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Happy now?: Four questions on the European banks’ stress test

- Question 1: Will the sector bounce strongly? "The US bank sector surged 70% around
the time of its stress test, but we do not think Europe will follow suit. The US stress test proved the catalyst for massive equity recapitalisations, coincided with an economic recovery, and was performed on a sector trading one-third below its long-run valuation. We believe the July 2010 European stress test is unlikely to lead to any meaningful capital raising, was released at a time of growing economic uncertainty, and has been conducted on a sector trading within 10% of its long-run valuation."
- Question 2: Is the test credible? "We give a qualified “yes”. Two year loan losses of 3.6%
represent 30-year highs for the sector but are dwarfed by the US’s 9% stressed level. Whilst such comparisons can be misleading, there does appear to be more individual bank “wiggle room” for European banks, which we see as disappointing. In addition, pre-provision profit assumptions feel optimistic. There are substantial differences by country; in Spain, for example, the assumption is for a cumulative decline in commercial property prices of 55%, yet for just 7% in Greece. This may reflect an element of delayed recognition in Spain. The absence of testing for full sovereign default is understandable, but new disclosure allows investors to conduct their own stress test."
- Question 3: Who was the stress test done for? "Our view is not for us in equities, but for the debt markets. Whilst the US test last year was conducted in the shadow of nationalisation risk, this test was prompted by a renewed funding crisis. Indeed shareholders’ equity has not even been tested. So what is the debt market likely to make of it? We see a “cautious welcome” as the likely view."
- Question 4: Will funding costs come down? "This is perhaps the key question. To the
extent that the market feared what it did not know, the full sovereign risk disclosure is likely to be a positive. However, much of the sector’s funding pressure is, in our view, structural: too many balance sheets (banks and sovereigns) chasing too few funds. With or without a stress test, Europe’s banks still have €1.5trn of debt maturing by 2012, as well as the need to repay over €500bn to central banks. Well-capitalised banks with limited exposure to SGIIP (Spain, Greece, Ireland, Italy, Portugal) sovereigns, such as HSBC and BNP Paribas, should continue to be best placed to benefit. Of the big caps in Europe, BBVA appears to us the weakest positioned. We suspect structurally higher overall funding costs – and the differential in costs among banks – are set to remain."
Barclays Equity Research 20100726

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