EU Bank Stress Tests-200710

8/9/2019 EU Bank Stress Tests-200710

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www.fitchratings.com

Special Report EU Bank Stress Tests: More AQuestion of Funding Than Capital

SummaryThe publication of stress test results for 91 European banking groups, due to start23 July, comes at a critical point for bank ratings in the region. Fitch Ratingsbelieves that capital will be made available by sovereigns where shortfalls areindicated and banks are unable to raise capital in the public markets. This might bevia existing national bank recapitalisation schemes (eg Germanys Sonderfonds frFinanzmarkstabilisierung (SoFFin) or Spains Fund for Orderly Bank Restructuring(FROB)) or bilaterally.

For those banks most exposed to wholesale refinancing risk, pressure on IndividualRatings and LongTerm IDRs that are not at their Support Rating Floors is likely tointensify if, in the aftermath of the stress tests publication, conditions in thewholesale funding markets do not improve. Even a resoundingly successful stresstest exercise may not, in isolation, resolve the tensions in European fundingmarkets unless market concerns over sovereign risk also ease.

Fitch rates 82 banks, with total riskweighted assets (RWA) of nearly EUR11tn, that arebeing tested either in their own right or as part of a Spanish merger group. Of these,28 IDRs (RWAs of around EUR4.4tn) are at their Support Rating Floors. 55 banks,aggregating to 84% of the rated groups RWAs, have Support Ratings of 1 or 2,implying an investmentgrade probability of support being provided to prevent default.

Stress testing 91 banking groups domiciled in 20 European countries (and operatingor regulated in far more) is complex. There is therefore greater execution risk inthe testing process being coordinated by the Committee of European BankingSupervisors (CEBS) and the communication of the results than was the case whenthe US Federal Reserve undertook its Supervisory Capital Assessment Program(SCAP) on 19 US banking groups in H109.

When combined with (thus far) a lack of transparency over the testing process,concerns over how stressful the tests are and worries that the level of disclosureof results may be poor, there remains a credible risk that the exercise will not havethe desired effect of improving bondholder or counterparty sentiment towardsEuropean banks.

Fitch believes that some of the markets concerns may be overestimated, though:The stress tests were only formally announced by CEBS in midJune, raisingquestion marks over the rigour of the process. However, the tests have largely beenbased on previous stress testing undertaken mainly through national regulators,many of which Fitch considers to have been very rigorous. The political authoritiesalso seem to have recognised the need for transparency over the process andresults. The CEBS tests have been very limited in their transparency so far, butFitch believes this will be rectified when the results are published.

The median loss rate experienced by the US banks subjected to the SCAP tests inH109 was equivalent to 7.5% of riskweighted assets (RWA). Most of Europes largestbanking groups should be able to withstand such a loss rate and still pass a 6% Tier 1ratio test hurdle by end2011 after allowing for two years of preimpairment

operating earnings and capital raised in or being otherwise generated in 2010.

Analysts

James Longsdon+44 20 7417 [email protected]

Bridget Gandy+44 20 7417 [email protected]

Related Research

Applicable Criteria

Global Financial Institutions Rating Criteria(December 2009)

Other Research

Spanish Financial Institutions Domestic Loan

Book Stress Tests (July 2010)

The Role of the ECB Temporary Prop or

Structural Underpinning?(May 2010)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=527825http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=532933http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493146&sector_flag=3&marketsector=1&detail=mailto:[email protected]


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EU Bank Stress Tests: More A Question of Funding Than CapitalJuly 2010 2

Rating Implications Funding & Liquidity are the MainRating DriversFitch believes any recapitalisation requirements that arise as a result of the stresstests will be met either by existing recapitalisation schemes or bilaterally betweena bank and a government if a bank that fails the tests is unable to raise capital inthe markets or release capital (eg via asset sales) independently. The EUR440bnEuropean Financial Stability Facility (EFSF) should be available to help eurozonegovernments raise funds for this purpose, if required. In the interests ofunderpinning systemic stability, the European Commission (EC) would be unlikely toblock any recapitalisations that fall foul of state aid principles. However, as in 2009,bank restructuring would almost certainly be required.

