Risk’s deal of the year could barely have occurred under more inauspicious circumstances. For banks already stumbling under the weight of toxic assets, the collapse of Lehman Brothers on September 15, 2008, served to heighten market nerves dramatically. At Benelux bancassurer Fortis, the situation was worse than most.
The beleaguered Brussels- and Utrecht-based firm had already seen its shares slide 50% from the beginning of that year to September 12. In the weeks following Lehman’s implosion, its stock dropped still further – from €9.10 on September 12 to just €5.20 by September 26. Worried about a possible failure of the firm, the governments of Belgium, the Netherlands and Luxembourg stepped in to rescue the group with a joint capital injection of €11.2 billion on September 29. As part of the deal, the governments would take 49% equity stakes in the Fortis banking businesses in Belgium, the Netherlands and Luxembourg, in return for €4.7 billion, €4 billion and €2.5 billion, respectively.
The solution was short-lived, however. With Fortis still facing a liquidity squeeze, the Dutch government decided to nationalise the firm’s operations in the Netherlands less than a week later. But while rescuing the Dutch segment, the move left the rest of Fortis at risk of collapse. For the Belgian Federal Holding and Investment Company (SFPI-FPIM) – the arm of the Belgian government tasked with managing its stake in Fortis – something had to be done. This would involve taking the rest of Fortis under government control and selling it to another financial group.
“Suddenly, the Belgian government was taking on an international financial organisation with a balance sheet double the size of the country’s GDP,” remarks Dominique Favillier, Paris-based senior banker for financial institutions at Société Générale Corporate and Investment Banking (SG CIB). Formerly of Bear Stearns, Favillier had been advising SFPI-FPIM on a freelance basis prior to his move to SG CIB.
Fervent in its desire to protect depositors and the rest of the financial system, the stakes could not have been higher for the Belgian government. Yet SFPI-FPIM had little or no experience to call upon in valuing the bank’s toxic structured credit assets, which remained with the Belgian part of the firm. “The Belgian government had to make sure it understood the values of various Fortis bank businesses and the potential losses in the Fortis bank portfolio. It had already sounded out potential interested parties to buy it out as quickly as possible,” Favillier recalls.
To seek help, Favillier called his former boss, Michel Péretié. Formerly chief executive and chairman of Bear Stearns Europe, he was now serving as chief executive of SG CIB. The French bank quickly sent in specialists in merger and acquisition advisory, corporate finance and structured credit in response. Leading the structured credit effort was Serge Moulin, another ex-Bear Stearns employee and Paris-based head of the bank’s global solutions for financial institutions group. Although the official announcement of the nationalisation of Fortis’ Dutch operations was not made until October 3, Moulin arrived in Brussels on the night of October 2. “At that point, we didn’t know much about the situation at Fortis, apart from what we had read in the newspaper,” Moulin says.
Looking at the Fortis portfolio, they soon realised the reality was far more complicated than had previously been communicated. While other teams went to work investigating other business lines to get an idea of the firm’s capital and liquidity situation, Moulin and his group began the task of valuing the bank’s complex structured credit assets.
While at Bear Stearns, Favillier and Moulin had worked together on several tough assignments involving toxic structured credit and monoline insurers. These included the transfer of troubled New York-based monoline CIFG from French bank Natixis to its two parent companies, Banque Populaire Group and Caisse d’Epargne Group, in November 2007. But even this experience wasn’t enough to prepare Moulin fully for the contents of the Fortis structured credit portfolio, which had a notional value of €42 billion.
“We arrived in the room and I was given an Excel file containing 6,000 lines of structured credit assets,” he says. Moulin was confronted with a jumble of various types of structured credit denominated in several different currencies, including US dollar, sterling and Australian dollar. The list featured Spanish, UK non-conforming and US subprime residential mortgage-backed securities, as well as collateralised debt obligations of asset-backed securities (CDOs of ABSs), corporate synthetic CDOs, commercial real-estate CDOs and CDO-squared transactions.
The work of Moulin and his team soon gravitated towards what they felt to be the bank’s most worrying exposures – six subprime-linked CDOs of ABSs. “Sorting the assets by type and amount, very clearly we had to focus on these six CDOs of ABSs, which constituted a massive position,” he says. These exposures had to be quickly modelled overnight, providing SFPI-FPIM with an accurate snapshot of the €42 billion portfolio. The need for this snapshot was urgent, because in a room not too far away from Moulin’s, the Belgian government was busily negotiating the sale of the toppled lender.
