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When is a ‘stress test’ not a ‘stress test’? One analyst raised the point in responding to the unveiling on Wednesday evening by the Committee of European Banking Supervisors of its stress tests of 91 European banks (more detail in our earlier post).
“This isn’t a stress test,” Jaap Meier, analyst at Evolution Securities, told Bloomberg. It’s “merely the current valuation of government bonds.”
FT Alphaville noted in an earlier post that some analysts, such as Goldman Sachs, think the stress tests could succeed overall in boosting battered confidence in eurozone banks.
But Bloomberg reports on Thursday that some analysts are warning that European regulators have underestimated probable losses from Greek and Spanish government bonds.
Indeed, indications are that the sovereign debt outlook among eurozone peripherals has not improved a great deal from its earlier shaky period.
As CreditWritedown’s Marc Chancler noted late on Wednesday, CDS markets – alongside analysts – seem to be pricing in odds of a larger haircut than the CEBS suggests:
Some reports suggest that the stress that European banks may be tested for include a 17% loss on Greek bonds and a 3% loss on Spanish bonds German bunds and possibly French bonds will not be stressed – that is to say the stress test will not include a long on bonds from those two. While these details have yet to be confirmed, the stress on Greek and Spanish bonds seem too modest. Greece pays 750 bp more than Germany on 10-year bonds today. If one were to assume a 17% haircut, the pricing would suggest a ball park odds of that haircut at about 44% (750/17)–on the idea that the premium over the risk free assets is a function of the size of a hair cut and the odds of a haircut. The 3% haircut in Spain, given the premium of 205 bp would suggest almost 70% chance of that side haircut (205/3). Moreover because the ECB has bought about 59 bln worth of sovereign bonds, mostly believed to be Greek, the price discovery process in the periphery bond markets may be skewed. The credit default market seems to be pricing in the odds of a larger haircut.
This is only preliminary reports and a quick back-of the envelop calculation, but these kind of numbers do not seem particularly robust that would ease market anxiety. If more people conclude this, the euro may come off.
One other analyst told Bloomberg, on this occasion, Europe’s regulators appear to be “letting the banks off lightly”, even though they should be applying a “20 per cent haircut on Greek bonds and 7 per cent on Spanish debt”.
In fact, as the Wall Street Journal’s “Heard on the Street” column suggested last month, the European stress tests are unlikely to be particularly stressful. Like the last CEBS stress test in 2009, the criteria for the European tests are “less demanding than those applied by some national regulators, including the UK’s Financial Services Authority”, it noted.
Even so, according to the FT’s recent report, the tests could force up to 20 European banks to make cash calls – possibly requiring them to raise up to €30bn ($37.3bn) in fresh equity.
With the CEBS’s stress test information raising more questions than it answered, you can expect attention on Thursday’s European Central Bank policy meeting to focus overwhelmingly on ECB president Jean-Claude Trichet’s accompanying news conference – even though, as the FT’s Ralph Atkins notes on MoneySupply, these are primary the responsibility of bank regulators (which don’t include the ECB).
Even so, adds Atkins, Trichet’s instinct throughout the crisis “has always been to stress the need for policymakers to rebuild confidence. It is not a new message, but we might hear it a lot [on Thursday]“.
Whether it will have any effect on “stress test stress” is another question.
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