The main ratings implications of the stress tests, therefore, are likely to depend ontheir success in easing investor and counterparty concerns about the solvency ofEuropean banks, thereby improving conditions in the funding markets. Unless theresults of the stress tests are effective in helping to ease conditions in the fundingmarkets, negative rating actions on Individual Ratings of those banks most in needof market funding (and therefore also on those IDRs not at their Support RatingFloors) will become increasingly likely.

Appendix 1 lists all rated banks subject to the stress tests, along with theirIndividual Ratings, IDRs and the number of notches IDRs are above Support RatingFloors. Of the banks subject to stress tests, 29 (representing 40% of the RWA of banksbeing tested) are at their Support Floors (see Chart 1). Of note, the IDRs of the Irish,Austrian, Belgian, Greek, two of the major UK banks (RBS Group and Lloyds BankingGroup) and all of the German banks except for Deutsche Bank are already underpinnedat their Support Floors. However, many of the Spanish, Italian, Scandinavian andPortuguese banks are presently rated above their Support Rating Floors.

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AA+ AA AA A+ A A BBB+ BBB BBB BB+

IDR not at support rating floor

IDR at support rating floor

Chart 1: IDR Distribution of Rated

Banks of The Sample

Source: Fitch

(Number of Banks)

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A A/B B B/C C C/D D D/E E E/F F

Chart 2: Individual Ratings

Distribution of Rated Banks of The

Sample

Source: Fitch

(Number of Banks)

Appendix 2 considers some of the indicators of stress in parts of the Europeanfunding markets, including public debt issuance levels and bank utilisation of theEuropean Central Bank.

Stress Test Process What is Needed for it to Work?In order to maximise the chance of being successful, the stress tests need to bestressful, thorough, transparent, relevant and backed up by timebound andcredible recapitalisation plans, where required. Fitch expects most of these criteriato have been met by the time the process is complete. However, one weak linkcould undermine the whole process. At present, the biggest weak link risk surroundsthe haircuts to be applied to sovereign debt exposures.

The highly successful SCAP process in the US in 2009 set a precedent for howEurope might manage the stress tests. However, CEBS and national regulators inEurope face a more complicated task than the Federal Reserve, given the greater

Recapitalisation needs notmet independently will be

covered by governments Main downgrade risk if

funding conditions fail toimprove

29 of rated banks beingtested underpinned attheir Support Floors

Market concerns overtransparency, robustnessand recapitalisation risklook overestimated

But CEBS tests carrygreater execution riskthan US SCAP tests

Sovereign debt haircutscould be the weakest link


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number of competing regulatory voices and the need to balance consideration ofnational nuances within countries domestic banking systems (eg commercialproperty risk is not the same in the UK as in France) and varying stages reached in

the economic cycle with some degree of harmonisation of approach. As a result,Fitch believes there to be greater execution risk in the European stress tests thanthere was in the SCAP process. There is also a greater risk of the results beingmiscompared.

StressfulCEBS has disclosed few details on the key parameters except that the adversescenario assumes a threepercentagepoint deviation of GDP for the EU comparedwith the ECs forecasts over 20102011. Fitch views this as being stressful (it is alsomore stressful than the deviation from consensus GDP change under the SCAP tests)and believes it reasonable to assume that similar conservatism has been applied inrespect of other key macroeconomic parameters.

One of the critical questions surrounds the haircuts to be applied to eurozonesovereign bonds and whether such bonds not marked to market for regulatory Tier 1ratios will be subject to haircuts. This is evidently a highprofile concern and couldprove the key impediment to the tests credibility unless a healthy degree ofconservatism is employed.

ThoroughAnecdotal evidence suggests that some of the assumptions for the tests have beenchanging as the tests have been pulled together. In general though, the testsappear to be building on stress tests undertaken, often very extensively, bynational regulators (and, for the larger banks, CEBS) since 2009 and even 2008.Because of this, Fitch believes that they ought in most instances to have beenrelatively thoroughly prepared.

