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Stress test questions hover over German, Austrian banks

Thegenerally high capital and strong asset quality of banks in Germany, France,the Netherlands, Belgium and Austria should be underscored by the EuropeanBanking Authority's 2016 stress test, yet significant weaknesses could still emerge,especially among German and Austrian lenders.

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CFO Marcus Schencknoted July 27 that this stress test, unlike its predecessor, focuses on therisks from sudden market dislocation and operational risk. It sounded like a hint.

Thelatter aspect requires banks to project the impact on profit from conduct andother operational risks, in part by using the average of historical conductcharges incurred between 2011 and 2015. An elevation of risk-weighted assetsattributable primarily to operational risk saw Commerzbank AG announce July 25 that its fully loaded common equityTier 1 ratio had fallen 50 basis points during the second quarter to 11.5%.This could well have been caused by the stress test, as one credit analystobserved when interviewed.

AtDeutsche Bank, Schenck admitted that "litigation remains a keychallenge," with the bank setting aside a further €120 million oflitigation provisions in the secondquarter and revealing that it has entered talks with the U.S.Department of Justice over a settlement related to crisis-era RMBS misdeeds.Schenck emphasized during the results presentation, however, that regulatorychanges mean that the payment of dividends and Additional Tier 1 coupons hasbeen significantly eased, whatever weakness the stress test might reveal. Thisreduces the market pressure on Deutsche Bank's AT1 instruments, although CEOJohn Cryan warned that regulators were demanding ever more capital irrespectiveof its effect on bank performance.

Austrian banks face stiff test

DeutscheBank along with France's BNPParibas SA, SociétéGénérale SA and Crédit Agricole SA look the weakest eurozone"core" banks among those subject to the EBA test. All four reportedCET1 ratios around or below 11% as of year-end 2015; Deutsche Bank has notimproved since, publishing a 10.8% figure at the end of the secondquarter.

Theadverse scenario foresees a long-term interest rate shock, drops in equity andproperty prices and a contraction of EU GDP amounting to 1.2% in 2016 and 1.3%in 2017. The precise figures vary by country, but Austrian banks are facing anespecially bearish scenario, with a 30.5% drop in the stock market in 2016followed by a 25.4% fall in 2017, alongside sharply falling house prices andespecially harsh stress models for Central and Eastern Europe. Exchangerate shocks from Central and Eastern Europe and Switzerland also feature, whicha bank equity analyst said could hit Austrian banks in particular.

Basedon a simulation of the EBA exercise, Credit Suisse analysts said July 22 thatthey expected Europe's banks to perform better than during the 2014 testbecause of their generally higher capital. Individual banks, however, couldcome under investor scrutiny if they have significant nonperforming loans,potentially substantive litigation costs and/or only a small buffer over theindividual capital buffer set during the ECB's Supervisory Review andEvaluation Process, they added.

Profitability challenge

Figuresfrom S&P Global Market Intelligence show that most core eurozone banksboast CET1 ratios of 12% and higher, giving them the strength to withstand thenegative stress scenario. Their main weakness isprofitability, with only KBCGroup NV and ABN AMROGroup NV achieving double-digit returns on average equity in 2015.

Thereis a strong correlation between low returns and weak margins, the latter beinglargely attributable to ECB policy, and the credit analyst thought it strangethat negative interest rates do not feature within the stress test, given thepressure they are exerting.

Weakprofitability means that the banks are less robust and more likely to incurlosses when stressed. Coverage ratios for NPLs are not especially high butoffer little source for concern if one assumes economic growth. That couldchange in a stress scenario; BNP Paribas would need more than €12 billion toraise coverage to 80% of NPLs; ING Groep NV would need nearly €10 billion andRabobank more than €7billion.

Unlike the previous test, there is no pass/fail capital minimum, and Credit Suisseanalysts said a bank being "just below" its SREP requirement underthe adverse scenario should not be a major cause for concern. Deutsche Bank,Commerzbank, BNP Paribas and ErsteGroup Bank AG fell below their fully loaded SREP benchmarks underthe adverse scenario in Credit Suisse's simulation.

Bycontrast, SocGen analysts thought that even without a clear divide between passand fail, markets would see banks with weak capital when stressed as needingmore equity.

"Atbest this could get shrugged off by the market," they wrote. "At[worst], it could remind investors that all is not well in Europe even five orsix years after the crisis."

 

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Click here to access the SNL worldwide bank ranking template and view key balance sheet figures, performance and capital adequacy ratios for individual European banks.

Click here to view SNL's profile of individual European banks and view key information in both tabular and graphical format for your selected company.