Stressed

by Larry Levin

At one point on Monday the US indices were down quite a bit from Friday’s close. That close, however, was artificially high due to a late short-covering spike.  Nevertheless, the markets were slammed with more bad news out of Europe: the banking "stress tests" were a scam.

During Europe's 15-month financial crisis, investor and analyst fears have centered largely on banks' holdings of sovereign debt issued by governments in financially shaky countries such as Greece, Ireland and Portugal. If those countries were to default, it could saddle banks and other holders of their bonds with big losses.

But Friday's test results shed light on another potential problem for Europe's banks: huge piles of residential mortgages, small-business loans, corporate debt, and commercial real-estate loans to institutions and individuals from ailing countries. As those economies struggle, the odds of rising defaults grow.

As of Dec. 31, its four largest banks-BNP Paribas SA, Crédit Agricole SA, BPCE Group and Société Générale SA-were holding a total of nearly €300 billion ($425 billion) in loans and other debt issued to institutions and individuals in Portugal, Ireland, Italy, Greece and Spain, the countries that are among Europe's most troubled. That's largely a result of some of the French banks having big retail- and commercial-banking operations in Greece, Italy and Spain.

The French banks' portfolios of commercial and retail loans in those countries dwarf their holdings of sovereign debt. For example, the four banks have a total of about €51 billion of loans to Spanish customers, according to the Journal's analysis. That compares with about €15 billion of Spanish sovereign debt, according to a separate analysis of stress-test data for the Journal by research firm SNL Financial. In Greece, whose economy is in a tailspin, the French banks have €33 billion of various types of loans, more than three times their sovereign-debt holdings.

It's a similar story in Germany. The dozen German banks that disclosed their stress-test results were exposed to €174 billion of commercial and retail loans to Greek, Irish, Italian and Spanish borrowers as of Dec. 31. They are holding an additional €70 billion of sovereign debt issued by those countries, according to SNL.

Some banks opted not to disclose details of their loan portfolios. For example, Lloyds Banking Group PLC is in the process of shutting down its Irish banking business, which has cost the big British bank billions of pounds in loan losses. But in its stress-test materials on Friday, Lloyds didn't provide a breakdown of loans to countries other than the U.K. and the U.S.

A Lloyds spokeswoman said the bank's Irish loans are included in a catch-all category marked "other."

Trade Date: 7/18/11

E-Mini S&P Trades*

(before fees and commissions):

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3. "Reading the Tape" positions (4) ...combined Secret's, Algo, & "Reading the Tape" total...-2.00

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