TransparentThe US SCAP test results were preceded, but only by a fortnight, by a white paperpublished by the US Federal Reserve (The Supervisory Capital AssessmentProgram: Design and Implementation, dated 24 April 2009) highlighting the keyfeatures of the test framework and three highlevel macroeconomic variables forthe tests (real GDP change, unemployment and house prices). Even though thepaper did not provide specifics of the tests in detail, it at least comfortedparticipants and observers that the framework was robust. The SCAP results paper(The Supervisory Capital Assessment Program: Overview of Results), released on7 May provided twoyear loss ranges for 13 major asset classes/subcategories andbankspecific loss calculations, but only in respect of eight asset classes.

The CEBS tests and stress testing of European banks in general has not, thus far,been transparent (Sweden and Denmark being exceptions) and many regulators maynow be regretting not having published details of national stress tests that havebeen undertaken since late 2008. With transparency being a major market concern,it seems inconceivable that CEBS and national regulators will not communicate theresults in a transparent manner. Using the SCAP experience as precedent, thetransparency hurdle may not even be that high.

RelevantCEBS has clearly stated that the test scenarios include macroeconomic variablesthat are differentiated for EU member states, the rest of the EEA countries andthe US (see CEBS press release of 7 July 2010). This is critical in order to captureappropriately risk characteristics in one country that may be different in another.

Fitch believes the tests will be relevant.


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Ratings of Banks Subject to the Stress Tests (cont.)

(EURm) 2009

Country Bank LT IDR

SupportRatingFloor

Notches

aboveSupport

RatingFloor

IndividualRating Total assets RWAs

Tier 1ratio

Slovenia 19,606 16,247Nova Ljubljanska Banka A A 0 C/D 19,606 16,247 7.2

Spain 2,929,913 1,692,383Banco Santander AA A 3 A/B 1,110,530 561,684 10.1BBVA AA A 2 A/B 535,065 291,026 9.4Caja de Ahorros y M. P. de Madrid A+ BBB 4 B/C 191,905 126,702 8.8Bancaja BBB BB+ 2 C/D 111,459 71,368 8.1Caixa d'Estalvis Laietana BBB BB+ 1 C/D 9,191 7,108 7.2La Caixa AA A 3 B 271,873 157,300 10.4Caixa d'Estalvis de Girona BBB BB+ 2 C/D 7,815 5,445 8.3Caja de Ahorros del Mediterraneo BBB+ BB+ 3 C 75,532 51,573 9.4Cajastur A BB+ 5 B/C 15,829 10,699 12.7Caja de Ahorros y M. P. de Extremadura A BB+ 4 B/C 7,590 5,045 9.1Banco Popular Espanol S.A A BBB 3 B/C 129,290 92,332 9.2Banco de Sabadell A BB+ 5 B/C 82,823 59,036 9.1Caixa Galicia BBB+ BB+ 3 C 46,340 35,601 8.5Caixanova A BB+ 4 C 31,738 23,035 8.3Caja de Ahorros de Murcia A+ BB+ 6 B 22,140 13,318 12.2Caixa d'Estalvis del Penedes BBB+ BB+ 3 C 23,042 14,663 9.5Sa Nostra BBB BB+ 2 C/D 14,114 9,121 6.7Caja General de Ahorros de Granada BBB+ BB+ 3 C 13,759 8,768 8.7Bankinter A+ BB+ 6 B/C 54,468 31,786 7.2Caja Espana de Inversiones, Caja deAhorros y M. P.

BBB+ BB+ 3 C/D 25,254 14,816 9.2

Unicaja A+ BB+ 6 B 32,156 21,235 11.9Cajasol A BB+ 4 C 28,244 19,998 10.6Bilbao Bizkaia Kutxa A+ BB+ 6 A/B 29,806 19,202 14.6Caja de Ahorros y M. P. del C. C. deObreros de Burgos

BBB+ BB+ 3 C 5,208 3,926 9.7

M. P. y Caja General de Ahorros deBadajoz

BBB+ BB+ 3 C 4,248 2,839 10.1

Caja de Ahorros de la Inmaculada deAragon

A BB+ 5 B/C 11,938 8,227 8.5

CajaSur BB+ BB+ 0 F 18,960 12,094 1.9Banco Guipuzcoano A BB 5 C 10,345 7,785 9.1Caja Vital A BB+ 5 B 9,252 6,652 11.4

