Argentine Banks in Tailspin

Banks, including American institutions such as Citigroup and FleetBoston, that made seemingly sensible bets on Argentina’s economy in the mid-1990s are now on the hook for billions of dollars in losses, as the nation’s devaluation and freezing of deposits have pushed the banking system to the verge of collapse.

Citigroup is expected to announce the extent of its Argentine losses today. Argentina is deemed to be a small sliver of its overall operations and no real threat to its stability.

Standard & Poor’s estimates that the $15 billion in Argentine bank equity that was on the books a few months ago may have largely vanished. The extent of losses is still impossible to pin down because the government is changing the rules governing its exchange policy and deposit freeze on an almost daily basis.

Just a few years ago, the Argentine banking system appeared to be a pillar of strength, after having attracted billions of dollars from foreign investors who acquired roughly half of the system through enormous bets on the future prosperity of Latin America’s third-largest economy.

A long and devastating economic recession, and government decisions, have combined to swamp Argentina’s domestic and foreign-owned banks. The measures include the devaluation, the conversion of dollar-indexed loans to devalued pesos and the government default on its bonds, of which $30 billion are held by banks.

The implications are harsh for the banks but worse for Argentina’s economy as it tries to climb its way out of its deep financial sinkhole. Without a functioning banking system to deliver credit and move funds through an economy, there can be no financial activity inside the country or trade outside it.

Business activity has largely shut down in Argentina. Trade, which in the past has been the escape hatch for countries suffering devaluations and economic depressions, has slowed because credit isn’t available.

“There is no [bank] equity in economic terms,” said Gabriel Caracciolo, S&P;’s associate director for Argentina. He said banks are not making loans or taking deposits. “So, the status of Argentina’s banking system is that it’s closed.”

With foreign institutions justifiably leery of throwing any more money Argentina’s way, a bank rescue as part of a massive international assistance program from the International Monetary Fund may be the only way to get the system working again, analysts say. A government plan to tax international oil sales and use the proceeds to help recapitalize banks is viewed as inadequate.

“If you don’t recapitalize the banks, the economy will never recover,” said Bruno Pereira, Latin American bank analyst for UBS Warburg in Rio de Janeiro.

The 28% devaluation announced by Argentina on Jan. 6 is only one of a host of problems that banks face. To ease the pain of the devaluation for the middle class, new Argentine President Eduardo Duhalde also announced that all loans under $100,000 that had been dollar indexed would be payable in devalued pesos--in effect making it easier to pay back the loans.

At the same time, Duhalde promised Argentines that they would someday be able to retrieve their $45 billion in dollar-denominated bank deposits--two-thirds of the total.

So in one swoop, banks were told that the earning power of their assets or loans were cut 28% while their obligations to depositors hadn’t changed, creating an instant balance sheet implosion and an operational nightmare. Pesos continued to lose value this week against the dollar, hurting banks’ portfolios even more.

On top of that, the government’s declaration of default on $135 billion of public debt delivered another blow to banks which hold almost one quarter of those bonds. A default meant an immediate drop in banks’ bond interest income.

It gets worse. This week the government was believed to be on the verge of converting all loans over $100,000 to peso denominations, digging an even deeper hole for banks. The backdrop to all this is a worsening economy making consumer and business borrowers bigger credit risks.

Some analysts predict Duhalde will eventually have to give in and convert dollar deposits to devalued pesos as well, distributing the pain of the devaluation more evenly among consumers as well as banks.

“In this context, the promise to dollar depositors that they will get their money back is unbelievable if you add up all the losses being piled on the shoulders of the banks,” S&P;’s Caracciolo said.

As for now, Citigroup and FleetBoston are bracing for hundreds of millions of dollars in losses, and J.P. Morgan Chase and Bank of America also are in jeopardy of losing money. But their exposure is dwarfed by two Spanish banks, Banco Bilbao Vizcaya Argentaria and Banco Santander Central Hispano, whose combined losses could exceed $4 billion.

FleetBoston is more vulnerable than Citigroup. On Monday, Moody’s downgraded FleetBoston’s debt to negative after the bank said it would take more than the $150 million in loss provisions attributable to Argentina that it had announced Dec.19. It also said it would delay release of its fourth-quarter earnings report.

Sanford Bernstein/Alliance says that FleetBoston’s Argentina losses might exceed $500 million.