Transatlantic Financial Risk Inverts: European Bank Default Risk Greater Than American For First Time

One of the oddest phenomena over the past two years has been the relative outperformance of European bank CDS compared to their transatlantic counterparts. Well, this peculiar relationship has now ended. European banks are finally, on average, riskier than American ones. Investors have finally realized that "regulatory capitalization" in Europe is an even more ephemeral concept than in the US. Furthermore as JPM pointed out yesterday, not only do European banks use more leverage, but the "the larger size of Europe’s banks argue against using simple GDP weights to assess potential risks to global markets.  Due to a buyer’s strike over the last month, European banks now have 3.5x as much debt to issue than U.S. banks over the remainder of the year." Also, as we have been pointing out every single day for the past week, European banks, or at least those that have excess liquidity, have been storing more and more of their euros with the Central Bank, instead of lending it out. Add to this the relentless rise in EUR Libor, and this trade should have been a no-brainer for months.

Bank of America adds some more perspective, and some more bias for their Long US Banks trade:

Financial Regulatory Reform and contagion from the European sovereign crisis are the two main issues weighing on U.S. bank spreads. Our view is that Financial Regulatory Reform makes bank credit safer by de-risking financial institutions. While the loss of systemic support is countering that, fundamental improvement dominates both from reform requirements but also from the steep yield curve and general turn in the credit cycle.

Furthermore the rating agency response to passage of the Senate bill has been to postpone their decisions on removing uplifts to bank ratings based on systemic support. That removes the immediate threat of ratings  downgrades that could leave some banks with diminished access to the short term market. Overall we find that the liquidity situation in the banking sector is quite favorable. U.S. banks have about $750bn in bond maturities through 2012but significant liquidity buffers.

While we think U.S. banks should decouple from the ongoing European sovereign crisis, and we remain overweight U.S. banks, clearly Friday’s weak U.S. employment report delayed that decoupling

Alternatively, now that the boat is shifting from port to starboard, the real question is when will enough people scream that the US financial sector has no clothes loud enough, to get the investing community excited enough to go from a European to a US financial short once again. Although with banks allowed to avoid all of the important accounting rules in the US, we don't think this will happen for a long, long time.