The True Elephant In The Room Appears: Trillions In Commercial And Industrial Loans To Europe's Insolvent Countries

With the market's attention over the past year exclusively focused on bank holdings of insolvent European sovereign debt, which as is now well known had been declining for months, many if not all forgot that banks also have credit exposure via far simpler conduits: retail and commercial debt. And as an analysis of the full disclosure in the EBA's second stress test exposes, banks are on the hook for literally trillions in various plain-vanilla commercial and retail loans to individuals and businesses. WSJ's David Enrich summarizes it best: "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." Oops.
From the WSJ:

Banks tend to be holding far greater quantities of those commercial and retail loans than they are of sovereign debt, according to a Wall Street Journal analysis of disclosures accompanying the stress tests.

This year's stress tests represent the first time there has been a uniform way to measure this exposure. Until now, banks have disclosed their portfolios of loans to customers in troubled countries on a piecemeal basis. That made it virtually impossible to aggregate data across the industry or to compare different institutions.

"The country-by-country exposure [data] is better than any data we've seen before," said Alastair Ryan, a London-based banking analyst with UBS AG. "It's giving me more things to be fearful of," Mr. Ryan added, referring to the disclosures of some banks' large holdings of loans to customers in troubled countries.

After Spanish and Italian banks, France's banks appear to be the most exposed. 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, or about $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 is 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.

Here is how this latest elephant looks like in chart format:

Germany, so far represented as a stalwart of investment prudence (despite its Landsbanken being decimated and on a constant lifeline by the CDO scammery of our own investment banks back in 2005-2006), is among the most impaired:

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

More than half of the German banks' loan exposures are concentrated in the country's two biggest lenders, Deutsche Bank AG and Commerzbank AG. Deutsche Bank alone is holding nearly €80 billion of loans in those countries, including €7.5 billion of residential mortgages in Spain. Deutsche, which passed the stress tests with a 6.5% capital ratio under the EBA's worst-case scenario, said Friday that it "feels well prepared" to hit its capital targets.

Naturally, it is no secret that the second Stress Test was nothing but another attempt at redirection:

While the tests did consider the impact of an economic downturn on banks' portfolios of loans and nonsovereign debt in Portugal, Ireland, Italy, Greece and Spain, many critics complained that the tests were overly benign. For example, the EBA's worst-case scenario for Portugal envisioned an 11.6% unemployment rate this year, rising to 12.9% in 2011. The unemployment rate there is currently 12.4%.

The stress-test figures actually understate some banks' holdings of loans in certain troubled countries. That is because the European Banking Authority required banks to disclose their loan holdings in countries only if they represent more than 5% of the bank's total loan exposures.

As a result, some banks opted not to disclose details of their loan portfolios.

Once again, just like in the case of Spain's LaMancha region lying outright about its deficit, "out of left field" discoveries such as this will keep reappearing until the full kit and caboodle of tens of trillions in impaired exposure finally hits the market. Of course, at that point nothing, not even the Fed's unlimited FX swap lines will do much if anything to help.