By Simon Jessop
LONDON (Reuters) - Fixed income investment firm Pimco's global banking specialist, Philippe Bodereau, expects 18 banks will be seen to have failed the European Central Bank's stress test of 130 regional lenders when results are published by the ECB on Sunday.
Bodereau, who manages $4.3 billion (2.68 billion British pounds) in the Pimco GIS Capital Securities Fund, said in an interview on Wednesday the failures would likely include some German and Austrian cooperative and public sector banks, as well as weak regional lenders in the southern periphery.
The stress test and an additional review of the banks' assets by the ECB are jointly aimed at answering the questions many investors still have about the health of the region's banking system in the wake of the financial crisis.
Describing the exercise as a milestone for cleaning up the banks, he said the test was "reasonably credible" when compared with previous tests and provided investors with a starting point to evaluate banks.
"It's pretty clear that not that many banks are going to fail it. A fair amount of balance sheet strengthening has taken place over the last six to nine months in anticipation of this exercise," Bodereau told Reuters.
Big national champions across northern Europe and also in Southern Europe should pass quite easily, he said, although he expected almost a third of those tested to pass by a narrow margin. This group would likely include many medium-sized banks.
"Probably the market will ask questions about their dividend policies, about their ability to grow balance sheet, etcetera. They will be under pressure to remain quite conservative on capital management and on deleveraging," said Bodereau.
He also said he did not expect to see any big rights issues as a result of the euro zone tests but did expect more banks to increase provisions for non-performing loans, which would hit their book value.
Given recent market volatility, he said it was more likely there would be a positive than negative market shock after the results are released, and that share prices for the region's biggest banks could be a market winner on Monday.
"A lot of bank stocks were up 10-20 percent in June and some are now down year to date," he said, citing the impact of negative sentiment that had weighed on markets broadly.
Bodereau said he had "quite aggressively" bought banks' contingent convertible (coco) bonds over the last three weeks as a result of the sell-off, including those of Lloyds Banking Group (L:LLOY) and Credit Agricole (PA:CAGR).
Come Monday, Bodereau said he expected the best risk-reward to be on offer in the additional Tier 1 coco bond market.
"Firstly, you've had a big re-pricing and can get a good entry point at 7-8 percent yields and secondly, most of the banks that are issuers in this market tend to be the large systemic banks, and I think all of those guys will do reasonably well in the stress test."
"Also, the whole stress test and (the ECB's related) asset quality review is a catalyst for credit in that it forces all banks to be conservative in their capital management."
(1 British pound = 1.6066 US dollar)
(Editing by Greg Mahlich)