Well here’s something to make the rally monkey jump for joy.
Ratings agency Moody’s has done its own stress test/survey of European banks — checking their ability to withstand “severe losses” on exposure to PIGS Greek, Portuguese, Spanish and Irish assets.
From the summary:
We believe that most European banks would be able to absorb losses stemming from their exposure to Greece, Portugal, Ireland, and Spain without requiring capital increases, even under what we qualify as a severe stress scenario. This is not to say that these banks are immune against a systemic crisis, the magnitude of which is impossible to predict. However, with the exception of a few outliers that already suffer from a weaker-than-average regulatory capital level (and thus already low ratings), the banks that we examined as part of our analysis have adequate capital cushions to absorb losses even under harsh economic scenarios.
Maybe we should tell the European Central Bank, which began buying peripheral bonds last month and reiterated the programme on Thursday. (Or perhaps, Moody’s is angling to rate that EU SPV?)
Anyway, what’s interesting here are the actual numbers.
More than 30 European banks from 10 countries responded to Moody’s confidential survey, indicating the amount and breakdown of their exposure to Club Med nations. In aggregate:
So when it comes to Greece, European banks’ exposure lies mostly in sovereign debt. But for Spain it’s mostly in the private sector. (Spain represents 67 per cent of the exposure to the four countries).
Moody’s has taken these numbers had tested them against a ‘stressed’ scenario for loan losses:
We do not anticipate any sovereign debt restructuring, but we simulate a forced sale of public sector bonds at 20% below the steepest fall in market valuation in recent months. Although highly unlikely given the systemic support program in place in the EU, we observe that this low probability event would nonetheless have the greatest impact.
And based on its calculations, Moody’s reckons everything is a-ok:
We believe that Europe’s largest banks will be able to absorb losses stemming from their exposure to Greece, Portugal, Ireland, and Spain without requiring capital increases even under what we qualify as a severe stress scenario. Most banks’ regulatory capital levels are well above 9%, and are typically closer to 10%, as the average is pulled down by a few outliers. (This capital deficiency is already reflected in their ratings). Although debatable as to when regulators would intervene, banks would likely be pressured to raise capital if their regulatory capital ratio were to get close to or fall below 7%.
Well that’s all right then.
The cynic in FT Alphaville would point out that it’s debatable whether a forced sale of peripheral debt would be anything but the orderly picture painted by Moody’s.
Luckily, though, we don’t have to.
Gary Jenkins over at Evolution Securities has done it for us:
Whilst the EU commitment to the no defaults policy holds this is merely a hypothetical exercise but even so, I cannot imagine what the markets would be like in reality if all of those countries debt was in a forced sale situation. Who exactly would be buying the bonds off the banks, and in the complete carnage, forget the capital, who exactly would be providing liquidity? This report might help to support the market because of the positive headline, but I do not consider it to have any basis in reality.
Related links:
Bank balance sheet management, the European way – FT Alphaville
Europe’s grim sovereign-bank loop – FT Alphaville