There’s a simple explanation for why the world’s zombie banks remain so reluctant to write off worthless assets and tap the equity markets for fresh capital. They don’t want to end up like UniCredit SpA.
This month has been a nightmare for the Italian bank’s shareholders. Since embarking last week on a 7.5 billion euro ($9.7 billion) stock sale at a steep discount to its Jan. 3 closing price, UniCredit shares have fallen 39 percent to 2.56 euros. It seems no good deed goes unpunished when it comes to lenders besieged by Europe’s debt crisis. A little bit of candor about the true state of a company’s finances can hurt a lot.
That undoubtedly is the message some other lenders facing large capital shortfalls will take from UniCredit’s troubles. The incentive now, just as most banks are undergoing their year-end audits, will be to stick with the pretense that all is well and there’s no need to raise additional capital.
Not that a lot of them have better options. There’s only so much private-sector capital available to go around. As sickening as the plunge in its share price may be, UniCredit secured an early-mover advantage by acting when it did. Even that might not be enough to ensure its survival without a taxpayer rescue.
This month’s offering was spurred in part by UniCredit’s decision in November to take large writedowns for the third quarter, resulting in a 10.6 billion euro loss, mostly for intangible assets such as goodwill leftover from ill-fated acquisitions. The loss was the largest disclosed for the period by a euro-area bank. The European Banking Authority also weighed in last month after its latest stress tests, saying UniCredit had almost an 8 billion euro capital shortfall.
The markets sense, with good reason, that the latest cash infusion won’t be enough. UniCredit’s stock market value stands at 14.8 billion euros, taking into account this month’s rights offering. That’s frightfully low, considering the company showed 52.3 billion euros of common shareholder equity and 950 billion euros of assets as of Sept. 30.
Investors still see a huge hole in the company’s books that UniCredit executives have yet to admit. Had UniCredit taken swift action sooner to mop up and replenish its balance sheet, it might not be in the precarious position it is today.
This is one of the lessons everyone should have learned from the collapses of Lehman Brothers Holdings Inc., Fannie Mae and Freddie Mac in 2008: Come clean about your losses to preserve the markets’ trust, and raise more capital than you think you will ever need to get through a crisis while you can, because you might not get another chance. UniCredit seems to be coming a tiny bit clean, and raising a smidgeon of the money it needs. At least it’s doing something, though.
Elsewhere in Europe this generally isn’t the case. On average the 31 companies in the Euro Stoxx Banks Index trade for 39 percent of common equity, or book value, according to data compiled by Bloomberg. France’s Credit Agricole SA trades for 23 percent of book. Yet somehow the European Banking Authority last month concluded it had no capital shortfall.
The situation in the U.S. is better, but not good. Bank of America Corp., for example, trades for 33 percent of book and insists it doesn’t need to sell new common shares, in spite of the markets’ contrary verdict. If Europe’s banks get shut out of the equity markets, leading the worst-off to seek government rescues, any window that remains open for U.S. financial institutions could close quickly, if it hasn’t already.
A telling example is Regions Financial Corp., which has about $130 billion of assets and still hasn’t repaid its $3.5 billion of bailout money from the Troubled Asset Relief Program. The Birmingham, Alabama-based bank pulled out all the stops in the third quarter to sidestep losses on its intangibles, as the research service FootnotedPro highlighted in a Nov. 4 report to its customers.
Avoiding the Problem
To help avoid writing down goodwill, Regions raised its estimate of the control premium an investor would pay to buy its commercial-banking unit, to 60 percent from 30 percent, even though Regions’ stock market value fell by almost half during the third quarter. (A control premium is the amount a buyer is willing to pay over current market value to purchase a company.) Basically, Regions was saying it disagreed with the market, which naturally made the company more valuable in management’s eyes.
Today Regions has a $6 billion market capitalization, slightly more than its $5.6 billion of goodwill, and trades for 44 percent of book. So the goodwill supposedly was worth almost as much as Regions itself, which makes little sense because goodwill isn’t salable.
Yesterday after the markets closed, Regions said it would take a $673 million fourth-quarter charge to earnings, mostly due to elimination of goodwill, after agreeing to sell its Morgan Keegan investment-banking unit to Raymond James Financial Inc. for $930 million. You have to wonder if Regions should have known a lot sooner that the business wasn't worth as much as its balance sheet said.
UniCredit was willing to take something of a hit to the intangibles on its books and use the chance to raise cash in hopes of saving the company. It’s doing the right thing, relatively speaking, and its stock is down 74 percent in the past year. Regions did the three-card monte, and its shares are down just 34 percent during the same period.
Other struggling lenders in Europe and the U.S. will see both examples as more reason to paper over their losses, which will make their problems and the eventual cleanup worse. Delay-and-pray is never a good strategy. Unfortunately it’s the only one a lot of zombie banks have left.
(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)
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