ECB comprehensive assessment

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1 Investment Research General Market Conditions 27 October 2014 Capital shortfall less than expected The result of the ECB s Asset Quality Review (AQR) and stress test, including the fact that 12 out of the 25 have already covered their capital shortfall, is better than feared. Importantly, there were no major banks failing the tests. It should overall reduce tail risk from the banking sector. The ECB only sees EUR9.4bn in capital shortfall on an aggregate level, which should be considered positive. Italy and Greece have the largest shortfalls but the latter is already managed by the European Commission s restructuring plans. For Italy, nine out of 15 supervised banks have a capital shortfall as of end-13 and adjusting for net capital changes throughout 2014 this still leaves four banks with a total capital shortfall of EUR3.3bn. The limited capital shortfall in the euro area reflects that banks have already raised capital in anticipation of the comprehensive assessment and going forward shortage of bank capital should be a smaller headwind for credit creation and economic activity. The stress test should be deemed credible as the adverse scenario implies a reduction in the median CET1 of 4pp. Compared to previous tests this is tough. We expect the release of the AQR and stress test to bring some relief to the markets as the exercise has been a concern throughout this year and the results are better than feared, while the stress test should still be considered tough. Today s key points 25 banks fail 24.6bn shortfall Italy (9) and Greece (3) have most failed banks 12 banks have already covered shortfall with only 9.5bn needed to be covered The adverse stress scenario would reduce the median CET1 from 12.4% to 8.3% in end-2016 Overall, we expect a muted positive reaction, as capital shortfalls were less than expected Failed banks across countries Italy stands out with the largest numbers Source: ECB Capital shortfall after AQR and stress test Capital shortfall post net capital raised Number of Net eligble EUR bn banks capital raised Italy Greece Portugal Austria Ireland Belgium Cyprus Slovenia France Germany Spain Euro Area Number of banks Analyst Anders Vestergård Fischer afis@danskebank.dk Senior Analyst Pernille Bomholdt Nielsen perni@danskebank.dk Senior Analyst Anders Møller Lumholtz andjrg@danskebank.dk Important disclosures and certifications are contained from page 7 of this report.

2 Details: Country overview and banks with a capital shortfall Country / Bank Year-end 2013 CET1% (%) AQRadjusted CET1% (%) Adjusted CET1 Ratio after Baseline Scenario (%) Adjusted CET1 Ratio after Adverse Scenario (%) Capital shortfall to threshold of 8% for AQR adjusted CET1 Ratio (EUR bn) Capital shortfall to threshold of 8% in Baseline Scenario (EUR bn) Capital shortfall to Capital threshold of Shortfall post 5.5% in net capital Adverse raised Scenario 2014YTD (EUR bn) (EUR bn) Austria 11.5% 10.6% 10.6% 7.5% Österreichische Volksbanken-AG 11.5% 10.3% 7.2% 2.1% Belgium 14.6% 14.1% 12.1% 7.4% Dexia NV 16.4% 15.8% 10.8% 5.0% AXA Bank Europe SA 15.2% 14.7% 12.7% 3.4% Cyprus 7.2% 5.0% 9.8% -0.4% Co-operative Central Bank Ltd -3.7% -3.7% -3.2% -8.0% Bank of Cyprus Public Company Ltd 10.4% 7.3% 7.7% 1.5% Hellenic Bank Public Company Ltd 7.6% 5.2% 6.2% -0.5% Estonia 28.5% 27.6% 31.0% 30.0% Finland 15.3% 14.8% 15.9% 11.3% France 11.5% 11.3% 11.8% 9.0% C.R.H. - Caisse de Refinancement de l Habitat 5.7% 5.7% 5.7% 5.5% Germany 13.1% 12.9% 12.8% 9.1% Münchener Hypothekenbank eg 6.9% 6.9% 5.8% 2.9% Greece 12.8% 9.9% 8.0% 2.0% Eurobank Ergasias, S.A. 10.6% 7.8% 2.0% -6.4% National Bank of Greece, S.A. 10.7% 7.5% 5.7% -0.4% Piraeus Bank, S.A. 13.7% 10.0% 9.0% 4.4% Ireland 13.6% 13.2% 11.6% 7.4% Permanent tsb plc. 13.1% 12.8% 8.8% 1.0% Italy 10.2% 9.5% 9.3% 6.1% Banco Popolare 10.1% 7.9% 6.7% 4.7% Banca Popolare Dell'Emilia Romagna 9.2% 8.4% 8.3% 5.2% Banca Popolare Di Milano 7.3% 6.9% 6.5% 4.0% Banca Popolare di Sondrio 8.2% 7.4% 7.2% 4.2% Banca Popolare di Vicenza 9.4% 7.6% 7.5% 3.2% Banca Monte dei Paschi di Siena 10.2% 7.0% 6.0% -0.1% Banca Piccolo Credito Valtellinese 8.8% 7.5% 6.9% 3.5% Veneto Banca 7.3% 5.7% 5.8% 2.7% Banca Carige 5.2% 3.9% 2.3% -2.4% Latvia 21.6% 20.6% 21.6% 19.3% Lithuania 18.2% 17.8% 18.7% 16.6% Luxembourg 18.3% 18.0% 17.7% 13.3% Malta 40.2% 39.5% 40.7% 34.0% Netherlands 12.1% 11.7% 12.2% 8.8% Portugal 12.1% 11.1% 10.1% 6.0% Banco Comercial Português, SA 12.2% 10.3% 8.8% 3.0% Slovakia 17.1% 16.5% 17.0% 14.5% Slovenia 18.0% 15.9% 14.4% 6.1% Nova Kreditna Banka Maribor d.d. 19.6% 15.7% 12.8% 4.4% Nova Ljubljanska banka d. d., Ljubljana 16.1% 14.6% 12.8% 5.0% Spain 10.6% 10.4% 11.6% 9.0% Liberbank, S.A. 8.7% 7.8% 8.5% 5.6% Euro Area 11.8% 11.4% 11.6% 8.4% October

