Back
The Stress-less, Stress Tests
20 July 2011
Neil Dwane, Chief Investment Officer of Europe at RCM, a company of Allianz Global Investors, comments: ?Version two of the EU stress tests has just been completed and the results can be summarised as ?nothing to see here, folks, move along, move along...? ?The European Banking Authority (EBA) stress tests were somewhat harsher than those last year but in general, they failed to address the issue of an European Union (EU) sovereign default, presumably because the mere mention of it might imply its actuality. Moreover this is somewhat strange since either the German position of some ?burden sharing? is merely a negotiating stance or no one told the EBA stress testers. Even more bizarre is that the markets have priced three EU sovereigns to partial default levels, so if banks are ?marking to market?, then the pain should have already been felt on their balance sheets. We are left concerned that the key EU stress points are being glossed over by Central Banks for political purposes. To the extent that they have even allowed banks to opt out for example Helaba. Banks cannot take the true levels of stress ?The fact of the matter remains that the banks as a whole cannot take the true levels of stress now is evident. Since 2008 the EU has been addressing a liquidity problem when it is a solvency one. Importantly, many commentators miss that investors should look to the whole banking industry. We learnt in 2008 that one systemic bank can bring the whole industry down through counter party and liquidity connections and whether the European Central Bank (ECB) can take the write-down of peripheral debt pledged to itself. Unsurprisingly, nothing has changed nor been fixed. ?EU politicians meet later this week but how much more their economies and financial entities can sustain is now irrelevant ? their prevarications over the last 15 months have exacerbated the situation and the austerity sentence handed to the Greek, Italian and Portuguese economies is already showing signs of economic failure. These same politicians now face key decisions about what resolutions they can now offer, be that the super-extension of the European Financial Stability Facility?s (EFSF) to handle the chance of Spain and Italy needing assistance, or the creation of an EU bond which leverages Germany's credit rating to the benefit all. ?Banks remain in denial about the scale of their balance sheets and the appropriate behaviours in the face of the new Basel III world and beyond. Returns on capital continue to fall as quantative easing (QE) distorts all asset prices and forces the banks to adopt greater risk appetite than their capital ratios should allow. However, they are sensitive to economic activity, so any solution to turn away from manic risk aversion would lead them to a strong bounce, perhaps with the arrival of QE 3 in the USA in the autumn. Deleveraging will continue ?The EU bank stress tests highlighted how few of them are strongly capitalised for the dire sovereign financial positions we are experiencing today and also revealed that many large banks, like Societe Generale, Deutsche and Unicredit are barely sufficiently capitalised despite recent fund raisings. It seems inevitable that deleveraging will continue and default on many bonds may unfold as this economic crisis continues. After 30 years, the bond returns which have exceeded equities, may now be ebbing as inflation and default risk are re-priced into the EU in a way which is the reverse of the ?correlation? trades of the 1990s, with perhaps the USA to follow as the debt ceiling debate intensifies. Signals for investors remain the state of deposit outflows from the financial systems in Europe?s periphery, supporting the Swiss Franc and the underlying health of their economies in retail sales and industrial production. Austerity and risk aversion may make it impossible for these economies to grow their way back for financial probity.? - Ends -Click below to download the full press release
20_July_2011_1974.doc
Download
