Bank stress tests: Private equity puts faith in finance

John Bakie
27 July 2010

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Despite much hype, the European Unionтs bank stress tests, published at the end of last week, were something of a non-event. With just a handful of banks failing the test, Europeтs banking institutions can perhaps be more confident in their business models following the financial crisis.

Out of 91 banks tested, just seven failed the test, with the bulk being Spain's regional cajas, which were already known to be overexposed to the Spanish property market. Despite five Spanish banks failing the test, the country's government used the opportunity to say the results were proof its banking system is solid. Some economists had suggested Spain could have seen even more of its banks fail the test, which was designed to push bank business models in the event of a future economic downturn.

One of the banks that failed, Banca Civica, took pre-emptive action ahead of the EU's announcement, saying it has a €450m convertible bond placement with JC Flowers. Though many details of the deal have yet to be finalised, the move by the US private equity group suggests it has more faith in the banking system than national governments.

The bonds pay interest of 7.5%, 25 basis points cheaper than the support offered by the Spanish state's restructuring fund, the Frob. This will allow Banca Civica, itself a combination of three of Spain's regional cajas, to further consolidate and strengthen its financial might. It also shows JC Flowers has confidence in the banking system, even if some regulators and governments do not.

JC Flowers will also be able to convert the securities into voting stock within two years, though only after the bank secures a stock market listing. The deal gives the private equity investor the foothold in European financial services it has been attempting to gain for some time. It has already made unsuccessful offers for UK insurer Friends Provident and the Northern Rock bank, which triggered Britain's own mortgage securities crisis. Reports suggest it is now close to entering the UK market, paying £50m for a stake in the Kent Reliance building society.

Good news for banks is also likely to be good news for private equity. With banks vital to support the industry, both as LPs and leverage providers, the largely successful stress tests may bring much needed confidence to European financial institutions, expanding opportunities for private equity.