3 Slovenia Greece Cyprus Belgium Ireland Malta Portugal Luxembourg Italy Austria Germany Finland Netherlands Slovakia France Latvia Lithuania Spain Estonia The ECB s AQR and stress test Overall, we expect the release of the ECB s AQR and stress test to bring some relief to the market as the exercise has been a concern throughout this year and the results are overall better-than-feared. Below are the main conclusions: The number of failed banks in the stress test (25 out of 130 supervised banks) is in the upper end of the expected range. But this number declines to 13 taking into consideration capital improvements carried out this year (see side box). Importantly, there were no major banks failing the tests (see the next page). From that perspective, the outcome should reduce tail risks for the sector overall and ease concerns about further skeletons lurking in the closets. From a market perspective it is vital that the net capital shortfall is only EUR9.5bn. Compared to previous capital shortfalls this aggregate figure for the euro area is very limited. Spain was in July 2012 granted up to EUR100bn to cover capital shortfall in the financial sector. Out of this EUR41.4bn has been disbursed. In Ireland, the total cost to the government from the bank recapitalisation amounted to EUR64.1bn out of which EUR10.4bn so far has been recovered. The most recent government supported bank recapitalisation of Portuguese Banco Espirito Santo amounted to EUR4.9bn. We believe the stress test will be deemed credible as there is a reduction in the median CET1 of 4pp in the adverse scenario (see right hand chart below). Compared to the previous stress tests this is tough. The limited capital shortfall despite a tough stress test, reflects that banks have already raised capital in anticipation of the comprehensive assessment. Banks participating in the exercise have raised EUR257bn since the onset of the financial crisis in The projection for economic activity and inflation in the baseline scenario (provided by the European Commission) looks optimistic based on the latest development in economic data. Moreover, in the adverse scenario inflation is only set to decline to an average of 0.6% and 0.3% in 2015 and 2016, respectively. Given the continued decline in inflation, a more adverse scenario could easily be anticipated for The rather limited capital shortfall could be seen as a sign of a too gentle stress test. The capital requirement for the test is also open for critics since it is not done on the basis of the fully-phased Basel CRD IV rules. Though they are valid points, this is the harshest stress test and most exhaustive review on the European banking sector with the considerable reduction in the median CET1 (see left hand chart below). Capital shortfall by main components The stress test should be deemed credible 14% 12% 10% 11.8% -0.4% 8.4% 14% 12% 10% 8% 6% 12% 11% 8% 7% 6% 6% 6% 5% 4% 4% 4% 4% 3% 3% 2% SSM Median 8% 6% -3.0% 4% 2% 0% 2% 2% 2% 4% -2% -4% -1% 2% 0% Reported 2013 CET1 Ratio Total impact of AQR Stress test effect 2016 adverse scenario CET1 AQR Stress test (adverse) Total reduction Source:ECB, Danske Bank Markets 3 27 October

