Is there anyone who cares about the stress tests?

Moody’s, the rating agency,  today has  published an interesting analysis about the market reaction to the results of the stress test the European Banking Authority released last Friday.

The bottom line is that markets did not really care – neither with regard to the Core Tier 1 Capital ratios (CT1) nor with regard to the information about the exposure of the individual banks to government bonds issued by the crisis countries.

Moody’s looks at the prices one has to pay for an insurance against the default of an individual bank, the so-called Credit Default Swaps (CDS). The higher the likelihood of a default of a particular financial institute, the more you have to pay for a CDS on that bank.

With regard to  CT1 and CDS prices they observe:

 “for most institutions there is little correlation between the EBA’s definition of stressed 2012 Core Tier 1 Capital Ratios (CT1R) and spread movements, suggesting that there were no great surprises in the levels(…)

There were two outliers/exceptions which we highlighted in Figure 1. One was EFG Eurobank Ergasias, a Greek institution. It had a low stressed CT1R of 4.9% and the bank’s CDS spread rose by 30% (from 1,650 bp to 2,147 bp). At the other end of the spectrum, Irish Life’s spread tightened by almost 20% (from 1,697 bp to 1,367 bp), and it did in fact have an extremely strong stressed 2012 CT1 level. “

Basically the same is true with regards to the exposure of public debt originated by the weakest countries of the

“[T]here is little correlation between banks’ exposures to these stressed sovereigns and spread changes. The obvious conclusion is that the market was largely aware of the exposures prior to the release of the test data. The largest moves since the test results’ publication have been for banks in Greece, Italy, Portugal, and Spain, where the market movement is much more likely based on views of the outlook for asset quality and profitability than on new information available”

Well, I wonder if I just wasted my time when I compiled my tables summarising the exposure of German banks and later of all 90 banks which were stress tested…

Anyway,  in general, CDS spreads show that the banking crisis in Europe is far from over, as the report stresses:

 “Average CDS spreads on European banks are high, and this is nothing new. The CDS market has been sending negative signals on European banks since the credit crisis began in the fall of 2007. The average CDS-implied rating for European banks, at Ba2, down from May, but actually an improvement from January.. While the average is distorted by the inclusion of Greek, Irish and Portuguese banks trading at Caa levels, we note the average implied rating for Spanish, Italian, and French banks is now in the Ba range.”

The full report by Moody’s, which is entitled “European Bank Stress Test Update: a Little Market Reaction to a Lot of Data” is available here.

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Filed under Banking, Financial Crisis

8 Responses to Is there anyone who cares about the stress tests?

  1. chb

    Don’t get depressed. The only function that Moody’s and the others have is to reinforce the trend that is making money from financial transactions. When packaging impossible mortgages was the winning game, they rated the results AAA. When speculation on the widening of cds spreads is on, they downgrade. Consider it no surprise that they would find that the counter-trend evidence offered by the stress tests is of no effect.

    These places hide behind some sort of aura of being information providers when, in fact, they are part and parcel of a cartel that is making – aided by the press and ecoblogs that are addicted to the hit count that blood on the streets provides – immense amounts of money at great expense to those not participating.

    I, personally, thank you for going to all that effort. btw.

  2. genauer

    I cared, and downloaded. We know now how much banks and countries are exposed. That Ireland is still running off balance sheet shenanigans. But the big elephant in the room was the Greece decision of today and this stress was of course not covered in the test. That most other banks knew approximately who is exposed how much, didnt get surprised and changed their ratings of the others by much, as stated in the Moodys report, is actually a good sign.

    I actually finished the CDS vs ratings comparisons (slideshare is compiling since 15 mins, on a 300 k ppt file).
    Basically a lot of downgrading happened early 2008, but people started to care (increase CDS spreads) only after Lehman. And the EU Summit today seems to save the summer vacation for everybody. Lets see, whether the US folks will also do a muddle through.

    Otherwise, most people (e.g. kantoo, ..) seem to be in vacation already.

  3. I care, and I thank you. I’ve read your past three of four posts since 18 July, as you’ve tried to dig through this mess.

    I’m a former employee of Standard&Poor’s, know statistics, finance blah blah blah. But the basic analysis that you are working through here really needs to be done before anything else. This is what the big fixed-income analysts should be doing. Perhaps they are, just aren’t sharing. Nevertheless, what you are doing remains commendable, as you ARE sharing. And this IS messy work!

    Although I referred to it as “basic”, please don’t infer that I think it is simple or easy. I noted your earlier posts where you tried to get clarification regarding context and terminology, with what I would have found frustratingly opaque results.

    The markets can choose to listen to whomever they want. Regarding corporate debt, Moody’s and S&P (and Fitch IBCA) give an opinion through their rating. No more, no less. A sensible analyst considers that as only one part of his/ her assessment of the security. I really don’t understand why the same isn’t applied to greater extent with sovereign debt. Credit rating agencies only have as much power as they are given. That’s why I don’t like headlines that read “Moody’s threatens to downgrade so-and-so”. Moody’s is merely a U.S. domiciled company, just like S&P, that issues research reports. These reports are informed guesses regarding credit risk and probability of default, and that is all. It troubles me that they would receive more attention than direct results from bank stress tests.

  4. Oxyartes

    “It had a low stressed CT1R of 4.9%”
    was heisst das auf deutsch:

    “Sie hatte ein tief belastetes CT1R von 4.9%” -> gut

    “Sie hatte ein tiefes CT1R von 4.9%” -> schlecht

  5. Pingback: Is there anyone who cares about the stress tests? » Greece on WEB

  6. ESV

    The Moody’s exercise is ill-conceived. The EU stress test should not be evaluated in terms of their short-term effects on market data. They should be evaluated in terms of whether the quality of the information and analysis they provide is useful to improve the understanding of the situation of banks and banking sector in Europe. I think it is, no doubt.

  7. jmg

    The stress test is based on outdated data from December 2010. Deutsche Bank reduced it’s exposure radically over the last six month.