We have already seen how an over-ambitious acquisition attempt by Banca Popolare Italiana (BPI) has led to grief. Leave aside the allegations of price fixing and wrong doing in the buying of Antonveneta shares that is currently being investigated by Milan magistrates.
The fact is: when a bank enters into the acquisition arena it draws attention to its balance sheet and so had better be sure that it stands up to analytic scrutiny.
Research house CreditSights decided to investigate capital quality in the wake of the BPI affair and found there were lots of questions to be asked – not just at BPI but across the entire European banking sector! That’s a fairly dramatic outcome from one failed takeover attempt.
The CreditSights approach is to ask how much of the capital base is available as an equity cushion for creditors of the parent bank and how much the capital make-up will be stretched in a bid situation.
The research company identifies four types of capital to make adjustments for: minority interests, preferred securities, pensions and unconsolidated investments in other financial institutions. “They are all items whose treatment is viewed as debatable by regulators and which purists might want to haircut fully in the capital base,” says their report.
The results are sobering. BPI had minority interests making up 65% of its Tier 1 capital base at the end of 2004 reducing to 41% following capital-raising exercises. For most other European banks, the ratio is 10%-15% of Tier 1, which is not a cause for concern.
There is no room for complacency, however. With UK and Spanish banks, preferred securities are the issue. RBS and Santander have preferred components of 39% and 30% of Tier 1, while Dutch and German banks have ratios of 20%-30% through use of silent partnership capital. Have regulators been too lenient in allowing this situation to develop? UK banks also have large pension deficits while the debate over unconsolidated investments in other financial institutions affects banks with large insurance operations.
CreditSights analyst Simon Adamson says: “Basel 2 deals a lot with the asset side of the balance sheet but has not touched on the definition of capital. There are questions about whether the quality of capital is deteriorating and whether regulators are being too lenient in allowing certain kinds of financial instruments to be counted as Tier 1.”
