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Europe’s bank stress tests are coming to an end on Friday. Now what about the recapitalisation risk afterwards?
Having sprung more leaks than the RMS Titanic, the tests seem to suggest that almost every bank has passed. We’ve even received the leaked list of questions to banks from regulators, via Reuters.
But we won’t know for sure until the final results — while recapitalisation remains a problem ahead of new Basel regulations and economic uncertainty. And, as analysts from Macquarie noted on Wednesday (emphasis in original):
There is still no regionwide commitment of governments to recapitalise banks in capital deficit. A key factor behind the success of the US tests was the commitment of government recapitalisation for banks in danger: such commitment might not be available, particularly in indebted peripheral euro-zone economies. Whilst the EC said that euro-zone governments will be able to use the â?¬450bn European Financial Stabilisation Fund to support their banks if they wanted to, governments might favour a lower capital level for their banks rather than the credibility risk that such a move might entail. This all means that peripheral economies and those with the greatest exposures to Sovereign risk will be at risk: this is true particularly for banks in Greece, Spain and Portugal, but also Belgium and the Netherlands.
Not something European bank equities really want to hear at the moment — given that the tougher US stress tests boosted stocks. Over to Macquarie, emphasis ours:
We believe that a similar reaction in Europe is highly unlikely. Even in the event that the European stress test is tough enough and disclosure is good, the likely lack of action post results might create a limbo situation, where banks failing the test might not be recapitalised until 2011, post the announcement of the Basel III capital amendments publication (November 2010). In the meantime, central banks’ support will remain crucial in providing unlimited liquidity. Limited lending growth, even if the crisis is averted, is likely, in our view, due to fiscal tightening (which will make firms and households reluctant to borrow) and due to uncertainties about Basel III new regulation (which will constrain banks’ RWA growth).
Speaking of central bank support — Portuguese banks borrowed a record â?¬40.2bn from the European Central Bank in June, according to data on Wednesday. This is getting a bit too Greek.
So it’s not even just about recapitalising — it’s also about, er, reliquidising by regaining affordable access to interbank lending.
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So where is this recapitalisation risk falling?
For a start, Evolution Securities’ European banks team observed on Wednesday that Banco Popular might well disappoint on Friday:
If there is a bank in our coverage universe that could fail the EU stress tests, it is Banco Popular: by running a similar exercise to the May 09 US stress tests we conclude that losses on loans and debt securities could cause Popular to be â?¬1.1bn short of a potential 6% Core Tier 1 benchmark. This being said, we have our doubts that the EU stress tests will be as tough as their US counterparts.
It’s also worth looking at what the recap issue would mean for Germany’s Landesbanken — who have been prime suspects in the stress-test fail stakes, especially since reports that Hypo Real Estate has missed the bar.
Citigroup have run their own stress test on capital needs for the Landesbanken, based on doubling the loan loss charges faced by Commerzbank in 2008-2009. The tests led to about â?¬11bn more capital needed for a 6 per cent Tier 1 ratio (or â?¬23bn to get to 8 per cent). Sums more than covered by the â?¬51bn still on offer from SoFFin.
But – surprise – proper recapitalisation and restructuring can’t be done quickly. As Citigroup concluded (emphasis in original):
While further consolidation among the Landesbank looks increasingly likely, it will probably be a 3-5 year process, in our opinion. Local politicians remain reluctant to give up control over their own Landesbank based upon the possible implications for the local economy. While conceding that some reforms are needed, such as a refocus on domestic German lending, the Landesbank (WestLB aside) have so far distanced themselves from the need for consolidation, despite pressures from both the EU Commission and German state. We struggle to see how the CEBS stress tests will change this stance.
Notable inhabitants of Dante’s Purgatorio, by the way: the gluttonous, the covetous, the slothful… and the late repenters.
Related links: Shorting (and scheduling) the stress tests – FT Alphaville Spain’s big chance – FT Alphaville CEBS reveals stress test details (at last) – FT Alphaville
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