After stress tests, bank­ing sec­tor is “pretty solid”

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

After the largest and most de­tailed re­view of bank as­sets ever con­ducted, the Euro­pean Cen­tral Bank pub­lished its As­set Qual­ity Re­view of euro-area banks’ bal­ance-sheets. The re­sults of the ECB’s stress tests sug­gest the eu­ro­zone’s bank­ing sec­tor is pretty solid, even though 13 banks will need to strengthen their bal­ance sheets by EUR 10 bln over the next nine months. Fol­low­ing the ECB’s an­nounce­ment of ad­di­tional credit eas­ing mea­sures this sum­mer (TLTROs, as­set pur­chases), the pub­li­ca­tion of the AQR was the last hur­dle in the way of a nor­mal­i­sa­tion of credit sup­ply con­di­tions in the eu­ro­zone. Even more im­por­tantly, the AQR marks the start of Europe’s bank­ing union project, which should lead to the grad­ual de-na­tion­al­i­sa­tion and har­mon­i­sa­tion of bank­ing sys­tems, and so to a more con­sis­tent euro-area. Gen­eral con­fi­dence in the health and trans­parency of the eu­ro­zone’s bank­ing sec­tor now has the po­ten­tial to im­prove, with fa­vor­able im­pli­ca­tions for fi­nan­cial mar­kets and the econ­omy.

Over the last year, thou­sands of in­spec­tors have combed through the books of 130 eu­ro­zone banks, prob­ing as­sets worth EUR 3.7trn, or 58% of their risk-weighted port­fo­lios.

Ac­cord­ing to the banks, this has been a sur­pris­ingly broad and in­tru­sive process, with a large share of banks’ as­sets checked in de­tail, es­pe­cially those as­sets most li­able to mis­state­ment. The re­sults in­di­cate that at the end of 2013, the value of bank as­sets was over­stated by EUR 48 bln, while un­der har­mo­nized stan­dards non-per­form­ing loans were un­der­stated by EUR 136 bln. The stress tests re­veal that un­der ad­verse eco­nomic and fi­nan­cial con­di­tions, bank cap­i­tal ra­tios (the common eq­uity tier 1, re­stated on the ba­sis of the find­ings of the AQR) would de­cline from 12.4% to 8.3%, well above the 5.5% min­i­mum thresh­old.

How­ever, the ECB found that at the end of 2013, 25 banks were overly vul­ner­a­ble to ad­verse sce­nar­ios, although 12 have al­ready ad­dressed their cap­i­tal short­fall by rais­ing eq­uity and sell­ing bad as­sets. Since the sum­mer of 2013, banks’ bal­ance sheets have been strength­ened by EUR 203 bln through the is­suance of eq­uity and con­tin­gent con­vert­ibles, earn­ings and as­set sales. As ex­pected, Italy and Greece face the big­gest prob­lems, although even there the cap­i­tal short­fall does not look in­sur­mount­able.

This does not mean that the eu­ro­zone’s bank­ing sec­tor, which suf­fers from ob­vi­ous over­ca­pac­ity, has sud­denly be­come rock solid and im­mune to shocks.

But the AQR and stress tests should ac­cel­er­ate the process of de­frag­men­ta­tion, end­ing the credit crunch in Europe. Mon­e­tary pol­icy should now stand a greater chance of reach­ing the real econ­omy, and a mod­est in­crease in ag­gre­gate credit ap­pears cred­i­ble next year.

In ad­di­tion, the AQR was also the first step of a long march to­wards bank­ing union in con­ti­nen­tal Europe, with the 130 tested banks com­ing un­der the su­per­vi­sion of the ECB from 4 Novem­ber this year. With the Euro­pean Com­mis­sion also propos­ing a cap­i­tal mar­kets union, the project should grad­u­ally re­duce the large dif­fer­ences among na­tional bank­ing and credit mar­kets, help­ing com­pa­nies and in­di­vid­u­als to di­ver­sify their sources of fi­nanc­ing. If cross- bor­der merg­ers and ac­qui­si­tions take place (as is now more prob­a­ble), the links be­tween sov­er­eign risks and bank risks would weaken, strength­en­ing the re­silience of the euro.

Al­ready, we can see that, apart from rare ex­cep­tions like Dexia, ‘multi-lo­cal’, pan-Euro­pean and global banks tend to be more re­silient and prof­itable than very lo­cal banks.

In this re­spect, it is no co­in­ci­dence that fol­low­ing the vi­cious Dar­winian se­lec­tion that has taken place since 2007, ge­o­graph­i­cally di­ver­si­fied bank­ing in­sti­tu­tions make up the lion’s share of mar­ket cap­i­tal­i­sa­tion in eu­ro­zone bank in­dexes: seven of the eu­ro­zone’s 10 most highly cap­i­talised listed banks, rep­re­sent­ing two-thirds of the MSCI EMU bank in­dex, get more than half of their rev­enues from out­side their home coun­try. For th­ese banks, the AQR went well, and in­vestors may re-rate them.

Over­all, the AQR should be bullish for bank stocks as it re­moves doubts about the real mea­sure of book val­ues. An­a­lysts and in­vestors will now read the AQR to iden­tify the most solid banks, as well as the po­ten­tial tar­gets. With most bank shares trad­ing be­low book value, and with div­i­dend yields above 4%, the po­ten­tial up­side is sig­nif­i­cant.

In a con­text of resur­gent wor­ries about the eu­ro­zone, and with eco­nomic weak­ness and po­lit­i­cal di­vi­sions rais­ing doubts about the sus­tain­abil­ity of the 2012/2013 re­lief rally, the pub­li­ca­tion of the AQR and the as­so­ci­ated launch of the ‘bank­ing union’ should help to limit the down­side, and could even re­vive some op­ti­mism about the eu­ro­zone.

Along with the ex­pected ben­e­fits from a weaker euro, lower oil prices and re­duced fis­cal drag, the AQR makes the case for a re-ac­cel­er­a­tion of the econ­omy next year more com­pelling.

Newspapers in English

Newspapers from Cyprus

© PressReader. All rights reserved.