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Spanish, German public banks in stress test focus

Source: Reuters - Fri 2th Jul 2010

European bank stress tests will train the spotlight on Spain's cajas and Germany's landesbanks due to opaque finances, political meddling and links to troubled sovereign debt and housing markets.

Large listed euro zone banks such as Santander, BNP Paribas, UniCredit and Deutsche Bank are under constant market scrutiny and their exposure to toxic assets, shaky sovereigns and bad debt is largely known.

But the 45 cajas, or unlisted savings banks, and eight landesbanks are uncharted territory in the European banking sector. The International Monetary Fund devoted extra chapters to both of them it its latest Global Financial Stability Report.

The disclosure of the stress test results this month could show that landesbanks' problems are not over after several bad investments led to serial multi-billion euro bail-outs.

"Many investors see the public sector (banks) in some countries as posing a potential systemic risk and hence contingent liability for the sovereign," Goldman Sachs analysts wrote in a recent note.

"A credible stress-test would add to investor understanding and could act as a 'circuit breaker' of negative sentiment."

For the landesbanks, the big unknowns that could be exposed in the stress test are their holdings of peripheral eurozone sovereign debt and parts of their loan books which could turn bad under the assumption of a severe economic crisis.

While Germany still has funds left in its bank stability plan that could be used to backstop banks failing the test, the problem for Chancellor Angela Merkel's government might rather be how to sell yet another bank bailout to voters.

For the cajas, who skirted U.S. toxic assets and went through the first part of the financial crisis unscathed, the main problem is the homegrown toxic asset they helped create themselves: the real estate bubble that is now deflating.

Analysts estimate that they have on their books two-thirds of the more than 300 billion euros in Spanish property loans that are turning sour as developers default and prices fall after a decade-long boom.


Germany's landesbanks were originally tasked with helping regional governments to support local business, as well as to offer wholesale services to local German savings banks and cater to large corporate clients on behalf of them.

But many of them went astray when they got access to outsized funding after a rush to bond markets in the early 2000s and were desperately seeking assets, many of which led to losses even before the financial crisis.

Their huge exposure to structured U.S. debt instruments required government cash injections and guarantees for four of them - WestLB, BayernLB, LBBW and HSH Nordbank - last year.

But as the crisis affected Germany's real economy and drove up corporate loan losses and as the eurozone periphery's debt woes evolved, two new vulnerabilities emerged. Both of them will be in the focus of the new European stress tests.

"We see more risk from Landesbanken"s exposures in foreign securities and loans, partly as they seem slow to recognize price changes in securities, partly as the credit quality deteriorates" said Deutsche Bank analyst Alexander Hendricks.

The few analysts who have taken a closer look at the banks' balance sheets say those who were propped up by the government have replenished capital levels enough to tide them over, and do not believe they will need fresh cash.

"Capital measures provided by the owners and the rescue fund Soffin were sizeable, and we do not expect additional capital requirements among the Landesbanks in the near term" said ratings agency Moody's analyst Katharina Barten.

However, some experts say that Landesbanken which have so far got through the crisis well, like NordLB or Helaba, could now be affected.

"Given the problems that could arise with corporate and mortgage bonds, it cannot be ruled out that the owners will have to prop up those banks with extra capital" said one investment banker who has looked at the banks.


The Bank of Spain's announcement that it would release bank-by-bank stress test results for the entire system has been the main driver for the publication of the European stress tests, opposed by European regulators until very recently.

With a largely unused 99 billion euro Fund for Orderly Restructuring (FROB) in place to backstop problematic cases, and with restructuring of the cajas almost finished, Spanish authorities appeared to assume that their move would have a similar confidence-boosting effect as U.S. stress tests last year.

Estimates for the cajas' capital needs range from 17 billion euros, which the IMF predicted in its April report, to 40 billion euros estimated by Morgan Stanley. Citi analysts in their own stress test arrived at 24-34 billion euros.

However, the recapitalization needs of the cajas, which between them make up half of the Spanish banking system, are very diverse, as exposure to troubled housing loans ranges from 6 percent of the book to 50 percent in some cases.

The Bank of Spain's strategy is therefore to arm-twist strong cajas to take over weaker ones, a process supposed to cut excess capacity and help recapitalize the weaker links. Those deals are backed by capital injections from the FROB fund.

Thirty-nine cajas are already involved in such deals, which overall will cut their number to around 15 to 20. They have so far asked for 10.5 billion euros from the FROB fund to make the mergers possible.

The deals mean sweeping changes for Spain's banking sector as caja Madrid, which jointly with peer Bancaja is taking over five smaller cajas, will become Spain's third-largest bank by assets through the deal.

Many of them are also expected to seek a change in their governance to make it easier in the future to take in outside investors or list on the stock market, something that is also encouraged by regulators.

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