4 Implications across countries Looking across countries, Italy is on a relative basis (as expected) the weakest among the bigger countries, see also Bank of Italy press release. Out of the 15 Italian banks included in the review there are four (9) banks failing with a net (gross) capital shortfall of EUR3.3bn (EUR9.7bn). As anticipated, Monte dei Paschi was the weak spot with a EUR2.1bn (EUR4.3bn) in net (gross) capital shortfall. The headline on the Italian bank system can easily be tweaked in a negative direction as nine out of the 15 banks failed the review. However, the weakness in Monte dei Paschi was expected. Excluding this and including the improvement in the Italian banking sector this year, the remaining capital shortfall amounts to only EUR1.2bn. On a country level, Greece is faced with the second largest gross capital shortfall of EUR8.7bn. Taking capital raised throughout 2014 into account two banks are left with a shortfall of EUR2.7bn. However, one must note, that this number omits the restructuring plan of the Greek banking sector signed off by the European Commission. Taking this into consideration almost removes the entire shortfall. The three other periphery countries have all performed well in the comprehensive assessment. Spain stands out as a winner with only Liberbank failing on the margin with a gross capital shortfall of just EUR30m a shortfall that has already been covered this year. 15 Spanish banks were included in the review and this proves that harsh restructuring of the Spanish banking sector over the past couple of years helped by large official capital injections have made Spain a winner. In Ireland only Permanent TSB came out with a capital shortfall of EUR0.85bn. Permanent TSB has already stated it will seek to raise a minimum of about EUR125m in the market as 80% of capital gap has already been addressed. Note also that Bank of Ireland passed the test with a strong margin. In Portugal, it was also just one bank, Portuguese Banco Comercial, that had a shortfall of EUR1.15bn. This sounds like a relatively large number but the bank has stated that this year s measures are sufficient to address the shortfall. For Ireland and Portugal, the banking sector has been a concern in terms of further credit rating upgrades and the risk factor should have diminished following the results published yesterday. Outside of the periphery countries, most had expected the mid-tier banks in Germany to show a capital shortfall, but the only bank in question (Münchener Hypothekenbank) has covered its capital shortfall already. This is the same case in France, where the shortfall for the only failed bank already has been covered. Gross capital shortfall by country (December 2013) Net capital shortfall by country (September 2014) AT (1), 0.9 BE (2), 0.5 SI (2), 0.1 DE (1), 0.2 FR (1), 0.1 IE (1), 0.9 ES (1), 0 IE (1), 0.9 BE (1), 0.3 SI (2), 0.1 PT (1), 1.2 IT (9), 9.7 AT (1), 0.9 IT (4), 3.3 CY (3), 2.4 PT (1), 1.2 GR (3), 8.7 Country (# banks), shortfall in EURbn CY (1), 0.2 GR (2), 2.7 Country (# banks), shortfall in EURbn 4 27 October

5 Economic implications Overall, the AQR and stress test should be positive for the European banking sector, by improving transparency and pointing to a modest need to raise additional capital. Also, there were no major banks failing the tests. From that perspective, the outcome should reduce tail risks for the sector overall. That said, the outcome is negative for banks with a capital shortfall or where significant AQR adjustments are applied. The finalisation of the comprehensive assessment should also be supportive for credit growth in the euro area, first of all as banks no longer have to worry about the review of their balance sheets and secondly as the result reveals that the headwind to credit creation from capital shortage should be limited and only be present in a few countries. Hence, from a supply side perspective, the results suggest that the slower pace of decline in lending to the private sector, which started after the ECB had taken its snapshot of banks balances for use in the AQR in December 2013, will continue (see left hand chart below). Regarding the demand side, the latest Bank Lending Survey from Q3 showed that demand for credit and loans is increasing and for consumers it is increasing at the fastest pace since the financial crisis kicked-in in 2008 (see right hand chart below). The Bank Lending Survey for Q4 is due for release on Wednesday this week and there is a risk of some setback in credit demand following the latest weakness in economic data. However, we continue to see the soft economic data as temporary and when the recovery strengthens again, the better credit supply conditions should be supportive for growth. Overall, yesterday s results seem to suggest that it is up to the demand side to improve credit growth to the real economy. Finally, the result should be positive for the upcoming TLTRO auction in December. This should follow as banks will find it more attractive to get cheap liquidity when their lending potential to the real economy is not limited by capital constraints. We expect a take-up around EUR150bn on the TLTRO in December compared to EUR82.6bn on the first TLTRO in September. Private sector loans to improve after AQR and stress test Demand for credit and loans needed to improve credit growth 5 27 October

