Stress Tests Pressure Europe's `Problem Children' Banks to Bolster Capital

As many as 24 European banks will be under pressure to show they can raise capital after failing, or barely passing, a second round of stress tests by regulators.

Eight failed the European Banking Authority’s stress tests yesterday, with a combined shortfall of 2.5 billion euros ($3.5 billion). As many as 16 more will need to bolster capital after their core Tier 1 ratio dropped below 6 percent, little more than the assessment’s 5 percent pass-mark, the EBA said.

“Six percent is the defacto pass-rate,” said Huw van Steenis, a banking analyst at Morgan Stanley in London. The result “puts pressure on national regulators to turn their attention to the banks which just passed.”

The tests mark a clash between the European Union regulator and national counterparts over what counts as capital. The EBA is pushing banks to raise more and better capital to meet the Basel III guidelines and boost investor confidence in the industry amid the sovereign debt crisis. Both German and Spanish regulators said their banks have enough. German lenders criticized the “political” stress tests for excluding a kind of non-voting capital recognized by local regulators.

“Neither the EBA’s 5 percent core capital hurdle, nor its decision on the composition of that capital, have legal equivalence,” the DSGV savings banks association said yesterday. “This is a case of high-handed measures being set to achieve political goals.”

Photographer: Marc Tirl/Newscom

The head office of the State Bank Hesse-Thuringia (Helaba) is shown in Frankfurt Main, Germany. Close

The head office of the State Bank Hesse-Thuringia (Helaba) is shown in Frankfurt Main, Germany.

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Photographer: Marc Tirl/Newscom

The head office of the State Bank Hesse-Thuringia (Helaba) is shown in Frankfurt Main, Germany.

‘Problem Children’

Greece’s EFG Eurobank Ergasias SA (EUROB) and Agricultural Bank of Greece (ATE) SA, Austria’s Oesterreichische Volksbanken AG (VBPS) and Spain’s Banco Pastor SA (PAS), Caja de Ahorros del Mediterraneo (CAM), Banco Grupo Caja3, CatalunyaCaixa and Unnim failed. They were found to have insufficient reserves to maintain a core Tier 1 capital ratio of 5 percent in the event of an economic slowdown. All banks examined in Italy, Germany, France, the U.K. and Ireland passed.

“The problem children are going to be the 16 banks between 5 and 6 percent, and what happens to those,” said Joseph Dickerson, a banking analyst at Espirito Santo Investment Bank in London. “The market will put substantial pressure on those banks to raise capital.”

Those banks include Banco Comercial Portugues SA (BCP), Espirito Santo Financial Group SA (ESF), Germany’s HSH Nordbank AG and Norddeutsche Landesbank. BCP and Espirito Santo will bolster capital or sell assets in the next three months, the Bank of Portugal said yesterday.

About 20 banks would have failed had they not raised capital through April, the EBA said. The capital shortfall would have totaled 26.8 billion euros without the additional money, the regulator said. In all, European lenders raised 50 billion euros of capital from January to April, according to EBA Chairman Andrea Enria.

‘Necessary Steps’

“For those banks that have not met the threshold, and for those that have but still demonstrate substantial weaknesses, we expect them to take all the necessary steps to reinforce their capital positions,” Michel Barnier, the EU’s financial services commissioner, and Olli Rehn, the economic and monetary affairs commissioner, said in an e-mailed statement from Brussels.

The EBA’s attempt to bolster confidence in the industry has been criticized by analysts for excluding a Greek default. Last year’s tests by the EBA’s predecessor were also attacked for not being tough enough: banks then were shown to need only 3.5 billion euros more capital, a 10th of the lowest analyst estimate. Investors expected as many as 15 banks to fail and raise 29 billion euros after the latest assessments, according to a survey by Goldman Sachs Group Inc. (GS) last month.

‘Same as Last Year’

“It feels the same as last year,” said Richard Barfield, a director at accounting firm PwC in London. Investors “are more interested in the disclosure of the sovereign exposures in the detailed analysis.”

The criteria include a review of how the 90 lenders tested would handle a 0.5 percent economic contraction in the euro area in 2011, a 15 percent drop in European equity markets and trading losses on sovereign debt not held to maturity.

