European Bank Shares Drop as Spanish Lender Concern Deepens

European banking stocks fell to a five-month low on concern that Spanish lenders’ deteriorating finances will spread turmoil elsewhere in the region.

The Bloomberg Europe Banks and Financial Services Index fell 2.3 percent to 65.85 at 12:25 p.m. local time. A close at that price would be the lowest level since Nov. 25. Deutsche Bank AG, Germany’s biggest lender, declined 2.2 percent. Shares of Bankia SA, the lender with the biggest Spanish asset base, dropped 4.3 percent.

The yield on the 10-year Spanish bond surpassed 6.55 percent today, the highest since November, on concern bailouts for banks and regional governments will hamper Spain’s ability to service its debt. The yield difference, or spread, between Spanish and German 10-year bonds increased this week to the highest since the creation of the euro.

Banks elsewhere in Europe may have to take losses on their Spanish debt holdings, hampering their ability to boost capital levels and satisfy regulators, according to Ingo Frommen, an analyst with Landesbank Baden-Wuerttemberg.

“If the house is on fire in Spain, there are consequences for Europe’s banking sector as a whole,” said Frommen, who is based in Stuttgart, Germany. “The last thing banks need is to show some losses in their second-quarter earnings as they’re gearing up to meet European capital requirements.”

ECB, Bankia

Spanish bonds slid today after the Financial Times said the European Central Bank rejected Spain’s plan to recapitalize Bankia, which was nationalized after property loans soured. Economy Minister Luis de Guindos said Spain didn’t present any such plan to the ECB. The central bank hasn’t been consulted by Spain on any plans to recapitalize a “major Spanish bank,” according to an e-mailed statement from the ECB today.

The Bank of Spain late yesterday said Governor Miguel Angel Fernandez Ordonez resigned a month early amid criticism from the governing People’s Party over his handling of Bankia.

“Spain looks to have gotten to the point where it cannot bear the burden alone,” David Mackie, chief European economist at JPMorgan Chase & Co., said today in a note to clients. The Spanish government “does not want the kind of burden sharing that was made available to Greece, Ireland and Portugal. The Spanish government wants the ECB to directly purchase its sovereign debt and for the EFSF/ESM to directly recapitalize its banks,” he wrote, referring to Europe’s rescue funds.

A Spanish bailout by the European Union and International Monetary Fund to cover the country’s gross funding needs through the end of 2014 could total about 350 billion euros ($435 billion), including 75 billion euros to recapitalize banks, according to JPMorgan estimates.

Europe’s leaders have sought to restore confidence in the banks’ ability to withstand the sovereign debt crisis by ordering lenders to boost capital by mid-year. The European Banking Authority told lenders in December to raise 114.7 billion euros in fresh capital to attain a core Tier 1 ratio, a measure of financial strength, of at least 9 percent of risk-weighted assets after accounting for writedowns on some European sovereign bonds.

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