ECB’s risky loan crusade has limits

Europe’s top banking watchdog Enria is threatening higher capital requirements unless banks rein in risk

  
A man walks towards the European Central Bank (ECB) headquarters in Frankfurt, Germany, July 25, 2019.

A man walks towards the European Central Bank (ECB) headquarters in Frankfurt, Germany, July 25, 2019.

REUTERS/Ralph Orlowski

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

LONDON - Europe’s top banking watchdog Andrea Enria is worried about lenders’ exposure to highly leveraged companies. Yet a crackdown has limits. Try too hard, and he’ll drain further revenue from already struggling groups like Deutsche Bank and push the problem elsewhere.

Enria, who chairs the European Central Bank’s Supervisory Board, said on Friday that years of low interest rates have made lenders complacent. His main beef is leveraged finance, where banks arrange funding for buyouts.

Big players like Deutsche and BNP Paribas would point out that they only hold loans for around a month before selling them to funds and insurers. Even during the Covid-19 crisis last spring, only a handful of loans got stuck on lenders’ books, bankers say, although unprecedented central bank intervention helped.

The sector is certainly getting riskier. The ECB reckons that over half of buyouts in the fourth quarter of 2020 saw the borrowers’ debt surpass 6 times EBITDA, compared with its guidance that transactions with that level should be “exceptional”. Some 97% of deals in the first quarter were “covenant-lite”, meaning they had minimal lender protections, Enria reckons.

And the market is swelling. Outstanding public European leveraged loans were 245 billion euros in May compared with 139 billion euros at the end of 2017, according to the European Leveraged Loan Index compiled by S&P Global’s LCD unit. Including undrawn credit lines, big lenders’ exposure to leveraged finance was equivalent to 50% of common equity Tier 1 capital in 2019, the European Banking Authority calculated.

Enria is threatening higher capital requirements unless banks rein in risk. Yet he may struggle to treat miscreants too harshly. Since most deals in the market now breach the ECB’s definition of excessive leverage, Deutsche and others would lose a huge amount of business at a time when low interest rates are hurting profitability. European banks on average earned just a 5% return on equity in the fourth quarter of 2019, according to the ECB, half their likely cost of equity.

A crackdown could push more risk towards private credit funds and other shadow banks, which oversee some $1 trillion of assets, Preqin reckons. Credit Suisse’s Greensill Capital debacle shows that blowups there can find their way back into the banking system if markets are not properly policed. Enria has spotted the right problem, but his bark may end up being worse than his bite.

CONTEXT NEWS

- The European Central Bank’s chief supervisor Andrea Enria on July 2 said that lenders are taking too much risk through leveraged loans and equity-related derivatives. Those that fail to rein in their activities could face higher capital requirements.

- Enria, who chairs the central bank’s supervisory board, said banks had become complacent and risk-hungry after years of low interest rates and rising stock markets. Speaking via video link at an event organised by the University of Naples, he warned that the bonanza may come to an end when pandemic-fighting public support measures are withdrawn or if investors start expecting inflation to accelerate and demand higher interest rates.

- This could hit banks through their direct holdings of leveraged loans and other instruments or through their exposure to investment funds and other non-bank lenders, Enria said.

- The ECB has told Deutsche Bank that it will probably need to hold more capital to account for the risks in its leveraged loan business, Bloomberg reported on June 22 citing people familiar with the matter.

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

 (Editing by Neil Unmack and Karen Kwok) ((SIGN UP FOR BREAKINGVIEWS EMAIL ALERTS http://bit.ly/BVsubscribe | liam.proud@thomsonreuters.com; Reuters Messaging: liam.ward-proud.thomsonreuters.com@reuters.net))


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