Bloomberg News

European Banks Should Keep Dumping Italy Bonds, Clausen Says

November 15, 2011

(Updates with analyst comment in fourth, 11th paragraphs.)

Nov. 14 (Bloomberg) -- Europe’s banks need to keep dumping Italian bonds and other assets tainted by the region’s debt woes to avoid being sucked into the epicenter of the crisis, said Christian Clausen, president of the European Banking Federation.

“The banks are doing exactly what they should be doing: they are reducing their risk toward this event. We can see that clearly as now Italian bonds are being sold off,” Clausen, who is also the chief executive officer of Nordea Bank AB, said in an interview in Stockholm. “They should keep doing what they are doing. The banks are actually moving out of the epicenter.”

The yield on Italian 10-year bonds surpassed 7 percent last week, the level that prompted Greece, Ireland and Portugal to seek bailouts, as investors fled the third-largest euro economy and its 1.9 trillion-euro ($2.6 trillion) debt burden. Europe’s banks are offloading assets infected by the debt crisis to meet stricter capital rules, said Clausen of the Brussels-based EBF, which represents Europe’s national bankers associations.

“Bank’s are reducing their exposure to many sovereigns as market volatility and an increased risk of debt restructuring are a lethal cocktail for holders of Italian bonds,” said Robert Liljequist, a Helsinki-based fixed-income strategist at Swedbank AB. “Bond yields are still high and banks will continue to cut their exposure over the coming months.”

Cut ‘Dramatically’

Lawmakers in Rome this weekend passed budget cuts to reduce Italy’s debt, which the European Commission estimates reached 120.5 percent of gross domestic product this year. Tensions over the austerity bill toppled Prime Minister Silvio Berlusconi’s government and will see in an administration to be led by former European Union Competition Commissioner Mario Monti.

Europe’s banks will need to raise 106 billion euros in fresh capital under tougher rules being introduced in response to the euro area’s sovereign-debt crisis, the European Banking Authority said last month. The extra reserves are needed to meet a temporary requirement for lenders to hold 9 percent in core reserves, after sovereign-debt writedowns.

Banks’ “actual holdings in bonds” sold by Europe’s most indebted sovereigns “have come down quite dramatically,” Clausen said in the Nov. 10 interview. “The banks are raising capital, they are holding back retained earnings, all kinds of things.”

Clausen said Europe’s banks will probably make broad use of hybrid capital to meet tougher regulatory requirements. Contingent convertible bonds that convert to equity when banks’ reserves slip below a given level, or CoCos, will become a standard feature of banks’ balance sheets, he said.

CoCos for All

“All banks will have to do that. This will be all over,” he said. “There will be core capital and then extra capital. All banks will have to add in other types of capital.”

The political response to the debt crisis so far shows there is a determination to keep the currency bloc intact, Clausen said. Still, the unraveling of governments in Greece and Italy amid opposition to austerity programs presents a risk to the integrity of the single currency bloc, he said.

“The refinancing risk in Italy is very high, as 200 billion euros of government debt is maturing by the end of April 2012,” Liljequist at Swedbank said. “With a relatively weak growth outlook, negative primary balance and high yields, the risk is high that Italian yields are soon back above the 7 percent level, which could prove devastating for the country.”

Italian Yields

The yield on Italy’s five-year note rose nine basis points to 6.51 percent today, while 10-year yields jumped 11 basis points to 6.53 percent. Italy sold all 3 billion euros of five- year notes it offered at today’s auction after Monti was asked to set up a government.

“I don’t think, for now, there is a euro risk, as such,” Clausen said. “But there is a risk that if the governments don’t start to really work on this, there might be a real euro risk at the end.”

In Sweden, home to Nordea, regulators want banks to adhere to tougher requirements than those targeted elsewhere. The largest Nordic country should impose higher capital requirements than most European countries because its bank industry is more than four times the size of the nation’s economy, Financial Markets Minister Peter Norman said in an interview. The spread of Europe’s debt crisis to Italy underlines the need for bigger buffers to guard against losses, he said.

‘No Bank Is Bulletproof’

If the Italian “crisis affects, for example, French banks, the banks are so entangled that it will affect Swedish banks,” he said. “It is important for the Swedish taxpayers to have higher capital requirements than the rest of Europe.”

Sweden’s four biggest banks, Nordea, Svenska Handelsbanken AB, SEB AB and Swedbank AB, should have core Tier 1 capital ratios that are “a few percentage points more” than the 10 percent minimum Sweden is targeting by 2013, Lars Frisell, the chief economist at the country’s financial watchdog and a member of the Basel Committee for Banking Supervision, said in an Oct. 24 interview.

“No bank is bulletproof these days, but they are much better prepared than they were back in 2008,” said Jan Erik Gjerland, an analyst at DNB ASA in Oslo.

The Swedish government will propose capital requirements for its banks by the end of the year, Norman said last week.

--With assistance from Johan Carlstrom in Stockholm. Editors: Tasneem Brogger, Jonas Bergman.

To contact the reporters on this story: Adam Ewing in Stockholm at aewing5@bloomberg.net; Johan Carlstrom in Stockholm at jcarlstrom@bloomberg.net

To contact the editors responsible for this story: Frank Connelly at fconnelly@bloomberg.net; Tasneem Brogger at tbrogger@bloomberg.net


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