Is a the European bank rally sustainable? European banks continue to rally marginally following the release of the European Bank Authority stress test. However, risks remain with a referendum to be held in Italy proposing to redesign their election process putting any Italian bank restructuring at risk. The EU banking committee proudly announced positive stress test results with the average risk weighted capital ratio of 13.2% at the end of 2015 up more than 400 bps from 2011 and up 200 bps from 2014 as European banks have increased capital by €180bn. Meanwhile, 14 of the 51 banks analyzed showed a hit to their Tier1 ratio by over 500 bps. Of course they did not include many banks that would be a problem by eliminate countries. The 2014 stress test was applied to 123 banks compared to this year just 51 banks. This, of course, has the smart money highly skeptical.

The one bank to face negative capital under the stress scenario of two years of negative GDP, was Italian Banca Monte dei Paschi di Siena whose stock price has failed to participate in the rally. More than a third of the Tuscan bank’s loans are non-performing. Announced along with the results of the stress test, Monte dei Paschi is expected to sell €10bn of its €47b of bad loans at 30% of face value to a government mandated fund, Atlante. The announcement of Atlante II to buy some of the estimated €360 billion of bad debt on the balance sheet of Italian Banks began the bank rally since the end of June. The first fund, Atlante was formed to invest equity in the Italian banks. The first fund has been largely funded by Italian banks only adding risk to healthier banks.  AdEPP, the association of sector-specific pension funds, has asked its members to invest in Atlante putting the assets of the pensioners at risk.

The banking crisis has hit the popularity of Italy’s Prime Minister, Matteo Renzi. PM Renzi has called an Italian referendum aimed to be held in October, proposing to reduce the number of senators from 315 to 100. In a hit to democracy the referendum also proposes that the senators be picked by local councils rather than the voters directly. A defeat which will likely benefit euro-skeptic party Five Star Movement and bring into the question not only the sustainability of the Euro but also the restructuring of Italian banks.

Surprisingly the Italian banks were not the weakest bank, the Austrian banks performed the worst both with capital ratios falling over 400bps under the stress test.

Deutsche Banks’ weakness is well known despite its recent rally. Deutsche Bank, CET1 ratio was 10.8% at the end of the 2^nd quarter, 11.2% proforma for the sale of its interest in Hua Xia Bank. Using the 540 bps impact from the stress test puts it capital ratio just below to the targeted 5.5% minimum under a stress scenario if the sale of Hua Xia falters. Meanwhile Deutsche Bank remains one of the top buyers of bad debt from other European banks. Cerberus remains the largest buyer of European bad debt. €300Bn of bad loans have been sold since 2013 with another €130Bn sales expected this year. Deutsche Bank stock appears to be choppy for the balance of the year.

Expressed in dollars, Deutsche Bank is trading at 14.35. Resistance begins at 18.55 and we really need a Daily closing above 19.70 followed by 20.70 to raise hope of a pause for a little while in the downtrend.