Comprehensive Assessment Paranoia

The ECB is currently busy stress-testing all “systemically relevant” banks in the euro area, the supervision of which it is going to take over as part of the banking union plan later this year. This stress test has given birth to new acronyms, such as “AQR” (asset quality review) and “CA” (comprehensive assessment). Banks that are found to be short of sufficient tier 1 capital will have to submit a credible  recapitalization plan very quickly after the CA has been concluded, and thereafter will have several months to implement it. 

As a result of the massive carry trade in government bonds of the periphery initiated by the LTROs and Draghi's OMT promise (as we have previously mentioned, the timing and sequence of events suggests that there were sub-rosa agreements between governments, the ECB and large commercial banks, with the caveat that this is impossible to prove), a number of bank balance sheets in countries like Spain and Italy probably look significantly improved  simply due to their vast accumulation of zero risk-weighted government debt. Moreover, the ECB's war on savers has clearly served as a redistributive device in favor of banks.

Nevertheless, the recent downfall of the Espirito Santo empire including the bank (Banco Espirito Santo) of the same name in Portugal, was a reminder that there may still be skeletons in a number of closets (an interesting backgrounder on the Espirito Santo affair can be found here by the way). A recent report in the NYT's dealbook suggests that there is a growing consensus that the ECB's stress test will discover many a bank balance sheet falling significantly short.  The Texas ratio has emerged as the analytical tool of choice for guessing which banks will be found wanting:


“As Europe slogs through its latest round of bank stress tests, a growing number of analysts have already reached their own conclusion: Eurozone banks need additional cash.

To buttress their case, some analysts have dusted off an obscure American bank metric that highlights the extent to which Europe’s increasing number of nonperforming loans is threatening to overwhelm existing bank cushions.

The measure, called the Texas ratio, was developed by an analyst who covered troubled United States banks during the late 1980s and early 1990s. During that period, numerous Texas-based financial institutions collapsed under the weight of faulty real estate loans.

Part of what has made the Texas ratio attractive to analysts and regulators is its simplicity. When the ratio of bad loans to equity and cash set aside exceeds 100 percent, it suggests that the bank is either ready to fail or is in desperate need of new capital — as was the case with Texas banks in the 1980s.

“We found it to be a very good guide telling you which banks would fail,” said Gerard S. Cassidy, the bank analyst who introduced the formula and coined the name. “It’s a ratio that everyone can understand.”

Now as the European Central Bank prepares to become the primary bank regulator in the eurozone, the extent to which lenders in troubled economies like Spain, Italy, Portugal and Greece have sufficient cash to protect against ever-rising bad loans has emerged as a crucial question for investors, banks and regulators.

The E.C.B. will publish the results of its half-year investigation into Europe’s 128 largest banks on Oct. 17. But until then, with worries mounting that the central bank will come down hard on banks with particularly weak loan books, investors and analysts have been scrambling to determine which of these lenders are most at peril.

And with European banks sharing similar characteristics with Texas banks in the late 1980s — nonperforming real estate loans and slim cash buffers — the Texas ratio has emerged as a popular analytical tool. This spring, banking analysts for Nomura in London used the Texas ratio to highlight 11 banks in Southern Europe that were most exposed to nonperforming loans relative to cash they had on hand.

Of the 11 banks that exceeded the 100 percent threshold, three banks stood out with ratios of 150 percent and above: Piraeus Bank in Greece, Banco Popolare in Italy and Banco Popular Español in Spain.


(emphasis added)

As the report notes, even the “good” large banks in Europe sport Texas ratios far above those of their US counterparts.


CHART-1-Euro-Stoxx-BanksEuro-Stoxx bank index, daily. A possible rounded top? – click to enlarge.


One interesting remark was this one, which indicates that the very biggest banks domiciled in Germany and France are far less robust than is generally believed:


“And last year, economists at the Danish Institute for International Studies came out with a report highlighting how low cash buffers were in European banks, especially in France and Germany.”


