Sector Study - European Banks - Stressing the Stress Test

8/3/2019 Sector Study - European Banks - Stressing the Stress Test

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Analysis of the CEBS Bank Stress Test

The stress test simulates both a deterioration of the economic environment and anadditional sovereign shock on 91 European banks, amounting to 65% of total assets of the European market. The focus of the exercise revolves around credit and market riskand a time-horizon of two years (until the end of 2011).

Core Tier I CapitalThe minimum regulatory tier I ratio for banks supervised in the EU stands at 4%. Thestress test carried out by the CEBS fixed a threshold of tier I ratio of 6% as symbolicbenchmark. These values appear extremely low when compared to the current level of capital sitting on banks balance sheet, although it should be kept in mind that theguidelines for the assessment of capital adequacy have been considerably relaxed.

If we take a look back at 2008 and 2009, we see how 6% was close to the weakest levelsof Tier I ratio in the banking industry during a period of severe market distress, thusgiving some empirical relevance to the benchmark threshold. Regardless of nominalvalues, the purpose of comparing institutions amongst each other will still be served.

The study simulates the impact of a benchmark and an adverse scenario for the Eurozone. The first one assumes growth for 2010 and 2011 of +0.7% and +1.5%respectively, while the latter a slowdown by -0.2% and -0.6%.

The aggregate Tier I capital ratio stood at 10.3% at the end of 2009. The materializationof the adverse scenario would result in impairments and trading losses totaling 596 bn,which would drive the ratio down to 9.2%. Its worth noting that the stress test takesinto account the contribution of approximately 197 bn of government capital support.Should we strip that out, we would see another 120bps being taken away from theaggregate capital figure. Those funds will eventually have to be paid back togovernments, although it is not in the best interest of governments to pressure banks asthat would translate into financial stress spiraling through the economy and moneymarket (drying liquidity once again with obvious consequences). Although banks will beable to refinance themselves (at least partly) on capital markets, as investmentsentiment toward the sector improves, the worst case scenario of 8% composite Tier Icapital ratio still sits well above the benchmark threshold of 6%.

Amongst the banks observed in the present analysis, none of them appeared to requireadditional capital, while 7 out of the 91 banks scrutinized by the CEBS would be expectedto raise additional capital to comply with regulation.

Sovereign DebtOne of the main areas of focus of the stress test was the assessment of the banks exposure to sovereign debt. These holdings are either recorded as trading book or


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of retail banking and investment banking products, the absolute figure still serves thepurpose of making banks comparable with each-others.

When assessing the risk of govies holdings, I have looked at market elements such ascredit rating and CDS and at economic factors such as budget deficit and debt. Thespecific variables I have considered were:

Budget-number of positive budget balance over the past 5 years-weighted average variation of budget balance over the same periodThe two numbers provide an indication of the extent and the trend to which a countryhas been creating surplus or deficit over the recent past.

Debt- most recent debt/GDP ratio-evolution of the debt in absolute terms over the last 5 years-evolution of the debt/GDP ratio over the last 5 yearsThese three variables provide information useful to discern those economies that aremore subject to liquidity shocks and those that are more flexible and efficient in terms of

growth/debt.

The weighs of these four parameters is fairly homogenous with the exception of thecredit rating (15%), which has been taken into account only for its impact on the cost of refinancing. Despite the frequent market over reactions, I considered the CDS (25%weigh) to be a better indicator (over time, although I have only considered the spotvalue given the relatively lower volatility in spreads) of the overall credit situation of thecountries studied. The debt and budget deficit (33% and 27%) have slightly higherimpact on the overall risk assessment as they tell us more about the fundamentaleconomic situation. Ultimately, its important to remember that CDS should, at leastpartially, price those variables in.

ResultsThe result of the country debt score was not surprising: Nordic countries clearly shine asthe strongest economies, also accompanied by Germany while the PIIGS and EasternEurope (the latter are the worst) come out as the obvious burden to the Europeaneconomy. Its worth pointing out that the UK scored fairly badly as well, ranking right

above Poland, the PIIGS and Eastern Europe. France obtained a score above average, inspite of being pressured by some of the worst budget deficit and debt situation observed.Amongst Southern European countries, Spain scored the ranked the highest as opposedto Portugal which was the worst.

