Lehman Failure’s Impact on European Banks
The fallout from the failure of Lehman Brothers is likely to have a significant effect on a number of large banks in Europe, given the sheer size of Lehman’s balance sheet ($600 billion at Aug. 31, 2008) and off balance sheet activities, says Standard & Poor’s.
The independent broker-dealer business model is not common in Europe, and indeed all of the largest European capital markets operations are part of large “universal” banks. These institutions– UBS (NYSE: UBS), Credit Suisse (NYSE: CS) , Deutsche Bank (NYSE: DB), Barclays (NYSE: BCS), Royal Bank of Scotland (NYSE: RBS), BNP Paribas (Euronext Paris: BNP), and Société Générale (Euronext Paris: GLE)–have a broader business profile, greater diversification, and lower reliance on wholesale funding, when compared with U.S. broker-dealers. “We therefore see them as less vulnerable from the point of view of a potential crisis of confidence and resultant liquidity problem.”
In a new report S&P assesses the financial impact according to three main factors:
1. Debt holdings. Lehman had outstanding long-term debt of approximately $110 billion at Aug. 31 Short-term commercial paper outstanding was around $8 billion at end-May, but has likely reduced significantly since this time. We believe that a broad range of financial institutions, not just banks, are likely to hold some of this paper. So far, we have not yet identified particular concentration that would threaten a rating, but some exposures are material.
2. Counterparty exposure. A more significant exposure is likely to be counterparty risk to Lehman affiliates. These exposures should mostly be confined to the largest banks and broker-dealers, but smaller institutions are also likely to have some exposure. Again, so far we believe that such exposures are moderate and manageable for large institutions.
3. Market price impact. In our view, even those capital market players with negligible direct exposure to Lehman will likely suffer, and to a potentially greater extent. This is because the unwinding of Lehman’s balance sheet is likely to result in further downward pressure on the valuations of a range of assets, most notably residential and commercial mortgage-backed securities (both U.S. and European), as collateral is sold into the market. However, it is also possible that a large unwind of trades will also place pressure on higher quality assets, leading to pricing pressure across a broader range of securities.
In general, we consider that the market price impact described above is likely to be the most significant risk factor for the larger, complex European institutions, even if it is possible that the unwinding of large positions will lead to renewed calls for the link between “market value” and fair value to be broken.
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