If a Danish institute says so, it must be true, as it is well known that Danes don't lie (see “Dänen lügen nicht” for details on this).

Meanwhile, in some of the euro area countries that have been struck by severe economic crises, bad loans have kept growing. The situation is nowhere worse than in Greece, where an estimated 34% of the aggregate loan book is said to be in default – which is up from an estimate of 28% made only in March. The total amount is reportedly between €75 to €77 billion, which is quite a big chunk of money for a country the size of Greece.

Expectations are currently that the ECB will demand capital increases of between €5 to €8 billion from Greece's banks. We're not sure how the math on this works, as it seems not very likely that the write-offs and loan loss reserves accumulated to date actually suffice to cover all these bad loans even remotely. Note here that assuming that it is true that NPLs have grown from 28% to 34% of the total loan book, they must have increased by more than $13.6 billion since March alone.


Plunging Government Bond Yields

Given a further slowdown in euro area CPI to 0.3% annualized recently, and a plunge in 5 year forward inflation breakevens to below 2% (see Draghi's Jackson Hole speech, which seemed to hint at “QE soon” because of this), government bond yields have continued to plunge. In Germany, short term yields up to 2 years have turned negative.  This is partly due to technical reasons (need for repo collateral), but there may also be other considerations in play. If one leaves these technical requirements aside, why would anyone pay the German government for the privilege of lending it money? This only makes sense if one fears for the safety of bank deposits. Note that the upcoming implementation of bail-in rules on a Europe-wide basis means that large depositors will no longer be as safe as they once were. The danger of getting the Cyprus treatment will become very real.


CHART-2-Germany, 2yr-yield,-0.0439Germany's 2 year government note yield falls below zero,  to 0.0438% – click to enlarge.


Of course, euro area economic data continue to be quite weak as well, and are suggesting that the largest economies are either already in recession or are on the brink of one.

Although CPI “inflation” is actually higher in Germany than elsewhere in the euro area, its 10 year bond is beginning to resemble the JGB – it sports only a tiny 0.8837% yield at the moment.



Germany's 10-yr. Bund is yielding a mere 0.8837% these days – click to enlarge.


Note here that contrary to the JGB market, the German bond market is actually still functioning. In the JGB market there is only a single big buyer armed with an electronic printing press, namely the BoJ, and no-one dares to stand in its way (not yet, anyway). On some days there is no trading volume at all anymore, so the JGB market has essentially expired for now.

Meanwhile, the y/y growth rate in euro area money supply has experienced a slight upward bump last month, but the larger downtrend still appears to be  intact. This could change once the TLTROs are offered in September and December – we will have to wait and see about that. In any case, the lack of private sector credit demand means there is still no pickup in inflationary lending by commercial banks, even with short term rates at nominal record lows. To the extent that euro area governments adhere to the new fiscal compact, the rate of new lending to governments should also slow down.

Depending on how much capital impairment the ECB's review brings to light, yet another disincentive for bank credit extension could be in the pipeline.


CHART-4-Euro Area TMSEuro area true money supply (currency & overnight deposits) and its annual growth rate – click to enlarge.



Europe seems to be close to another recession, just as the ECB's bank review is drawing to a close. European banks overall should be in somewhat better shape at present than they were two or three years ago, but many are probably still capital-challenged. If another broad-based economic downturn does hit, troubles that were held to have been overcome are likely to quickly resurface.


Charts by: BigCharts, ECB




Emigrate While You Can... Learn More




Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.


Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA


One Response to “European Banks – Still Full of Holes?”

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • No results available

Support Acting Man

Item Guides

Austrian Theory and Investment


The Review Insider


Dog Blow


THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts


Gold in USD:

[Most Recent Quotes from]



Gold in EUR:

[Most Recent Quotes from]



Silver in USD:

[Most Recent Quotes from]



Platinum in USD:

[Most Recent Quotes from]



USD - Index:

[Most Recent USD from]


Mish Talk

Buy Silver Now!
Buy Gold Now!

Diary of a Rogue Economist