The implications of the country risk assessment are fairly interesting. Contrary to theirpoor country debt/budget score, UK banks were only second to Nordic banks due to their


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Conclusion

The assumptions used by the CEBS as the backbone of the stress test look way toorelaxed. However, it was interesting to analyze the results of the study in order toextrapolate the capital solidity of European banks on a relative basis. The availability of core capital as opposed to risky assets holdings has been in the spotlight for a while nowand continues to be the object of particular attention, especially given the ongoingconcerns over sovereign debt. However, as macro condition stabilizes and economicactivity remains on a path of normalization, equity valuations (as well as business modeland growth prospects) will progressively regain relevance to the eyes of existing andpotential shareholders.

Equity and credit scores hold limited relevance when taken on a standalone basis andthats by combining those results together that we obtain the most useful information.For instance, the equity ranking of National Bank of Greece, which includes bothmultiples and growth potential, is of all due respect (8th out of 32). That figure mightlook counter-intuitive only until we take a look at the credit score of NBG. In effect, thecore capital and sovereign exposure rankings are amongst the weakest ones within thesample analyzed, which would explain the poor equity performance, earnings

deterioration, consequent cheap valuations and relative high growth potential.Credit and Equity scores diverge for the majority of financial institutions screened, whichimplies that equity investors have already moved on a number of stocks by pricing inbanks capital position and risky exposure. This does not mean that financial institutionwith strong credit scores trading at high multiples (i.e. Scandinavian banks) hold limitedupside potential, but rather that some other companies stocks with an equally strongcapital base are not pricing in that edge. Those names include banks such as Barclays ,Deutsche Bank . There are other names that appear as worthy investment candidates:

KB C, BNP and SocGen were, in effect, held back by their sovereign exposure. The firstone presents a high PIIGS/core tier I ratio (mostly Italian debt) and a significantexposure to Eastern Europe while the French peers are burdened by a mix of Italian,French and Eastern European countries debt (especially SocGen). Conversely, Lloydsand RBS, which scored extremely well under a credit stand point, achieved low equityrankings due to expensive multiples and not meaningful growth figures given theconstraint on earning imposed by the restructuring. Its interesting to note that these twobanks have a net tangible book lower than the book value (besides BCPE and Nordea),implying a negative goodwill. The price to net tangible book value of Lloyd s and RBS ,the valuation ratio most widely used for banks, is among the lowest ones in the industryand is backed by very solid core capital numbers.Although I did not include UBS and Credit Suisse in the study, given their exclusion fromthe stress test, a look at their capital situation and multiples reveals that quality comesat a cost.


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CREDIT RECAP

Total sov. Exposure/ T1 capital PIIGS /T1 capital

Govies HoldingRisk (1-10)

Govies HoldingRanking Tier 1 end 2009

Tier 1 under

adverse scenarioand govies Capital Score Capital ranking

A Erste Bank 2.22x 0.23x 5.11 15 10.4% 8.0% 6.29 25A Raiffeisen 1.35x 0.03x 4.86 13 10.6% 7.8% 6.61 28

BEL Dexia 3.31x 1.48x 5.27 20 13.4% 10.9% 2.07 2BEL KBC 3.77x 0.81x 5.31 21 12.2% 9.4% 3.91 13DEN Danske Bank 1.65x 0.08x 2.80 3 11.7% 10.0% 3.71 11FRA BNP 1.52x 0.54x 5.22 19 11.4% 9.6% 3.48 9FRA BPCE 1.21x 0.24x 5.20 18 10.2% 8.5% 5.44 19FRA Socgen 1.21x 0.31x 5.48 23 11.9% 10.0% 2.76 7

GER Commerz 2.51x 0.60x 4.41 8 10.5% 9.1% 5.80 23GER Deutsche Bank 0.96x 0.29x 4.42 9 13.2% 9.7% 4.22 15GER Deutsche Postbank 3.70x 1.52x 5.10 14 7.9% 6.6% 7.71 32GRE EFG 1.89x 1.41x 7.55 33 11.7% 8.2% 5.69 22GRE NBG 2.70x 2.60x 8.17 35 11.7% 7.4% 6.56 27GRE Piraeus Bank 2.64x 2.44x 8.16 34 10.9% 6.0% 7.24 31IRE Allied Irish Bank 1.12x 0.64x 6.04 28 9.5% 6.5% 6.81 29IRE Bank of Ireland 0.14x 0.13x 6.75 31 9.0% 7.1% 8.36 33ITA Intesa 2.35x 2.15x 5.97 27 9.8% 8.2% 5.09 18ITA MPS 3.09x 3.08x 6.05 29 7.6% 6.2% 8.87 35

