EU Bank Stress Tests Missing Sovereign Defaults Fail to Convince Analysts
European banks may have to raise as much as 80 billion euros ($112 billion) of additional capital as the stress tests failed to allay investor concern about a Greek default and governments’ ability to bail out their lenders.
The eight banks that failed out of the 90 tested on July 15 had only a combined capital shortfall of 2.5 billion euros, the European Banking Authority said July 15. As many as 20 banks need to bolster capital, JPMorgan Cazenove analysts led by Kian Abouhossein wrote in a report after the results were published.
Regulators didn’t include a Greek default in the tests even though credit default swaps indicate investors see an almost 90 percent chance of one. The EBA included a 25 percent writedown on 10-year Greek government bonds held in banks’ trading books even as the securities trade at about 50 cents on the euro. The exams won’t succeed in reassuring investors until governments put in place a mechanism to stop failing banks weighing on public funds, said Gary Greenwood, an analyst at Shore Capital.
“The EBA are stress-testing the wrong thing,” said Hank Calenti, a bank strategist at Societe Generale SA in London in a telephone interview. “They need to be testing the ability of the euro zone to support its banks. It’s firstly a question of the ability of the sovereign to bail out the banks, and then who is going to bail out the sovereign.”
Bank Stocks Drop
European bank stocks posted their steepest one-day decline in almost a year. Lloyds Banking Group Plc and Banca Monte dei Paschi di Siena SpA (BMPS) led the 46-member Bloomberg Europe Banks and Financial Services Index down 3.2 percent at 4:40 p.m. in London today. Lloyds tumbled 7.5 percent to 41.35 pence, the lowest since June 2009, while Banca Monte dei Paschi di Siena dropped 7.2 percent to 46.03 cents, a record low.
“The European banking stress test is unlikely to provide much in terms of assurance to the markets,” said Dirk Hoffmann- Becking, an analyst at Sanford C. Bernstein in a note to clients today. “Concerns about contagion of the sovereign debt crisis into core Europe have taken center stage.”
Euro-area government leaders will hold a special summit on July 21, stepping up efforts to stem the contagion from Greece. Leaders are at odds with one another and with the European Central Bank over demands by Germany and Finland that private investors bear some of the burden for a second Greek bailout.
Yields on two-year notes from Ireland, Portugal and Greece hit euro-era records today. Spanish and Italian 10-year bond yields jumped to the most since the euro’s inception in 1999.
“You should probably be stress-testing the sovereigns not the banks,” said Liverpool, England-based Greenwood. “The only thing that can ultimately give the markets some comfort is evidence that the sovereigns themselves have sorted out their balance sheets.”
Allied Irish Banks Plc (ALBK) and Bank of Ireland Plc passed the EU’s examinations in 2010, while Anglo Irish Bank Corp. wasn’t tested. Later that year, a liquidity shortfall caused when depositors withdrew funds from Irish lenders helped prompt EU governments and the International Monetary Fund to agree on an 85 billion-euro bailout for the country.
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 this year’s tests. 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.
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. Investors expected as many as 15 banks to fail the stress tests and raise 29 billion euros after the latest assessments, according to a survey by Goldman Sachs Group Inc. last month.
Based on a stricter 7 percent capital target, and including writedowns on sovereign debt in the banking book, 20 banks would need to raise capital, according to JMorgan analysts. U.K. banks including Lloyds Banking Group Plc (LLOY) would have a 25 billion-euro shortfall, French firms including Societe Generale would require a further 20 billion euros, and German lenders including Deutsche Bank AG (DBK) about 14 billion euros.
‘Waste of Time’
“I’m quite skeptical that this whole exercise will have any favorable consequences,” said Cesar Molinas, a former head of European fixed income at Merrill Lynch & Co. and now an independent consultant. “It seems to have been something of a waste of time and money.”
About 20 banks would have failed had they not raised capital through April, the EBA said. The shortfall would have totaled 26.8 billion euros without the extra money, the EBA said. In all, European lenders raised 50 billion euros from January to April, according to EBA Chairman Andrea Enria.
The evaluations only took into account possible losses only on government bonds the banks trade, rather than those they are holding until maturity. Banks have to write down the value of bonds in their banking book only if there is serious doubt about a state’s ability to repay in full or make interest payments.
‘Story Isn’t Over’
“The capital-raising story isn’t over,” said Christopher Wheeler, a banking analyst at Mediobanca SpA in London. “The tests haven’t comforted the market. The banks still need to raise capital in the event of a sovereign default.”
UniCredit SpA (UCG), Deutsche Bank, BNP Paribas (BNP) SA, Credit Agricole SA (ACA), Societe Generale (GLE), Banco Santander SA (SAN) and Credit Suisse Group AG are among banks that may have to raise a combined total of about 62 billion euros in additional capital, Wheeler said. All the banks passed the EBA’s tests.
The criteria included a review of how the 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. The EBA is also carrying out a review of risks to lenders’ liquidity. The results of that won’t be published.
“We remain worried about the secondary effect of the sovereign crisis into funding,” the JPMorgan analysts said. “Funding is the key concern, and without stress liquidity assumptions, the picture remains incomplete --especially in current market conditions.”
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