DEFINITION of 'Degearing'

Degearing is the action of a company altering its capital structure by replacing long-term debt with equity, thereby easing the burden of interest payments and also increasing management's flexibility.

BREAKING DOWN 'Degearing'

A company is highly geared or leveraged when a large portion of its capital structure is made up of long-term debt. Degearing is a movement away from this capital structure in the effort to decrease financial risk, which is the possibility that shareholders or other financial stakeholders will lose money when they invest in a company that has debt if the company's cash flow fails to meet its financial obligations.

Degearing and the Banking Industry

After the recession of 2007-2009, many banks and the real estate sector had to shed debt and degear. For example, the Royal Bank of Scotland had to sell property assets built up before the recession, including the sale of $2.6 billion to $4 billion of property loans in July 2010. The bank had to reduce $256 billion of non-core funded assets it had identified and its strategy was seen as crucial for the future of the UK property market because 26 percent of the portfolio was linked to commercial property.

Most of the loans originated in the UK, but it was not clear how stressed the properties were. Harm Meijer, an analyst at JPMorgan, told the Telegraph that, "As well known, the real estate sector faces a giant degearing process. As such, any effort to speed up or tackle this problem is welcome, while we continue to hope that the listed sector will play an active role in this."

In a report by PwC in 2012, "Banking Industry Reform" consultants wrote there was a significant amount of degearing of bank balance sheets after the economic crisis. As a result, the performance expectations of the pre-crisis era were no longer valid. By some estimates, wrote PwC, as much as four percentage points of banks' pre-crisis return on equity (ROE) was attributable to gearing alone. Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. Return on equity (also known as "return on net worth," RONW) measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.

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