ECB stress test results: keep calm & carry on

The European Central Bank announced the results of its Comprehensive Assessment of 123 banks’ capital on 2 November and the market was relieved that the results contained no major negative surprises.

The joint exercise with the European Banking Authority comprised an Asset Quality Review (AQR) and Stress Test, with the latter conducted under baseline and adverse scenarios. The results were based on figures as at the end of 2013.

Twenty-five banks failed the stress test under the adverse scenario, meaning that their CET1 ratio would fall below 5.5%, but of these 11 had already taken measures in 2014 to improve their capital ratios. This left 14 banks still failing and their combined shortfall was Eu24.6bn, according to Crédit Agricole CIB analysts.

The biggest shortfall was at Monte dei Paschi di Siena, which had a Eu2.11bn capital shortfall. Like other institutions that failed, it has since taken actions to address the shortfall and in MPS’s case this includes a sale of the bank.

Although some questions were raised about the methodology used — for example, deflation risk being untested and litigation issues not being taken into account — the results were generally well received by the markets.

“The review seems harsh enough to be convincing but still manageable for banks,” said the Crédit Agricole CIB analysts. “This should improve confidence, and we see this outcome as positive for the whole sector, notably on the subordinated segment.”

Indeed, after the results were announced on the Sunday, SEB reopened the AT1 market on Thursday, 6 November (see separate article), while other institutions saw the way open to access the market.

“Doing a subordinated capital deal fairly closely ahead of the announcement of the stress test results would have been rather inappropriate,” said a funding official at one bank that went on to issue in the aftermath. “I think that’s why several banks waited to take a decision on going ahead with such deals.”

An investor meanwhile said that the outcome of the exercise should help the asset class.

“It is very positive for AT1,” he said, “because what you can basically see is that if that stress test played out, no AT1 would have been triggered.

“But at the same time,” he added, “if you really had these losses, it’s very likely that most of the coupons would also have been deferred by 2016.”

He said that the results were in line with his expectations.

“I think they perhaps should have been a bit more stringent with the definition of capital,” he added. “Some of the larger banks looked a bit better than they should have because they used phased-in rather than fully-loaded numbers, and what was missing was the litigation and operational risk. And the ECB said itself that DTAs were treated too generously.

“So they have to tighten things up a bit going forward, but otherwise, the rest was good.”