As we’ve discussed repeatedly, bank stress tests have been a confidence building exercise, an effort to talk bank CDS spreads down and bank stock prices up. That was clearly the intent of the first effort by the US Treasury in 2009 and it succeeded so well as a PR exercise that the Eurozone copied it last year, incredibly finding that obviously undercapitalized Eurobanks needed a mere €3.5 billion euros more in equity. Mere months after the release of the results, lenders were being much more stringent and shunning banks who had been given an official clean bill of health.
This pattern has continued. Earlier this year, the EBA said the Eurobanks needed €80 billion in additional capital. We hooted:
Things have gotten so ludicrous that you can now read contradictory stories in the Financial Times mere days apart (I’m not criticizing the FT but the apparatus that does the messaging). The day before yesterday, Eurozone banks “threatened” that they’d have to be nationalized if the haircuts on the aforementioned Greek funding deal were increased from 21% to 50%. Note credible estimates as early last year put the level of writedowns needed on Greek debt at a minimum of 50% (75% was not an uncommon number) and Greece has undershot forecasts repeatedly since then.
The idea that nationalization is a horrible outcome to anyone other than bankers shows how far down the rabbit hole we’ve gone. But aside form that, recognize the implication: increasing the haircuts from 21% to 50% on Greek debt would tank banks. Even if we use the total amount of Greek debt outstanding, €350 x .29, we get €102 billion. But that figure is high, since what is relevant is the debt held by banks, not the total. A FT Alphaville story reported the private debt target for participation in the earlier restructuring plan (the goal was 90% participation) was €135 billion. Gross that up and you get €150 billion, and take 29% of that, and you get €44 billion.
If a mere incremental €44 billion loss across Eurobanks is such a devastating event, the banks are pretty wobbly as it is. Mind you, we all know that, but the banks have just said that, loudly and publicly. And pretty much no one expects the resturcturings to stop with Greece.
Yet today, the FT tells us that European officials thinks the level of recapitalization needed is a mere €80 billion. Earth to base, if they are so fragile that €44 billion in losses will allegedly put a lot over the edge, they need a lot more dough than that. The prevailing estimates of the magnitude of the combined banking/sovereign is in the €2 to €3 trillion range. This measure is not a solution, and it falls so far short that it’s an embarrassing and dangerous admission that the European financial leadership isn’t merely politically constrained, it’s utterly clueless. At best, the authorities must view this action as tantamount to administering a shot of adrenaline to the heart of a failing patient.
A week after this post ran, the EBA increased the amount banks needed to raise to €106 billion.
In a further embarrassment, the EBA today, a mere six weeks after their October assessment, announced stress test results that found that Eurobanks now need €115 billion in additional capital. It appears to be difficult to pretend that banks have big enough risk buffers when interbank funding has dried up and central banks are going through all sorts of hoops to provide emergency support.
The problem is, just as the rating agencies generally issue downgrades only after the markets have given a big thumbs down on current ratings, so too have the Eurostress tests been shown to be useless as anything other than a measure of the regulators’ degree of denial. And even with this overdue recognition that the Eurobanks need more equity, pray tell where are they gonna get it? Sovereign wealth funds have been cool on bank equity since they were burned in 2007 when they were asked to be the fillup of near last resort. Bank stock prices are sufficiently low that banks will be loath to issue shares even under duress (and will the investors even take up shares on the scale needed? When I was a kid, you could do tech IPOs only two or three years out of five, the market simply was not there otherwise. There may not be a price at which, say, Unicredit could sell €8 billion worth of shares in the next two or three months). Consider this quote from two weeks ago:
Uninvestable is just about the worst word in a shareholders’ vocabulary.
The term – meaning that the market sees no point at all in investing in a certain asset – is being used increasingly when talking about European banks.
“It is an absolute disaster zone. I wouldn’t touch them. You couldn’t make me buy a bank,” says Paul Casson, director of pan-European equities at Henderson Global Equities.
Even some bank chief executives seem to agree. “I’d be very interested to see the investor who is prepared to put more capital towards UK banks. All of them are thinking that’s a dumb place to put capital,” Stephen Hester, chief executive of RBS, the part-nationalised UK lender, said this week.
The big banks have threatened to shrink their balance sheets to reach target equity levels, but that seems questionable in the current environment. Who exactly is gonna buy their riskier assets now (unloading riskier assets would have the biggest effect on reducing capital needs)? Even if there was some appetite among institutional investors for this trade, there isn’t enough in aggregate. And the bigger constraint is the banks would have to sell those assets for no lower than the price at which they are carried on their balance sheets now. Selling assets at a loss would reduce their equity levels, defeating the purpose. (Note they could still let existing loans roll off and then not extend new credit in the same volume, but that is a much slower route for reducing balance sheet size).
The EBA also set its targets for particular institutions in specific amounts, rather than percentage levels, so the regulator may also have decided to change posture to block the banks’ largely empty threat to shrink to meet target capital levels.
All in all, this is predictably too little, too late. The biggest news in this release is the willingness to admit that German banks might be wobbly. Ahem, anyone with the faintest acquaintance with the financial news understood that the “rescue the periphery countries” exercise was really to save French and German banks. So how could any remotely adequate stress test NOT find German banks coming up short?
From the Financial Times:
Germany’s banking system was shown to be far weaker than previously thought in a new round of European stress tests, raising the prospect of further taxpayer bail-outs….
Some analysts had expected the overall capital deficit to fall from the €106bn October figure, as banks have hoarded profits, begun converting some debt to equity-like instruments and “deleveraged” – selling asset portfolios and shrinking lending.
The capital shortfalls include 15.3 billion euros for Spain’s Banco Santander SA (SAN) and 7.97 billion euros for Italy’s UniCredit SpA. (UCG)…
“It looks as if the banks are running just to stand still,” said Matthew Czepliewicz, a banking analyst at Collins Stewart in London. “The backdrop has worsened, therefore banks in the interim have decided to lower their sovereign holdings and some have raised equity, so they’ve reacted and yet the aggregate number hasn’t changed much.”…
Other lenders needing to bolster their reserves include Deutsche Bank AG, with a shortfall of 3.2 billion euros, Banco Bilbao Vizcaya Argentaria SA (BBVA), which missed the target by 6.33 billion euros, BNP Paribas (BNP) SA, with a shortfall of 1.5 billion euros, and Societe Generale SA (GLE), which needs 2.1 billion euros. Commerzbank AG (CBK) needs 5.3 billion euros to meet the target, German regulator Bafin said. France’s Groupe BPCE, the owner of Natixis SA, had a 3.7 billion euro shortfall, and Italy’s Banca Monte dei Paschi di Siena SpA (BMPS) needs to raise 3.27 billion euros.