Success for Bank Stress Tests Hinges on Data, Not Failure Count

By Andrew MacAskill and Jann Bettinga
July 23 (Bloomberg) -- The success of the European Union’s bank stress tests hinges on how much detail regulators provide about the basis for their conclusions, not on the number of lenders that fail, investors said.
"The more transparency, the more important that the results will be," said Peter Braendle, who helps manage $51 billion at Swisscanto Asset Management in Zurich. "If the methodology is a black box and we just get some results, that will not be very helpful."
Regulators are scrutinizing banks to assess if they have enough capital, defined as a Tier 1 capital ratio of at least 6 percent, to withstand a recession and sovereign debt crisis, according to a document from the Committee of European Banking Supervisors. Lenders that fail the trials will be made to raise additional capital. The results will be published by CEBS and national regulators starting at 6 p.m. Brussels time today.
The assessors haven’t so far provided full details of their criteria, raising concern among investors they will not be stringent enough. U.S. regulators published the metrics they used to test their banks before they released their results last year. U.S. bank stocks rallied 36 percent in the seven months following the trials.
Governments are publishing the results of the region’s first coordinated stress tests as they seek to end concerns about the health of the banking system almost three years after the subprime crisis roiled global financial markets. The 54- member Bloomberg Europe Banks and Financial Services Index has risen 9.3 percent this month, boosted by optimism that lenders will pass. By comparison, the U.S. Standard & Poor’s Financials Index has gained about 4.7 percent.

‘Create Your Own’

"It’s pretty clear that a lot of banks will pass this test," said Lutz Roehmeyer, who helps manage about $15 billion at Landesbank Berlin Investment, including bank shares. "It will be more important to see what raw data will be published.
With that you can create your own, more stringent scenarios."
Analysts’ estimates for the amount of capital European banks will need to raise range from 30 billion euros ($38.7 billion), according to Nomura Holdings Inc., to as much as 85 billion euros at Barclays Capital.
Investors have criticized the tests, saying they may not be rigorous enough. In particular, they are questioning to what extent regulators are examining banks’ sovereign-debt holdings, including how government bonds in the trading and banking books will be valued in the event of a sovereign debt crisis.

Sovereign Holdings

The tests won’t include the possibility of sovereign defaults, Dutch Finance Minister Jan Kees de Jager said last week, indicating that there will be no assumed losses on government bonds held in lenders’ banking books.
"Banks hold the majority of their sovereign bonds in the banking book, and as a EU country’s default is not part of the stress test’s scenarios, impairments are not necessary," said Konrad Becker, a financial analyst at Merck Finck & Co. in Munich. Lenders only write down the value of bonds in their banking book if there is serious doubt about a state’s ability to repay its debt in full or make interest payments, he said.
CEBS will publish the aggregate test results from 6 p.m.
National regulators and banks will then publish their results on an individual basis, according to CEBS’s Web site.
Banks may give breakdowns of their sovereign debt holdings.
Regulators have asked them to publish a list of each lender’s gross and net exposure to central and local governments in 30 countries in the region, including Greece, Spain, Ireland, Italy and Portugal, according to a July 15 confidential draft template by CEBS that was obtained by Bloomberg News.

Markets Closed

The results will be released when European markets are closed, giving banks that fail the test time to raise funds to fill their capital shortfall before markets re-open. Officials have yet to spell out how they would deal with a bank that fails the tests and how additional capital may be provided.
EU Economic and Monetary Affairs Commissioner Olli Rehn said yesterday the union has the means to fix any problems that may be found in the tests. Ailing lenders should first seek funding from their shareholders and the markets before seeking help from national rescue funds, Rehn said in an e-mailed copy of a speech given in Pori, Finland.
Analysts say the banks most likely to fail are Germany’s state-owned lenders and Spanish savings banks. Europe’s largest banks from Societe Generale SA to Barclays Plc and Deutsche Bank AG are expected to come through the tests without needing to raise additional capital, according to analysts.

Hypo Real Estate

Hypo Real Estate Holding AG, the commercial-property lender rescued by the German government, has failed the criteria, people with knowledge of the situation said this week, making it the first bank known to have flunked the tests. The bank declined to comment. Nova Ljubljanska Banka d.d., Slovenia’s largest bank, said it needs to raise 600 million euros following the tests.
"I think there will be a few sacrificial pawns, such as Hypo that will fail the tests," said Frances Hudson, head of global thematic strategy at Standard Life Investments in Edinburgh, which oversees $221 billion. "But, overall, I think that the vast majority of the banks will pass."
Bank of Ireland Plc and Allied Irish Banks Plc, the country’s two biggest banks, passed the tests, according to a person with knowledge of the situation. Deutsche Bank AG, Commerzbank AG and Deutsche Postbank AG, Germany’s biggest publicly traded banks, also have sufficient capital, separate people with knowledge of the situation said. National Bank of Greece SA, the country’s biggest lender, will pass stress tests, chairman Vassilios T. Rapanos said this week.