These Banks Passed the Stress Tests: Are They Buys Now?

The European Banking Authority released the results of its much-anticipated stress tests late last week. The EBA put 90 European banks from 21 countries through the wringer, providing regulators with more than 3,000 data points per bank!

Per Bloomberg, "The criteria include a review of how the 90 lenders tested would handle a 0.5 percent economic contraction in the euro area in 2011, a 15 percent drop in European equity markets and trading losses on sovereign debt not held to maturity." The end result is a look at how their capital positions would look on Dec. 31, 2012, after these stress events.

Eight of the 90 failed to meet the 5% core Tier 1 capital ratio that represented adequate capital. A ninth bank is disputing the results. Another 16 passed, but fell into the 5%-6% danger zone. Yet no major bank failed the tests. As you'll see in the chart below, the large banks that many U.S. investors follow all exceeded both the stress test 5% and the danger zone 6%.

Sources: EBA EU-Wide stress test summary and Yahoo! Finance.

Each of the banks above (except HSBC) trades below a price-to-book ratio of 1.0 -- the traditional threshold at which value investors salivate.

If you trust the stress tests, this basket of large European banks looks quite compelling. Unfortunately, it's not that easy.

Just as they did with last year's European stress tests, critics are pointing out that the stress tests were too easy. For example, the tests assumed a 25% haircut to 10-year Greek bonds, but the potential for outright Greek default wasn't factored in.

Another data point noted by the Wall Street Journal gives an additional illustration: "For example, they envision a worst-case Spanish unemployment rate of 21.3% this year and 22.4% next year -- compared with the 21.29% Spain reported at the end of the first quarter." That's notable both for the assumption and to remind investors how bad the economic situation is (21.29% unemployment!).

So take these tests for what they are -- an attempt to calm markets by providing more transparency. Stay tuned as analysis of the nearly 1,000 pages of released documents starts making its way online. Some of those 3,000-plus data points per bank will be much more valuable to us than the knowledge that the banks passed a relatively easy stress test.

For more analysis in another hot sector, click here to access our free report "3 Stocks for $100 Oil."