Impact of recent European bank stress tests on MD holdings

July 26, 2010

The Committee of European Banking Supervisors (CEBS) released the results of its bank stress tests on July 23. Seven of 91 European Union banks that were evaluated failed with a combined capital shortfall of 3.5 billion euros. Specifically, Hypo Real Estate Holding AG, Agricultural Bank of Greece SA and five Spanish savings banks have insufficient reserves to maintain a Tier 1 capital ratio of at least 6 percent in the event of a recession and sovereign-debt crisis.

The bank stress test results had little impact on the equity markets as investors perceived the tests to be designed to reassure the wholesale funding and interbank markets, not equity markets. The tests took into account only potential losses on government bonds the banks trade, rather than those they are holding to maturity, which, in turn, understates exposure to sovereign debt.

Stress tests are forward-looking economic assessments that help to determine whether or not banks have enough capital to withstand adverse scenarios. The results help to understand loss estimates for certain types of loans, and determine resources that might be needed to absorb these loans under an adverse economic scenario.

At MD, we see the impact of these stress test results on MD funds and MDPIM as low. Our funds and pools generally have limited exposure to the European banks, and all our holdings that were tested passed, including our largest three holdings – Intesa (Italy), Santander (Spain) and HSBC (UK).

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