SocGen On The Stress Test: "It Does Not Reflect Reality" And "A Political Error Can Trigger A Freeze In Money Markets"
And we thought we were harsh on the EBA's second farce of so-called 'stress tests'. Enter SocGen's Hank Calenti and team: "The test does not reflect current reality, in our view; even if GIIPS sovereign are further stressed within this test, a €22bn shortfall and a relatively healthy average 6.2% core Tier 1 appear. The European banking sector is captive to politics at the moment. A political error can trigger a freeze in money markets, and a liquidity crisis could quickly turn into a solvency crisis. Only improved governance would avoid such a nasty scenario." We wonder what Calenti would say about the US in this case...
Some other disclosures from the "test" Europe wishes could forget had ever been conducted (at least until Stress Test 3 next summer... or this winter).
The EBA was effectively in a lose-lose situation: too few failures and the test is branded too lenient; too many failures and some will worry that the system is in worse shape than they had expected.
The stress tests confirmed two already well know results. First, the bulk of exposure to the weakest sovereigns is held by the domestic banks (in both absolute and relative terms). Taking the example of Greece, of the total exposures to the Greek sovereign reported for the 90 banks taking part in the stress tests almost 60% is held by Greek banks. Second, exposure of non-domestic banks to, respectively, Greek, Irish, Portuguese and Spanish sovereign risk is relatively moderate.
The tests will inevitably be criticised for such a small number of failing banks (eight) with an aggregate capital shortfall of just €2.5bn, and the fact that sovereign default is not considered. By including the possibility of sovereign default across multiple jurisdictions (haircut of 50% for GIP sovereigns, 20% for Italy/Spain), our analysis suggests 13 banks of a sub-set of 40 of the larger, quoted banks could fail, with an aggregate capital shortfall of €22bn. The average core Tier 1 capital would remain at a still relatively healthy 6.2%.
Like the equity market, credit market reaction to the stress tests is also likely to be relatively muted in our view, with few easily decipherable surprises discovered within a large volume of disclosures. We do not envision a flood of new bank debt issuance in the short term for two reasons. It may be more advantageous to de-lever than raise funds in the international capital markets. This would clearly have attending feedback into the bank-to-sovereigns and economy causality.
Unfortunately, there is no discussion of the WSJ's earlier disclosure of the critical several trillion in PIIGS C&I loan exposure. In retrospect, perhaps it makes sense it was omitted.
As for how to trade this data, the following chart of CDS vs Tier 1 Capital (and we certainly do not vouch for the credibility of the Tier 1 data) may be the best tearsheet of who is relatively cheap in terms of risk, and who is rich.
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