Stress Test Puts Banks’ Euro Zone Debt in Spotlight

Pressure on Europe’s banks to raise more capital increased on Monday after last week’s stress tests revealed their holdings of European sovereign debt, with likely losses on Greek bonds a growing concern.

A health check of 90 European banks unveiled late on Friday was slammed as being too soft, but provided more than 900 pages of data to allow investors and analysts to run a harsher test.

Putting in a realistic stress on peripheral euro zone bonds could add at least €40 billion [$56.32 billion] to capital needs, and require banks to raise far more cash than under the formal test.

By 11:30 GMT the European bank sector was down 2.1 percent at €167.8 [$236.26], its lowest level for two years. Intesa Sanpaolo, Unicredit, Deutsche Bank, Société Générale and Barclays all fell more than 3 percent.

The European Banking Authority (EBA) said late on Friday eight banks failed its test with a total capital shortfall of €2.5 billion ($3.52 billion).

This amount — puny in the broader context of European banking — sparked a repeat of last year’s accusations that the stress tests were again unrealistic given the euro zone’s sovereign debt crisis.

The major shortcoming of the test was the lack of real stress applied to euro zone bonds held in long-term banking books, where about four-fifths of the bonds are held.

Current market prices imply a much more severe loss than the EBA’s assumption of a 15 percent loss on Greek bonds and a 1 to 2 percent “haircut” on Irish and Portuguese debt.

The EBA data showed banks held €98.2 billion [$138.26 billion] of Greek bonds (67 percent held by domestic banks), €52.7 billion [$74.2 billion] of Irish sovereign debt (61 percent held domestically) and €43.2 billion [$60.82 billion] Portugal (63 percent at home).

Applying more realistic losses of 52 percent on Greek bonds, 38 percent on Irish debt and 33 percent on Portuguese bonds would reduce capital buffers by about €75 billion [$105.6 billion] after allowing for provisions already made, according to a Reuters Breakingviews calculation.

That would leave 27 lenders in need of €25 billion [$35.2 billion] extra capital to get to 5 percent core capital, but that would be manageable for the industry and only create real problems for banks in Greece and Cyprus, Reuters Breakingviews said.

“Disclosure is comprehensive and should give investors some confidence in who owns what,” said Daniel Davies, analyst at Credit Suisse. “Nevertheless, the actual test appears benign.”

Banks needed about €83 billion [$116.86 billion] of additional capital, he estimated, based on a sample of 49 banks, applying market prices on sovereign holdings and a minimum core equity requirement of 7 percent.

The knock-on effect on funding markets could be more damaging, analysts said, leaving attention fixed on how talks progress later this week on finding a solution to the Greek crisis.

“The European banking sector is captive to politics at the moment,” said Hank Calenti, credit analyst at Société Générale.

Euro zone leaders meet on Thursday in a bid to agree a second bailout for Greece and a package to address the broader fiscal woes of the euro zone that last week moved beyond Greece, Portugal and Ireland to Italy and Spain.

This broader package may include measures whereby banks agree to take a hit in some form on the sovereign debt they hold to give euro zone countries more breathing space to recover.

Banks warned that too much transparency, such as news of BNP Paribas’ €24 billion [$33.8 billion] exposure to Italy, may make markets even more jittery.

The banks that failed were small, nearly all untraded and mainly in Spain, where banking problems have long been known. Shares in Greece’s EFG Eurobank, one of the failures, were down 4 percent.

Sixteen banks scraped through the test and analysts expect them to come under market pressure to bring capital cushions up to scratch well before the EBA’s April 2012 deadline.

They include Spain’s Bankia, which plans to list this week and on Monday slashed the price it will sell shares at in a bid to get the sale done, three sources close to the deal said.

The listings of Bankia and smaller rival Banca Civica are seen as a key test of whether Spain is managing to strengthen its banks, and the shares are being sold at a steep discount.

Other near failures included Popula, Sabadell and four more Spanish banks, along with Italy’s Banco Popolare, Greece’s Piraeus and Cyprus’s Marfin.

Portugal’s biggest bank Millennium BCP also nearly failed the test and set the tone for swift action by saying late on Friday it would raise €400 million [$563.2 million].

Europe’s banks would need €41 billion [$57.73 billion] to keep their core capital ratios above 7 percent, the global minimum from 2013 under the Basel III accord and already required by markets in practice, according to Reuters’ calculations.

This compares with the 5 percent pass mark in the test.

Running tougher tests, Morgan Stanley analysts said banks could need between €40 billion [$56.3 billion] and €64 billion [$90.11 billion] of capital, while JPMorgan analysts said 20 banks alone could be €80 billion [$112.64 billion] short of capital.

Europe’s banks raised €50 billion [$70.4 billion] in the first four months of this year ahead of the test results, the EBA said, adding that the greater transparency should restore confidence among investors.

But it has faced some resistance, and Germany’s Helaba pulled out of the test just before the results were announced, disputing it would have been failed. The Bundesbank said it was happy with Helaba’s capital position.

(Additional reporting by Sonya Dowsett in Madrid and Ingrid Melander in Athens; Editing by David Holmes, Ron Askew)