Worries after bank stress test

Banks are underperforming the wider market Monday following results from the latest eurozone stress tests. This was never going to be the toughest test to pass, but some of the results were on the low side, and concerns that Lloyds Banking's return to the dividend list may be delayed is playing on investors' minds.

An EU-wide stress test of 123 banks, carried out by the European Banking Authority (EBA), was designed to assess the resilience of EU banks to adverse economic developments and to uncover any remaining weak points. The test revealed that on average, EU banks' common equity ratio (CET1), or capital adequacy, falls by 260 basis points over three years from 2013-2016 to 8.5%.

"Over the three-year horizon of the exercise, 24 banks would fall below the 5.5% CET1 threshold and the overall shortfall would total €24.6 billion," said the EBA. "The main drivers for this impact are credit risk losses, which account for 440 basis points of CET1 ratio decrease and an increase in total risk exposure (110 basis points)."

Numis has set out the results for UK banks in a chart below. It shows that all of them met the capital benchmarks established for the purpose of the stress test. The key column to focus on is Adverse 2016, or adverse scenario. The baseline stress test hurdle rate was set at 8%.

(click to enlarge)

"UK published adverse stress test capital ratios were generally lower than our forecast, with LBG (Lloyds) the stand-out at 6.2% versus our 8.5%," said the analysts at Deutsche Bank. "RBS was low at 6.7%, but above our forecast of 6.1%."

Clearly, there will be concerns about the ability of both Lloyds and Royal Bank of Scotland to begin paying dividends again. In the short-term, the pressure is mostly on Lloyds. Management have already said they'll seek permission for a payout this year. But Deutsche remains confident.

"We think the capital generation of the four UK banks participating in this test is sufficiently strong to allow dividends as we forecast, including LBG returning to a maiden 1p payment for its 2014 final results," the broker said. "Our views on the shares are unchanged by today's announcements."

It's worth remembering also that the EBA stress test ignores balance sheet deleveraging at Lloyds, responsible for an extra 1% of additional CET 1, plus run-down of costs from its Simplification programme.

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