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”
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.