Sweden 940,087 361,277Nordea Bank AB AA A 3 B 507,544 191,858 10.2Skandinaviska Enskilda Banken A+ A 2 B/C 225,320 77,622 12.8Svenska Handelsbanken AA A 3 B 207,223 91,797 9.1

UnitedKingdom

6,265,656 2,384,629

Royal Bank of Scotland Group plc AA AA 0 C/D 1,909,441 608,910 14.1HSBC Holdings plc AA NF B 1,647,990 789,802 10.8Barclays PLC AA NF Not rated 1,552,022 430,686 13.0Lloyds Banking Group plc AA AA 0 C 1,156,203 555,230 9.6

Source: Fitch


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Appendix 2: European Funding Markets A Snapshot ofFitchs ConcernsThe severe contraction in bank liquidity and capital market access is one of Fitchsprimary highlevel concerns for the European banking sector. Fitchs concerns aremore acute for some banking sectors (eg Greek, Irish, Portuguese, parts of theSpanish caja sector) than others. Having raised USD250bn in public debt in 4M10,EMEA bank debt issuance reduced to a trickle in May (see Chart 3), beforerecovering in June, but really only because some of Europes largest and/or leasttroubled banks were able to return to the market. In response, the EC has neededto allow a number of governmentguaranteed debt schemes (eg Netherlands, Spain,Greece, Denmark) to be extended until end2010. If markets do not improve inH210, there may be little option but to reactivate or extend governmentguaranteed debt schemes further.

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Total amount issued in EMEA (LHS) O/w proportion of guaranteed issues (RHS)

Chart 3: Debt Issued in EMEA and Proportion of Guaranteed Issues

(USDbn)

Source: Dealogic DCM analytics

In Fitchs report entitled The Role of the ECB Temporary Prop of StructuralUnderpinning?, published in May 2010 and available from www.fitchratings.com,Fitch was concerned at the increase in eurozone banks structurally dependent onthe ECB for funding (as opposed to using the ECB simply for liquidity). For Spain,Ireland and Greece, the high utilisation of ECB funding compared with theirnatural share, as indicated by their share of eurozone banking sector assets as awhole, is represented in Charts 46 below. Fitch believes the European Central Bank(ECB) will remain accommodative in its provision of liquidity to eurozone banks.

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Spanish usage of total ECB facilities Spanish banking assets in eurozone system(%)

Chart 4: Spanish Usage of ECB Facilities

Compared to Spanish banking system assets

Source: ECB, Banco de Espana


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Irish usage of total ECB facilities Irish banking assets in eurozone system(%)

Chart 5: Irish Bank Usage of ECB Liquidity Lines

Compared to total Irish banking system assets

Source: ECB, Central Bank and Financial Services Authority of Ireland

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Greek usage of total ECB facilities Greek banking assets in eurozone system(%)

Chart 6: Greek Usage of Facilities

Compared to Greek banking assets

Source: ECB, Central Bank and Financial Services Authority of Ireland

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Copyright 2010 by Fitch, Inc., Fitch Ratings Ltd. and its subsidiaries. One State Street Plaza, NY, NY 10004.Telephone: 18007534824,(212) 9080500. Fax: (212) 4804435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rightsreserved. All of the information contained herein is based on information obtained from issuers, other obligors, underwriters, and othersources which Fitch believes to be reliable. Fitch does not audit or verify the truth or accuracy of any such information. As a result, theinformation in this report is provided "as is" without any representation or warranty of any kind. A Fitch rating is an opinion as to thecreditworthiness of a security. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specificallymentioned. Fitch is not engaged in the offer or sale of any security. A report providing a Fitch rating is neither a prospectus nor asubstitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of thesecurities. Ratings may be changed, suspended, or withdrawn at anytime for any reason in the sole discretion of Fitch. Fitch does notprovide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment onthe adequacy of market price, the suitability of any security for a particular investor, or the taxexempt nature or taxability of paymentsmade in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for ratingsecurities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitchwill rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single

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EU Bank Stress Tests-200710

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