The proposal also seeks to tighten cooperation among regulators, with each multinational bank overseen by a college of authorities from every country where it does business.
McCreevy's proposal will now go to the European Parliament and the council of EU governments. Both policy-making bodies must agree on the package for it to become law, which at the earliest would be 2011. Notably, there is likely to be political resistance from smaller countries--especially in Eastern Europe--which fear they will play second-fiddle to regulators in larger financial markets. The proposal has received opposition from Germany, England, and the Netherlands.
Growing government involvement in the credit crisis may also have adverse effects for investors. Governments acquiring significant stakes in financial sector firms may demand veto rights over significant corporate undertakings including assets sales, acquisitions, and stock issues. Such rights may serve to weaken those of other shareholders by reintroducing control-enhancing mechanisms just as the EU steps up efforts to curb such instruments.
Fortis as Case Study
Fortis in many ways provides a case study in how poor decisions, made during a period of easy credit, have come back to haunt investors. Indeed, it was a dream for the company's CEO and chairman when in 2007 leading Dutch bank ABN AMRO was put up for sale. Fortis joined forces with Royal Bank of Scotland and Spanish banking titan Banco Santander to each purchase various units of ABN AMRO. The consortium announced its offer in April 2007, with Fortis managers and shareholder believing the deal would transform the company into a key player in Europe's banking sector. Fortis shareholders approved the transaction in August 2007. However, the company had to reach deep into its wallet to complete the deal, and the resulting financing burdens, combined with a drying of credit, began to weigh down the banking-insurance company.
That the ABN acquisition was going to be tough for Fortis was something virtually all market observers agreed on. They feared that Fortis would face financing risks and post-merger integration risks, given that the acquisition was considerable relative to Fortis's own size. Fortis was responsible for 33.8 percent of the combined offer, which amounted to €24.0 billion. To finance the acquisition, Fortis had to raise €13 billion of new equity financing via a rights issue and up to €5 billion of new Tier 1 capital, and to release up to €8 billion of capital. The latter included the sale of non-core assets, securitization, and other similar transactions. Fortis faced the greatest risk exposure, since the financing required a larger proportion of its business than for the other two consortium members. Furthermore, Fortis's rights issue involved more than half its share capital at the time of the offer.
At the beginning of 2008, industry analysts highlighted the challenges for Fortis, thereby fueling concerns over the company's financial position. On Jan. 27, Fortis issued a press release to counter speculation about its solvency, and the company reaffirmed its views at the April 29 annual meeting. However, the concerns raised by industry analysts were confirmed when Fortis announced additional capital-raising measures on June 26. The company announced that it would strengthen its capital position by more than €8 billion, €1.5 billion of which would be raised through newly issued shares. The market's reaction to the announcement was unambiguous: the company's share price plummeted by 19 percent. Fortis fell to €10.23 per share, a decrease of nearly 65 percent from its €29.13 price when the ABN deal was first announced. In total, Fortis was worth less than the €24 billion the company paid to acquire part of ABN.
Shareholders were enraged and demanded that Fortis implement drastic changes to restore confidence in management. The company announced July 11 the dismissal of CEO Jean-Paul Votron and the tapping of Herman Verwilst, former deputy CEO, to the post. On Aug. 1, meanwhile, the company announced that the chief financial and risk officers, as well as the general counsel, would report directly to the CEO.
The capital measures announced in late June, combined with governance problems, significantly weakened investor confidence in the company. In a bid to restore confidence, Fortis organized information sessions for its shareholders in August. The efforts failed as its share price languished between €9 and €10.
With the bad news mounting in overseas financial markets in early September, the company's problems grew. Fortis increasingly suffered from speculation over solvency issues and concerns about further announcements for additional capital measures. The declines in share price put pressure on the company, whose customer base shrank due to rising concerns over its future, resulting in liquidity issues. Fortis issued press releases to rebut the rumors, but these had little effect as the share price dropped 43 percent within two weeks. On Sept. 26, Verwilst resigned and was replaced by Filip Dierckx, the CEO of the Fortis Bank SA unit.
After a long weekend of speculation, it was announced Sept. 28 that the company would receive a €11.2 billion lifeline from the Dutch, Belgian, and Luxembourg governments. Belgium agreed to inject €4.7 billion to buy a 49 percent stake of Fortis's Belgian banking division, while the Netherlands and Luxembourg would put up €4 billion and €2.5 billion respectively, to buy 49 percent of the banking subsidiaries in their respective countries. Fortis was required to sell its stake in ABN and make changes to its governance structure. The three governments were given significant board representation and forced out the board chairman and former CEO Maurice Lippens.