According to the calculations of SG CIB, the writedowns Fortis would need to take on the structured credit portfolio were just €2 billion–€3 billion away from the bank’s existing valuations. Moreover, despite gyrating markets, the better half of the portfolio was found to be in relatively good shape. “One part of the portfolio was extremely impaired. The other was in a bad mark-to-market situation but was money-good,” says Moulin. This discovery gave the Belgian government the information it needed to negotiate the sale of Fortis’ banking and Belgian insurance operations to BNP Paribas – by then, the sole remaining bidder. “We were able to advise them to go ahead with BNP Paribas and not worry about the toxic assets, because we were able to contain the problem,” he says.
The deal to save Fortis would have to involve two aspects in particular: a so-called bad bank for the very worst structured credit assets; and a Belgian government guarantee for a small portion of the remaining bad assets, which would stay with the part of the bank being sold. On Monday October 6, a memorandum of understanding to sell the banking and Belgian insurance operations of Fortis to BNP Paribas was announced. During the following weeks, SG CIB set about conducting a more rigorous analysis of the firm’s assets to gather precise cashflow estimates. “We took each of the assets and modelled the cashflows under different scenarios, line by line,” says Moulin. This included a bullish scenario, a bearish scenario and a ‘super-bear’ scenario. One of the things that made this particularly tricky was the correlations between different kinds of assets in the portfolio. “We thought there was no way the US market would stabilise without many of the assets moving with it. In the same way, a worsening of the situation would increase the delinquencies on all asset classes,” he says.
Once SG CIB had modelled the cashflows, the bank came up with a structure for the bad bank that would optimise asset guarantees offered by the Belgian government. On November 20, 2008, a vehicle called Royal Park Investments (RPI) was established, which would purchase assets from Fortis worth €20.5 billion in notional value, in exchange for a payment of €11.7 billion. A small €1.7 billion equity portion would be financed jointly by BNP Paribas, SFPI-FPIM and Fortis. At the super-senior level, the part of Fortis to be acquired by BNP Paribas would supply a €5 billion loan, secured by the assets contained in RPI. To mitigate any foreign exchange risk, the loan was divided into sub-loans denominated in different currencies, depending on the expected cashflow of the assets.
Another €5 billion in senior debt would consist of a €500 million loan from BNP Paribas, with the rest funded through a commercial paper programme placed with institutional investors. To placate fears about the liquidity of these instruments, the notes were underwritten by the part of Fortis acquired by BNP Paribas. In extreme circumstances, the notes would also benefit from a guarantee extended by the Belgian government to RPI, in exchange for a fee of 70 basis points. Meanwhile, the better half of the Fortis structured credit portfolio, amounting to €21.5 billion in notional, would stay with the part of the firm bought by BNP Paribas. However, the bank benefits from a government guarantee at the mezzanine level, covering €1.5 billion of potential losses above a €3.5 billion equity tranche retained by the bank.
The deal was carefully crafted to avoid breaching European Commission (EC) rules and consolidation with Belgium’s national debt. Demonstrating the deal was in line with EC rules meant working out the value of the guarantees provided by the Belgian government and the likelihood they would be drawn upon, says Moulin. SG CIB also had to convince the EC that RPI would return a profit to its shareholders. “We spent many days and nights with the EC’s experts to justify how each of our models and assumptions worked. The big challenge was to show the EC that the valuations of assets were at a fair economic level and that RPI was a true commercial company,” he says. This involved producing an airtight profit-and-loss statement for RPI under various economic circumstances, to demonstrate the vehicle would generate market rates of return even if conditions deteriorated.
Controversial from the outset, the rescue of Fortis and the deal to sell it to BNP Paribas encountered several legal and shareholder challenges. On December 19, 2008, the Belgian government collapsed over claims it attempted to sway a court ruling on an appeal by the company’s shareholders. It was not until May 13, 2009, that the closing of the final deal was announced, with some changes to the original agreement. BNP Paribas took a majority stake in Fortis’ banking activities and a minority stake in its Belgian insurance business – down from an original 100%. The exact amount of equity each of RPI’s shareholders would take was also tweaked.
Despite the acrimony and subsequent collapse of the Belgian government, SG CIB’s structuring expertise paid off considerably for SFPI-FPIM. “The people in the team proved to be very flexible, efficient and qualified and they kept an open approach,” remarks Koen Van Loo, Brussels-based managing director at the agency.
SG CIB’s involvement in the deal continued as Risk went to press. As well as continuing to advise SFPI-FPIM, the bank also acts as valuation agent for RPI on behalf of all the entity’s shareholders. Favillier puts the bank’s success down to its ability to quickly marshal diverse groups of expertise within SG CIB to respond to its clients’ needs. Completing the deal was both rewarding and exhausting, he says – the banker claims to have spent less than four days staying at his own home in London during the last quarter of 2008.
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