ITA Unicredit 2.09x 1.04x 5.13 17 10.0% 7.8% 6.16 24NL Abn/Fortis 1.40x 0.18x 4.23 6 12.0% 9.9% 4.62 16NL ING 1.37x 0.35x 5.11 16 11.2% 8.8% 5.56 21NL Rabobank 1.11x 0.09x 4.36 7 14.8% 12.5% 2.12 3

POR BCP 0.64x 0.31x 6.73 30 9.4% 8.4% 6.54 26POR ESFG 1.00x 1.00x 7.47 32 9.2% 6.9% 6.96 30SPA Jupiter 1.37x 1.25x 5.76 24 8.8% 7.0% 8.57 34SPA BBVA 1.94x 1.83x 5.79 25 10.6% 9.3% 3.71 11SPA Santander 0.94x 0.85x 5.92 26 11.0% 10.0% 2.73 6SWE Nordea 1.03x 0.05x 1.94 2 11.3% 10.1% 2.71 5

SWE SE Banken 1.36x 0.05x 3.18 4 11.8% 10.3% 3.63 10SWE Svenska 0.81x 0.00x 1.54 1 10.2% 8.9% 5.51 20UK Barclays 0.88x 0.16x 4.17 5 15.8% 13.7% 0.30 1UK HSBC 0.63x 0.08x 4.78 12 11.7% 10.2% 2.71 4UK Lloyds 0.17x 0.00x 4.74 11 10.8% 9.2% 4.04 14UK RBS 1.44x 0.19x 4.63 10 14.1% 11.2% 3.21 8


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COUNTRY DEBT SCORE

Budget DebtScore Score Rating Score Spread Score Score Rank

Austria 12.4 10.5 AAA 1 81.1 12 10.5 8Belgium 11.6 13.9 AA+ 12 112.1 15 13.3 15Bulgaria 2.6 1.8 BBB 24 265.7 23 10.0 7Cyprus 9.2 7.5 A+ 16 153.9 17 11.4 10Czech Re 14.0 12.5 A+ 16 83.8 13 13.4 16Denmark 1.4 14.1 AAA 1 38.3 5 6.5 4Estonia 6.0 13.6 A 20 94.3 14 12.1 11

Finland 1.0 12.0 AAA 1 27.8 2 4.9 3France 16.4 15.8 AAA 1 70.4 10 12.9 13Germany 9.6 12.5 AAA 1 41.4 6 8.7 5Greece 19.2 17.9 BB+ 28 772.5 26 21.5 26Hungary 17.6 16.3 AAA 1 27.8 2 11.3 9Iceland -- -- BBB 24 -- -- -- --Ireland 13.6 22.2 AA 13 241.9 21 18.4 22Italy 14.4 15.0 A+ 16 158.8 18 15.7 20Latvia 16.0 19.8 BB 29 320.8 24 20.7 25Liechstenstein -- -- -- -- -- -- -- --Lithuania 15.6 16.2 BBB 24 234.8 20 17.8 21Luxembourg 2.2 16.1 AAA 1 -- -- -- --Malta 13.6 11.4 A 20 -- -- -- --Netherlands 6.4 15.9 AAA 1 44.9 7 9.1 6Norway -- -- AAA 1 23.8 1 0.4 1Poland 16.8 10.9 A 20 126.9 16 15.0 18Portugal 18.0 17.1 A- 23 244.0 22 19.3 23Romania 17.2 15.7 BBB- 27 334.1 25 19.8 24Slovakia 14.8 12.4 A+ 16 74.8 11 13.1 14Slovenia 12.0 15.8 AA 13 69.8 9 12.5 12Spain 10.4 17.0 AA 13 203.1 19 15.2 19Sweden 1.8 6.0 AAA 1 37.3 4 3.7 2