“We’re aware the treatment of sovereign exposures is very contentious,” Enria told reporters in London yesterday.

The cost of insuring European financial-company debt against default stayed higher after the tests. The Markit iTraxx Financial Index of credit-default swaps on the senior debt of 25 banks and insurers was 9.5 basis points higher on the day at 189 basis points as of 5:30 p.m. in London yesterday, unchanged after the test results were released. The euro and the pound were little changed against the dollar after the results.

The EBA included a 25 percent writedown in the value of Greek 10-year government bonds in the tests, it said yesterday. ATEbank, one of two Greek banks that failed, said its exposure to 7.85 billion euros of Greek sovereign bonds and loans was the main reason for failing the test.

Volksbanken

The five Spanish banks that failed have a combined shortfall of 1.56 billion euros, with CAM accounting for 947 million euros. Even so, none of lenders that failed will need to raise capital because they have other instruments that absorb losses, according to the Bank of Spain.

Volksbanken, Austria’s fourth-biggest lender, failed with a core Tier 1 capital ratio of 4.5 percent in the test’s adverse scenario. About a third of its capital was disqualified under EBA’s rules for the exam, the lender said. The Austrian bank and the two failed Greek banks are also selling assets to boost capital.

One further bank may have failed the test. Landesbank Hessen-Thueringen on July 13 refused to give the EBA permission to publish all of its data as it disputes the regulator’s measurements of core Tier 1 capital because they don’t include some instruments allowed by German regulators. That would push the lender’s core capital ratio to below the 5 percent threshold required to pass the test.

Sovereign Crisis

Rating company Standard & Poor’s own stress test, published in March, found European banks would need as much as 250 billion euros in fresh capital if faced with a “sharp” increase in yields and a “severe” economic downturn.

The results come during a week of rising sovereign debt yields. The yield on two-year Greek notes rose above 32 percent this week and the extra rate investors demand to hold its 10- year bonds relative to German bunds of similar maturity was 14 percentage points. Credit-default swaps indicate an 86 percent chance Greece will fail to meet its commitments within five years, according to CMA prices.

Concern about Greece also triggered a surge in 10-year borrowing costs for Italy and Spain this week to the highest since the introduction of the euro in 1999. The cost of insuring Irish and Portuguese government bonds also hit records this week, implying a 60 percent chance of default.

‘Perceived Weaknesses’

Banks’ disclosure of the size and maturity of their holdings of sovereign debt will allow analysts to model their own stress tests, a potential threat to financial stability, according to a confidential document prepared by EU officials. There is an expectation the results will be “challenged by market tests” aiming to address “the perceived weaknesses in the design,” according to the paper obtained by Bloomberg News.

Euro-area government leaders will hold a special summit on July 21 to put added political momentum behind efforts to halt the debt crisis, European Union President Herman van Rompuy said after the stress test results were announced.

“It’s an interesting academic exercise,” said Alex Potter, a banking analyst at Berenberg Bank in London. “But I think gyrations in the sovereign market and the true creditworthiness of some European governments, as well as the political willingness to form a consensus, are far larger stories than the stress tests.”

Failures:
Spain:    Caja de Ahorros del Mediterraneo
          Banco Pastor
          Banco Grupo Caja3
          Unnim
          CatalunyaCaixa
Greece:   Agricultural Bank of Greece
          EFG Eurobank Ergasias
Austria:  Oesterreichische Volksbanken

Near-failures with 5 percent to 6 percent core Tier 1:
Espírito Santo Fin Group
Marfin Popular Bank
Piraeus Bank Group
Nova Ljubljanska Banka
Banco Popular Español
NovaCaixaGalicia
Bankinter
Banco Comercial Português
BFA Bankia
HSH Nordbank
Hellenic Postbank
Norddeutsche Landesbank
Grupo Banca Civica
Caixa Ontinyent
Banco Popolare
Banco de Sabadell

To contact the reporters on this story: Ben Moshinsky in London at bmoshinsky@bloomberg.net; Gavin Finch in London at gfinch@bloomberg.net

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net Anthony Aarons at aaarons@bloomberg.net

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