You Can Run, But You Can’t Hide.

Europe is desperately working to prop up Spain’s wobbling banks, but the European leaders still face a problem that plagues the Continent’s increasingly vulnerable financial institutions; an addiction to borrowed money that provides day-to-day survival financing.

 

Analysts are now saying that one of France’s biggest banks, Crédit Agricole, could face heavy losses in their lending exposure to Greece.

Italy, whose fragile economy is even bigger than Spain’s and whose banks also rely heavily on borrowed money to get by, is in serious trouble as well. In Spain’s case, the flight of foreign money to safer harbors, combined with a portfolio of real estate loans that has deteriorated along with the economy, led to the collapse of the mortgage lender, Bankia. It was their failure that set off the current contagion.

“I think you are lying.”

Europe claims that this latest bailout — worth up to 100 billion euros that will be distributed to Spain’s weakest banks via the government in the form of loans, adding to their long-term debt — can resolve the problem. I think they are either lying or in denial, or both. Heavy emphasis on the lying part.

Investors and analysts worry that highly indebted banks in other weak countries like Italy might face constraints similar to those of Spain in the months ahead.

Last month, the ratings agency Moody’s Investors Service downgraded the credit standing of 26 Italian banks, including two of the country’s largest, UniCredit and Intesa Sanpaolo. Moody’s warned that Italy’s most recent economic slump was creating more failed loans and making it very difficult for banks to replenish their coffers through short-term borrowing.

Because they have yet to experience a colossal real estate bust, Italian banks have long been viewed as healthier than their bailed-out counterparts in Ireland and Spain. And bankers in Italy were quick to argue in recent days that Italian banks should not be compared with those of Spain.

Italy may not have the mortgage exposure that the Spanish banks have, but as economic activity throughout the region came to a near halt, the worry was that bad loans and a possible flight of deposits from Italy would pose a new threat to banks that already were barely getting by on thin cushions of capital. And Italian banks cannot avoid the stigma of the government’s own staggering debt load. Italy’s national debt is 120 percent of its gross domestic product, second only to Greece among euro zone countries.

Also hanging over Europe’s banks are the losses that will hit them when (not if) Greece leaves the euro currency union, throwing most of their euro-denominated loans into a state of default. Banks in France and Germany would be hurt the most, as they have been longstanding lenders to Greece.

For decades, the loans that European banks made to individuals, corporations and their own spendthrift governments far exceeded the deposits they were able to collect — the money that typically serves as a bank’s main source of ready funds. To plug this funding gap, which analysts estimate to be about 1.3 trillion euros, European banks borrowed heavily from foreign banks and money market funds. That is why European banks have an average loan-to-deposit ratio exceeding 110 percent — meaning that on any given day, they owe more money than they have on hand.

This, as you might have guessed, is not a really good thing for a bank.  

Europe’s Banks Reluctant to Aid Companies in Need of Cash.

The death spiral continues.

 

Petroplus, the largest independent oil refiner in Europe, said it was filing for insolvency after lenders demanded repayment on $1.75 billion of outstanding debt.

 European governments are not the only ones struggling with debt — so are some of the region’s companies.

As profits and sales slip, some European businesses are scrambling to pay their bills. With banks reluctant to lend, the fear is that companies will be unable to come up with the cash and will be forced to take drastic action, further weighing on the economy.

“There’s a lack of business confidence across Europe” said Jonathan Loynes, chief European economist in London at the research organization Capital Economics. “Lending to the private sector is deteriorating, and there’s enormous stress on the European economy.”

The pressure is mounting. Insolvency — when a firm’s debts exceed its assets and cash flow — is expected to rise 12 percent this year in the euro zone. Countries like Greece, Spain and Italy are expected to record the highest annual increases. In the United States, the number of insolvencies is falling.

In January, Petroplus Holdings of Switzerland, the largest independent oil refiner in Europe, said it was filing for insolvency after lenders demanded repayment on $1.75 billion of outstanding debt. The company, facing dwindling margins as a result of high oil prices and weak economic conditions, tried to negotiate with creditors. But BNP Paribas of France, Credit Suisse of Switzerland and other lenders already dealing with the fallout from the European sovereign debt crisis decided that Petroplus was not worth the risk. When Oil companies start to fail, you know there is a real problem.

“We were ultimately not able to come to an agreement with our lenders to resolve these issues given the very tight and difficult European credit and refining markets,” the company’s chief executive, Jean-Paul Vettier, said in a statement on Jan. 24.

