Within the next week, European leaders may announce a third round of stress tests for European banks. We think that in doing so, the European Banking Authority may finally acknowledge the potential for private investors (for example, banks) to take losses on peripheral sovereign debt by incorporating haircuts into the stress tests. We find that a new, tougher stress test could find capital shortfalls at about two thirds of the major European Union banks that we cover. We expect that the largest shortfalls are likely to be found at banks headquartered in PIIGS countries, and that meaningful shortfalls may also be found at French banks.
Key Takeaways:
-- The third round of eurozone bank stress tests may assume haircuts on sovereign debt and incorporate a higher 9% core Tier 1 hurdle rate;
-- Banks in Spain, Italy, Greece and France may face substantial capital shortfalls;
-- The form any bailouts take is critical. If banks are required to raise common equity, the capital raises are likely to be highly dilutive;
-- We do not foresee capital shortfalls at Barclays (BARC), HSBC (HSBA), KBC (KBC), Lloyds (LLOY), or Royal Bank of Scotland (RBS);
-- Commerzbank (CBK) appears to be well priced, even after factoring in a dilutive capital raise.
The above is an excerpt from a Morningstar Institutional Equity Research report. Read more from analyst Erin Davis on the EU banks here.
