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European Bank Stress Tests

07/25/2010
Let's begin with a quick summary of the July 23rd Committee of European Banking Supervisors (CEBS) stress test for 91 European Banks. Clearly to be categorized as it has to be too good to be true, only seven failed out of the 91: five Spanish banks, one Greek bank, and one German bank. Very few expected such a low number. The collective capital shortfall was 3.5 billion euros, again much better than the 25 to 50 billion euros the market anticipated.

Think about the stress tests of U.S. financial institutions in early May 2009 - 10 out of 19 institutions were flagged as being in need of capital raises for a collective sum of $74.6 billion. Confidence was established rather quickly in the days following the tests, as private sector demand gobbled up equity offerings and, in some instances, raised more capital than was required.

The cumulative loss estimate was 566 billion euros, largely impacted from impairments on loans. The average tier 1 ratio was 9.2% in 2011 versus a 6% threshold. Keep in mind that the European Financial Stability Facility (EFSF) could recapitalize banks with the estimated 440 billion euros the facility maintains.

The following CEBS website link provides "full disclosure" not only on the process, but also on the sovereign debt holdings for each financial institution. This unprecedented transparency was applauded by the capital markets. So for those conspiracy theorists, breakout the calculator and do you're testing, all the info is there.
http://www.c-ebs.org/EuWideStressTesting.aspx

I believe the true stress test in the euro zone occurred from mid-April until early June with the plummeting euro (figure 1).

The market implications are that a resumption of the euro spring downtrend did not happen as a result of these results. Obviously, I believe that is positive for global risky assets. Additionally, the economic data coming out of the euro zone continues to surprise on the upside. UK GDP (Figure 2) actually beat expectations this week and German business confidence (Figure 3) remains robust .

For the record, buying the equity of any of those 91 financial institutions tested is not on my "to do list." No thanks, not for me. However, I do believe that these results force advocates of "Armageddon 2: The Sequel" to take two giant steps backward. 

Spot Euro Currency Year to Date (figure 1)


Source:  Bloomberg 

UK GDP 12/31/07-July 2010 (figure 2)

Source:  Bloomberg 

German Business Confidence 8/31/06-7/31/10 (figure 3) 

Source:  Bloomberg

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