6 Market reaction We expect the release of the AQR and stress test to bring some relief to the government bond market as the exercise has been a concern throughout this year and the result is better-than-feared. As mentioned above, from a rating perspective this is likely to be considered a credit positive for the euro area sovereigns and supportive factor for further rating upgrades in peripherals such as Spain, Ireland and Portugal. Italy on the other hand is on a relative basis the weakest among the euro area sovereigns due to the EUR2.1bn capital shortfall in Monte dei Paschi. For the EUR covered bond market as a whole, we would expect the test outcome to have little impact on the ongoing spread compression, which is driven by contracting market volume, as well as demand stemming from preferential regulatory treatment and expected bond purchases by the ECB. However, in the specific cases, covered bond programmes backed by banks which have seen significant AQR adjustments could see some underperformance, though the impact is likely to be relatively modest. In the FX market we expect EUR/USD to bounce on the announcement as the results are better than feared and should reduce the risks of financial stresses in the euro area. However, we expect the bounce in EUR/USD to be short-lived as relative growth performance supports a lower EUR/USD near-term. We expect the recent high at to be protected and clients should use a bounce in EUR/USD ahead of that level as an opportunity to establish fresh shorts. Over the medium- to long-term, the stress-test results support our call for that the euro area will recover in 2015 and hence for a rebound in EUR/USD October

7 Disclosure This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S ( Danske Bank ). The author of the research report is Anders Vestergård Fischer, Analyst, Pernille Bomholdt Nielsen, Senior Analyst and Anders Møller Lumholtz, Senior Analyst. Analyst certification Each research analyst responsible for the content of this research report certifies that the views expressed in the research report accurately reflect the research analyst s personal view about the financial instruments and issuers covered by the research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report. Regulation Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority (UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation Authority are available from Danske Bank on request. The research reports of Danske Bank are prepared in accordance with the Danish Society of Financial Analysts rules of ethics and the recommendations of the Danish Securities Dealers Association. Conflicts of interest Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of highquality research based on research objectivity and independence. These procedures are documented in Danske Bank s research policies. Employees within Danske Bank s Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and the Compliance Department. Danske Bank s Research Departments are organised independently from and do not report to other business areas within Danske Bank. Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. Financial models and/or methodology used in this research report Calculations and presentations in this research report are based on standard econometric tools and methodology as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be obtained from the authors on request. Risk warning Major risks connected with recommendations or opinions in this research report, including a sensitivity analysis of relevant assumptions, are stated throughout the text. Date of first publication See the front page of this research report for the date of first publication. General disclaimer This research has been prepared by Danske Bank Markets (a division of Danske Bank A/S). It is provided for informational purposes only. It does not constitute or form part of, and shall under no circumstances be considered as, an offer to sell or a solicitation of an offer to purchase or sell any relevant financial instruments (i.e. financial instruments mentioned herein or other financial instruments of any issuer mentioned herein and/or options, warrants, rights or other interests with respect to any such financial instruments) ( Relevant Financial Instruments ). The research report has been prepared independently and solely on the basis of publicly available information that Danske Bank considers to be reliable. While reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and Danske Bank, its affiliates and subsidiaries accept no liability whatsoever for any direct or consequential loss, including without limitation any loss of profits, arising from reliance on this research report. The opinions expressed herein are the opinions of the research analysts responsible for the research report and reflect their judgement as of the date hereof. These opinions are subject to change, and Danske Bank does not 7 27 October

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