Alastair Gray of UBS has a pretty harsh response to the impending publication of stress tests on twenty-five EU banks.
He wants to see some failure in the mix:
Stress tests are not a panacea. Without a significant proportion, by assets and number, failing, the tests potentially amount to little more than an empty gesture.
Harsh — but fair, actually, if you look back over the recent history of stress tests:
In US stress tests over half of participants failed The ‘successful’ US stress tests, which are commonly associated with a turning point in US bank equity prices and better fixed income markets, saw over half of participants fail. The US$75 billion in common equity they raised in the following weeks was, in our view, the key to the exercise raising confidence.
UK stress tests saw almost £50 bn requirement of common equity The UK bank stress tests (there were several) saw the banks required to raise almost £50 billion in common equity. All banks ended up with some equity need, with the extremes close to £30 billion for RBS and less than £1 billion for HSBC Bank. The Irish tests saw all banks needing equity uplifts of 50% or more of their existing base.
In light of that, Gray turns to the set of stress tests that will probably be in most focus given recent reports over interbank health — Spain’s:
We see little value in ‘stress test’ that major Spanish lenders all passed
We consider banks on the basis of ‘stressed’ credit loss risks, but also more broadly to include margin trends, funding needs, market structure and the macro situation. With customer spreads falling rapidly, €650bn of wholesale funding needs, overvalued property and declining nominal GDP, we would see little value in a credit ‘stress test’ that major Spanish lenders all passed.
It’s currently up in the air whether we’ll get to see the methodology for the Spanish results — the Bank of Spain told FT Alphaville that “it is not clear yet exactly how the stress tests will be published.”
Nevertheless, we’ll be keeping a keen eye out for details on the methodology on these tests.
Stress tests — both within banks and organised by regulators — have attracted criticism for not factoring in fat-tail risk or outlier events, after all. And surely the fears of sovereign default swirling around Europe since Greece are in response to precisely this kind of risk.
In the meantime — back to what the stress tests on Spanish banks might show.
Barclays Capital’s Aziz Sunderji and team note that CDS markets are doing their own stress-testing among BBVA and Santander at the moment:
But while BarCap are also wary of what the European stress tests will actually do to calm investors, they’re doubtful that the big Spanish banks are in that much trouble compared to the small savings institutions that have been failing so far.
As they argue:
Although cajas are in a more precarious situation, there is no funding crisis for large Spanish banks – they are simply reducing their reliance on covered bonds (which have historically comprised the majority of their term funding) in favour of cheaper ECB repo funding. Away from wholesale funding, deposits continue to hold up. The issue is therefore one of cost of funding (a profitability issue) rather than access to funding (a more acute liquidity issue), at least outside the caja sector.
See the chart below — click to enlarge:
Interestingly, Credit Suisse has also previously argued that cost of access was being conflated with actual availability of access in recent concerns that BBVA had been locked out of US commercial paper markets.
But hang on — it’s also been argued that Spanish banks have been using this cheap ECB liquidity to buy up high-yielding sovereign debt in a form of carry trade, which has caused them to correlate ever more with the Spanish state in CDS markets.
That’s something to watch in the stress tests, we guess. And in that case — would it be too much to ask for some sovereign stress tests, too?
Related links:
Recapitalise, or resisting the lure of liquidity – FT Alphaville
Moody’s says everything is just FINE in European banks – FT Alphaville
Failing the stress test; or, in the long run, we’re all dead – FT Alphaville
Stress-testing, a retrospective view – FT Alphaville