For the last few months, many difficulties have beset European banks, with the latest hardship being write-downs announced by several of these firms. Despite these problems, financial institutions are still performing relatively well, even in the face of the negative headlines.

"It's like people think these big, dirty banks have gone and lost all of our pensions," a European analyst said, "when the reality is obviously the opposite, since the banks have shown massive creativity in generating solutions. But for investors, they seem to feel the banks are full of greedy brokers and greedy borrowers, and the press, well, I've recently read that asset securitization is now a toxic swamp,' and the write-down of assets a feeding frenzy.'"

The analyst said that the ongoing sale of Northern Rock, the fifth-largest mortgage lender in the U.K., negatively impacted investor outlook on the securitization market overall. The mortgage lender lost the majority of its retail business in a bank run (ASR, 10/1/07) that happened in mid-September, and the future of the bank is still in question three months afterward.

"It's horrible," a market observer said. "You have these Angela Merkels and Nicolas Sarkozys banging their fist on the podium talking about new regulations to the securities market, after just a five-minute brief on the subject from a junior staffer. They don't even understand tranching, and yet want to change it." He said that with Basel II implementation in 2008, banks will be required to hold enough capital, including liquidity, against risk. "And through all this, Northern Rock is not going to be solved by year's end, and more banks are continuing write-downs. There is obviously a priority-response issue here."

Northern Rock ownership is now down to two sincere bidders. The first, a consortium lead by the Virgin Group, is on an "accelerated" status, meaning its bid is preferred by the Bank of England. The other, from the investment group Olivant, is also considered a serious bid.

Olivant's proposal would involve acquiring a 15% stake in the bank and recapitalizing the company through a rights issue. Olivant announced that investors controlling 23% of the share capital stood behind its plan. "From the point of view of the Treasury, it is positive firstly because not only does it envisage the possibility of paying back a larger portion of the Bank of England loan immediately (GBP10 [$20.4 billion] to GBP15 billion), but also the loan would be fully repaid earlier by the end of 2009)," Deutsche Bank analysts said. "Also, it would give the Bank of England a warrant on 5% of the company, which would allow it to share in any upside in the share price if it rose substantially."

The shrinking of Northern Rock to facilitate repayment of the Bank of England loan could be part of the Olivant proposal, a move that might impact the mortgage firm's Granite RMBS trust. Olivant said that it had no plans to sell any of Northern Rock's assets and it is also committed to maintaining the mortgage lender's credit rating, which means the trust could still be utilized under this plan.

"Olivant has the most cunning trick for dealing with [Northern Rock's master trust] Granite," an analyst familiar with the bid said. "They will feed the master trust for a few years, to maximize their shorter-dated funding, and then stop the feed cold, sending it into run-off." This way, he said, Granite bond holders will receive the "maximum" payoff, should they follow Olivant's advice.

Write-downs, Write-downs Everywhere

As the Northern Rock situation drags into 2008, other European banks announced write-downs. Swiss bank UBS will write down its U.S. subprime holdings by approximately $10 billion, primarily on CDO and super senior 1 holdings. However, market sources said the bank creatively protected itself from real losses by raising CHF 19.4 billion of Tier 1 capital, placed with two strategic investors: Government of Singapore Investment Corp. and an undisclosed "strategic investor" in the Middle East, the bank said.

Marcel Rohner, group chief executive officer at UBS, said the bank is well positioned for future profits and that the write-downs, while "very disappointing," came at a time when most of the bank's other businesses were generating close to record levels of profit. "I am confident that, after these write-downs and with a strong balance sheet, we are well positioned for growth and profitability," Rohner said.

The Royal Bank of Scotland (RBS) also announced write-downs of GBP950 million resulting from "credit market deterioration in the second half" of 2008, the bank said. RBS also said that its subsidiary, ABN AMRO, had exposure of GBP1.7 billion to super senior tranches of high-grade ABS CDOs, net of hedges and write-downs, totaling around GBP300 million in real write-downs.

These write-downs will be reflected in 2007 results for ABN AMRO but will not affect the RBS earnings, as they will be dealt with as part of accounting adjustments undertaken after the acquisition, the bank said.

"It's all about the CDOs for European banks," a market observer said. "Any bank with CDOs is in trouble. They took on senior notes, as it was thought there was very little risk, but RBS has found a way to keep earnings intact despite being blindsided."

British bank Lloyds TSB also announced a comparatively smaller GBP200 million write-down based on its exposure to the European credit crisis. Lloyds is not in too much hot water since the bank's mortgage lending arm, Scottish Widows, has no exposure to U.S. subprime ABS. The GBP23 million of short-dated SIV commercial paper held by Scottish Widows is also not a concern since the bank has been slowly winding the SIV down since June.

"The Group remains firmly on track to deliver a good performance for the year, and good economic profit growth while maintaining a robust capital position," said Eric Daniels, group chief executive at Lloyds. "Underlying earnings for 2007 are in line with expectations, and we remain confident in the Group's earnings growth prospects over the next few years."

Another source, who works in residential mortgages for a non-European bank, said the only way the banks could get into a real fix would be through massive downgrades by rating agencies. This would create a knock-on effect leading to a multiplication of impacts.

"This year's conference in Barcelona seems like a different world compared to what we've seen now," he said. "The assets are very different, it's a benign property market and there is a consensus that 2008 will see little primary issuance and little origination. But whatever we may say, write, view or do, in the end, the banks are going to be all right."

(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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