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Who Is Likely to Fail Europe's Bank Stress Tests?

The hype around results of pan-European bank stress tests is growing with each hour that nears the deadline for publication. So much so that even the deadline is now a hotly disputed issue.

Will the results finally throw light on how deeply affected European banks are by the various market disturbances? Yes and no, various analysts told CNBC.

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The Committee of European Banking Supervisors (CEBS) will publish results of the tests of 91 banks in 20 European Union countries on Friday and officials such as European Central Bank President Jean-Claude Trichet have said that this should bring back confidence in the continent's banking sector.

"Very few banks will fail this stress test and we don't think there will be a lot of capital raising," Antonio Ramirez, analyst at Keefe, Bruyette & Woods (KBW) told CNBC.com in a telephone interview.

The CEBS initially said the results will be released at 5 pm London time (noon New York time) but various sources were quoted in the media over the past 24 hours saying that maybe they would be released before European markets open on Friday.

The timing of the release "is quite irrelevant," Ramirez said. "We have been waiting for these stress tests for a year, we can wait another day."

The criteria that will be used in European stress tests have not been made public, but various media and analyst reports suggest that a Tier-1 capital ratio - equity capital and disclosed reserves as a percentage of the bank's assets – of 6 percent is one of the conditions for a bank to pass.

This would be in line with criteria used in the US and UK stress tests last year.

Numbers Unclear

KBW has run its own, harsher stress test on banks that are listed across Europe. According to this, 10 banks are likely to fall below the 6 percent Tier 1 ratio and would need to raise 9.8 billion euros ($12.5 billion) – although the number would be higher if the unlisted sector were added, KBW specified.

The banks that would fail the KBW stress test—assuming that dividends would be cut to help preserve capital—are Greek banks National Bank of Greece (NBG), Piraeus, EFG, Marfin and Alpha Bank, Portugal's BPI, Germany's Deutsche Post Bank (DPB), Italy's Monte Dei Paschi Di Siena, Bank of Ireland and Bank Inter Portugal.

"Very few banks will fail this stress test." -Analyst, KBW, Antonio Ramirez

"Clearly this is a small number, but would be greatly increased if we added the unquoted sector," KBW said in a research note.

Besides the listed banks, Spanish savings banks—cajas—and German regional banks—Landesbanken—are in danger of having poor results, according to various analysts.

In a tough economic environment over the next three years, but without a sovereign default, Spanish commercial banks would lose 5 percent of their Tier-1 capital but this should be readily absorbed by their existing capital cushion, according to MF Global analysts.

Savings banks, on the other hand, would lose 22 percent of their Tier-1 capital and would need to be recapitalized, MF Global analysts calculated.

In Germany, Landesbanken are likely to suffer because, as IMF modeling shows, they have yet to account for losses incurred because of the writedowns on securitized assets, especially collateralized debt obligations, the MF Global research note shows.

Bad News Baked In

Macquarie Research analysts estimate that "only a handful" of banks would need to be recapitalized in a stress test scenario in which a 20 percent markdown on Greek debt is assumed.

These are all the Greek banks, Bankinter, Postbank, Banco Popolare, BCP, Commerzbank and Sabadell, according to Macquarie Research.

However, if loan loss charges are more severe and a markdown of 40 percent is applied on Greek debt, their number would rise to 22, the note also said.

But markets need not give in to doom and gloom once those results are published, analysts told CNBC.

"Market expectations I think are veered to the negative side," Bob Parker, senior advisor at Credit Suisse, said. "A lot of bad news is discounted already in the market."

Even if Greek banks, Spanish cajas and German Landesbanken were to fail the stress test, they would have no problems raising capital, according to KBW analysts.

Greece has 10 billion euros set aside from its 110 billion euros IMF/EU bailout, Spain can expand its Fund for Orderly Bank Restructuring (FROB) to 99 billion euros and Germany has 52 billion euros of unused capital in its Financial Market Stabilization Fund (SoFFin) fund, they said.

Finally if stress tests are "so overwhelming" that a country cannot issue debt to inject capital into its banks, it could turn to funds from the EU, KBW analysts said.

But markets will not look only to capital requirements. Transparency will be very important – and here, the omens are not good, analysts said.

The EU is faced with a "damned if you do, damned if you don't" situation where if the stress tests are too lenient they would lose their credibility and if they are too harsh they would potentially scare investors.

Sovereign Debt Exposure

Investors are mostly interested to see details about each bank's exposure to sovereign debt, since markets have been roiled by risks of default during a good part of spring and summer. But they are not likely to get them, some analysts said.

"The level of disclosure is likely to be similar to the one of US stress tests last year. They did not provide a full breakdown of exposure, only assumptions of loss ratios and impact," Ramirez said.

Meanwhile, managing investors' expectations is in full swing.

German bank Hypo Real Estate will likely be among the banks to fail the test but this is not relevant for the nationalized lender, sources told CNBC. Moreover, if HRE were to pass the test, questions should be asked on how stringent were they, the sources added.

José Oliu Creus, chairman & CEO of Banco Sabadell, told CNBC he was confident that his bank will pass the test. (Click here for full interview)

BPI CEO Fernando Ulrich said that he is relaxed about the news his bank will get Friday. "I think most of the fears regarding European sovereign debt were exaggerated and we continue to invest in European sovereign debt," Ulrich added. (Click here for full interview)

NBG's chairman told CNBC that his bank will pass. (Click for video interview)

Other big banks have already expressed their confidence that they will pass the stress tests.

European banking stocks were higher Thursday afternoon, as investors covered short positions ahead of the release of the tests. Greece's EFG was leading the pack with a surge of 8 percent, followed by Alpha Bank and National Bank of Greece, up 6 and 5 percent respectively.

- Correction: A previous version of this story listed Turkish BKT as failing the KBW test, instead of Bank Inter Portugal.

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