UK 18.8 18.9 AAA 1 62.0 8 14.1 17

Total Risk RankRating CDS


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EQUITY VALUATIONS OVERVIEW

P/TBV Ranking Score2010e 2011e 2010e 2011e 2010e 2011e Current

A Erste Bank 12.3x 8.5x 7.5% 10.8% 0.9x 0.9x 1.2x 15 14.6

A Raiffeisen 12.6x 7.1x 7.1% 11.4% 0.9x 0.8x 1.4x 12 12.9BEL Dexia 9.2x 7.8x 6.4% 7.7% 0.6x 0.5x 1.0x 11 12.8BEL KBC 8.2x 7.2x 13.9% 14.1% 1.0x 0.9x 0.7x 1 5.3DEN Danske Bank 18.7x 8.3x 4.5% 10.2% 0.9x 0.8x 1.0x 19 16.6FRA BNP 8.9x 7.6x 12.1% 12.4% 1.0x 0.9x 1.4x 8 10.9FRA BPCE 9.8x 8.3x 7.8% 8.7% 0.8x 0.7x 0.6x 4 10.4FRA SocGen 9.8x 7.4x 8.9% 10.8% 0.8x 0.8x 1.0x 5 10.4GER Commerz 18.3x 12.5x 4.9% 6.3% 0.8x 0.7x 1.2x 29 21.0

GER Deutsche Bank 7.8x 6.9x 11.9% 11.8% 0.8x 0.8x 1.2x 3 8.7GER Deutsche Postbank 22.8x 11.3x 3.8% 8.1% 1.0x 0.9x 1.7x 31 22.2GRE EFG 32.5x 11.4x 2.5% 7.2% 0.7x 0.7x 0.9x 26 19.4GRE NBG 9.8x 6.5x 8.8% 12.0% 0.7x 0.7x 1.7x 7 10.9GRE Piraeus Bank 39.6x 12.2x 1.3% 4.9% 0.5x 0.5x 0.9x 27 19.9IRE Allied Irish Bank -- -- -- -- -- -- -- -- --IRE Bank of Ireland -- -- -18.9% -5.0% 0.8x 0.8x 0.1x -- --ITA Intesa 11.7x 8.9x 5.4% 6.3% 0.6x 0.6x 1.5x 24 17.8ITA Unicredit 15.8x 9.3x 3.1% 4.3% 0.4x 0.4x 0.9x 20 16.8ITA MPS 18.9x 9.6x 3.1% 6.1% 0.6x 0.6x 1.2x 25 19.2NL Abn/Fortis 11.9x 10.6x 5.3% 5.4% 0.6x 0.6x 0.9x 22 17.1NL ING 7.6x 5.8x 10.3% 10.5% 0.7x 0.6x 0.8x 2 6.1NL Rabobank -- -- -- -- -- -- -- -- --

POR BCP 9.5x 7.9x 5.7% 6.3% 0.6x 0.5x 0.7x 10 11.6POR ESFG 10.3x 9.1x 7.7% 7.8% 0.7x 0.6x 0.9x 13 13.1SPA BBVA 12.0x 9.6x 7.2% 7.9% 0.8x 0.8x 1.0x 18 15.6SPA Jupiter 8.3x 7.5x 16.5% 16.8% 1.2x 1.1x 2.2x 9 11.0SPA Santander 9.5x 8.2x 12.6% 13.7% 1.2x 1.1x 2.2x 14 13.1SWE Nordea 13.1x 11.5x 10.2% 11.1% 12.3x 11.6x 1.5x 21 17.0SWE SEBanken 19.0x 12.1x 5.2% 9.1% 1.1x 1.0x 1.2x 28 20.5SWE Svenska 12.3x 11.3x 12.6% 12.7% 1.5x 1.4x 1.7x 16 14.7UK Barclays 10.6x 8.2x 7.9% 9.4% 0.8x 0.7x 0.8x 6 10.6UK HSBC 13.9x 10.5x 10.2% 12.6% 0.9x 0.8x 2.0x 17 15.3UK Lloyds 32.0x 10.0x 3.7% 10.2% 1.1x 1.0x 0.9x 23 17.4UK RBS 157.9x 14.8x -1.3% 3.7% 0.7x 0.7x 0.3x 30 21.1

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Sector Study - European Banks - Stressing the Stress Test

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