German Chancellor Angela Merkel at a media conference after an EU summit in Brussels on Oct. 27, 2011.Geert Vanden Wijngaert/The Associated Press
Europe's grand bank rescue has had an ecstatic reception from equity investors. The Stoxx Europe 600 Banking index soared 9 per cent after regulators revealed that the continent's lenders needed an extra €106-billion in capital.
In one sense, the euphoria is justified. Part of the reason that the bank index dropped by a third between July and October was because investors assumed the euro zone crisis would involve wholesale bank nationalizations. But aside from lenders in bailed-out countries like Greece and Portugal, most won't need government help to reach a 9-per-cent core Tier 1 capital ratio after sovereign haircuts before the June 2012 deadline imposed by the European Banking Authority.
Take Spain. The €26-billion bill for the country's five largest lenders looks eye-watering – especially the €15-billion chunk required by Santander. But Spain's largest bank can generate €8.5-billion of capital by turning mandatory convertible notes into equity, and thinks it will generate another €3.6-billion from retained earnings by June. Add in €4-billion from balance sheet tricks like reducing the risk weighting of its assets, and the shortfall disappears.
The message is the same for most other big European banks. Some, like BNP Paribas, claim they can hit the target without raising equity in the market or even cutting dividends. Others, like Société Générale, might in a worst case scenario need to tap investors for a billion euros or so. But this can probably be done via a friendly Middle East investor – or even a rights issue. Italian banks have yet to confirm their individual shortfalls, but even if the government had to foot the country's entire €15-billion bill, it would barely move the sovereign debt dial.
However, banks will still be vulnerable if euro zone growth remains anemic. And it's far from clear that the recap will be sufficient to reopen markets for term funding, which have been closed since the summer. An EBA plan to provide a mutual euro zone guarantee for bank debt is still on the drawing board. When equity investors come down from their highs, these problems will still remain.