Now, other companies, including energy multinationals and private equity firms, are sifting through the pieces. Nearly 40 bidders are assessing the British operations of Petroplus, according to PricewaterhouseCoopers, which is overseeing the sale of the assets in Britain.

It is a bad omen. Roughly two thirds of European companies that become insolvent will eventually file for bankruptcy, according to Ludovic Subran, chief economist of Euler Hermes, a credit insurance firm in Paris.

“The business environment has become worse,” Mr. Subran said. “Many companies are losing their competitiveness and being hit by a reduction in consumer spending.”

This year is shaping up badly for the Continent. The International Monetary Fund said on Jan. 24 that the euro zone’s gross domestic product would fall an estimated 0.5 percent in 2012. The downturn will be most severe in Southern Europe, where Italy’s economy is expected to contract by 2.2 percent and Spain’s by 1.7 percent.

The economic headwinds are wreaking havoc on corporate profits. As Europe grapples with recession, unemployment is rising, consumer confidence is plunging and manufacturing orders are falling.

Consumer-focused companies have been hit especially hard. In January, the giant British retailer Tesco issued its first profit warning in more than 20 years, and said earnings for 2012 would be $709 million lower than analysts’ expectations. Carrefour of France, the global grocery chain that recently replaced its chief executive, has estimated that operating income for last year would fall by 15 to 20 percent, with sales taking a hit in France and Southern Europe.

“Banks are being more conservative about who they lend to, and Europe’s economic problems are weighing on companies’ future prospects,” said Brian Lochead, a business recovery services partner at PricewaterhouseCoopers in London. “One problem is driving the other.”

Without the financial lifeline banks can provide, debt-laden businesses are selling assets and cutting investment in order to conserve cash.

To restructure its finances, Punch Taverns, a British pub chain that borrowed $7.4 billion to expand rapidly in the last decade, decided to split itself in two last year. A smaller group, the Spirit Pub Company, was created with Punch’s most profitable locations. Punch, which was left holding 75 percent of its $4.8 billion of outstanding debt, is now trying to sell more pubs to reduce its burden. Roger Whiteside, the chief executive of Punch, said the plan would help return the company to growth within the next five years.

Some companies are running out of options.

In December, Seat Pagine Gialle, the Italian yellow-pages publisher, said it would not pay $72 million to creditors as the company looked to restructure its balance sheet. It was the second time Seat had defaulted on its debt in less than a year, although creditors have yet to push the company into insolvency.

Others may follow. European companies with credit ratings below investment grade have a combined $72 billion of debt to repay this year, according to Standard & Poor’s. Defaults among this group are expected to rise by as much as 8.4 percent in 2012, S.&P. estimates.

The sovereign debt crisis is only exacerbating the problems. A recent survey released by the European Central Bank showed that institutions had cut back on the credit available to companies in the third quarter of last year, the latest figures available. More worrying for Europe’s corporate sector, banks also said they would pull back even further in the final three months of 2011.

“If companies aren’t viable and don’t have access to refinancing, banks don’t want to throw good money after bad,” said Ángel Martín Torres, head of restructuring for Spain at the accountancy firm KPMG.

Regulators’ attempts to spur lending have yet to pay off. In December, the European Central Bank moved to provide the financial sector with 489 billion euros ($639 billion) of low-interest loans. Authorities had hoped the money would ease the credit pressure on European banks so they would start lending again to the wider economy.

But instead of offering the money to credit-starved companies, institutions have preferred to deposit the cash with the central bank for safekeeping. On Jan. 18, officials said European banks had parked about $700 billion in overnight deposits with the central bank, the highest level since the euro was established in 1999.

The distress could open the doors for potential takeovers. Cash-rich multinationals, including Siemens of Germany and Philips of the Netherlands, have been hunting for attractive assets at troubled companies. And private equity firms that specialize in buying distressed assets also are on the lookout.

In January, Sun European Partners, the private equity firm, bought Bonmarché, a division of the insolvent British fashion chain Peacocks that caters to older women. Sun European already owns other retailers in the sector, and it plans to use the acquisition to expand its market share.

“Many companies have good assets but bad capital structures,” said Mark Sterling, managing partner of law firm Allen & Overy’s restructuring and insolvency practice in London. “So if they are good underlying businesses and have no sources of refinancing, that creates opportunities.”