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AQR aftermath: top managers on the stress test fallout

AQR aftermath: top managers on the stress test fallout

The ECB’s much-discussed banking ‘stress tests’ concluded on Sunday with 25 of the 130 banks put under the microscope being deemed vulnerable to a sudden shock.

While investors pour over the details, the snapshot responses appear to paint Italy as the biggest concern in the region, with nine of the struggling banks being based here.

But does that tell the whole story? Citywire Global canvassed a host of leading equity and fixed income fund managers to uncover what investors should really make of the results.

Italian market view

Citywire + rated Luca Mori of Italian asset manager Zenit believes markets are overreacting to the outcome for Italy, with the country’s financial sector in better health than many believe.

At European level, the results of the Asset Quality Review and the stress tests came out better than expected.

As for the Italian banking sector, the ECB’s ‘report cards’ are suggesting an improving state of health. The results for Banca Popolare di Milano (BPM) and Banco Popolare represent an especially positive surprise, whereas the situation for Monte dei Paschi di Siena (Mps) looks significantly negative.

Overall, the European banking industry has come out stronger, and we believe that markets are poised for a re-rating of the sector in the coming months.

It seems that the measures that have been taken by banks in the run to the results are beginning to weave the desired effect, and we believe that over time this will result in a recovery and an increase in business loans.

Echoing Mori’s comments is Citywire A-rated Alberto Chiandetti, portfolio manager of the Fidelity European Opportunities fund, who was buoyed by the outcome.

At sector level, Italian banks come out better than expected from the AQR, as the required total adjustment of €7.5 billion is lower than the expected figure of more than €10 billion.

Instead, the impact of the stress tests defies market expectations on the negative side for two banks [Monte dei Paschi and Carige] in need of a larger recapitalisation than it was previously thought.

Among the banks that have passed the tests some of the smaller, local banks came out better than expected, despite the market already pricing-in less positive scenarios.

The true impact of the revision is evaluative. Some institutions see their equity at lower levels than expected, leaving the titles mathematically more "expensive" than what the market was pricing.

In conclusion, this review is the springboard for the ECB to attain supervision over the entire European banking system. Properly capitalized budgets will have positive effects on the system’s credit provisioning capabilities, a necessary condition – though not sufficient in itself – to restart lending.

The analyses carried out on the European banking system therefore ended in a positive way and thus constitutes a step forward for Europe to regain the confidence of international investors.

Equity market view

Didier Van De Veire, head of European equity at Belgian group Petercam, pinpoints UK banks as the ones which came out worst from the comprehensive assessment.

After an initial relief rally due to limited capital dilution for European banks post the AQR and stress test, the key question will be if this exercise restores banks willingness to lend now they feel less capital constrained?

This is the key question not only for European banks, but also and more importantly for the European economy, which has its own positive or negative consequences for banks’ ability to rebuild capital anyway.

No major surprises resulted from the stress test, with a relief that the dilution impact is minimal certainly in some heavily debated names. But we never believed this was the key risk, more importantly is the relative losers and ability to compare scenarios.

It will take some time to run through all those data, and compare them with our own and consensus expectations but in general domestic UK banks seem to be relative losers (but UK stress test still forthcoming) here and domestic Spanish banks do better than anticipated.

For James Sym, who runs the Schroder European Alpha Plus fund, the relatively positive outcome for financials is a perfect reason to be bullish on the sector.

I have seen fewer failures than expected, and think that these stress tests’ results are relatively credible. I’m very bullish on European recovery and a healthy banking system is crucial for this purpose.

I now expect European banks to start lending more and the whole sector to gain some confidence. This is also because of less austerity in the periphery and the new ECB measures.

The asset quality review is a good way to evaluate and compare an Italian to a German bank, for example. The whole point is about harmonising the region’s financial sector and making single lenders convergence on similar parameters.

From my point of view, this is a buying opportunity. I’m massively overweight European peripheral banks and keep finding good opportunities in that area. Italian banks are cheap and not very profitable. They do need a pick-up of the country’s economy to grow again. But the AQR’s real losers are not the single Italian banks, but the Bank of Italy as it has been too lenient in the past years.

Citywire + rated Stephen Macklow-Smith of JP Morgan AM believes the stress tests served an important role in the ECB's transition to assuming a stronger regulatory role. 

The Asset Quality review wrote down the value of some loans by more than had so far been acknowledged by the banks in question:  this is a positive, as it helps to create common banking standards.

The key point about the overall exercise is that it paves the way for the ECB to assume its position as head regulator for the eurozone banking system. ‘

The Eurozone Banking Union is now in place, and with the ECB’s measures to stimulate supply of credit and help banks to make the balance sheets more flexible, the groundwork has been laid for credit to assist with the recovery in growth next year.’

The wide stress tests for banks are not yet over – later this year we will see the results of the Bank of England’s tests, and in early November the G20 will attempt to reach agreement on capital buffers for the world’s largest banks.’

Bond market view

According to Philippe Bodereau, head of financial research at PIMCO, equity markets are set to be the big winners. The bond manager, who outlined major concerns last week, also thinks CoCos can continue to shine.

The outcome of Sunday’s European Central Bank (ECB) stress tests is positive for market sentiment, with only 12 banks identified as needing to raise additional capital. The headline number of 25 bank fails is not the number to focus on as this excludes the capital hikes already completed in 2014.

All core eurozone banks passed with a reasonably large margin, and there were no narrow passes in the largest systemic banks. In peripheral eurozone banks, we saw a negative surprise in Italy, with Banca Monte revealing the largest capital shortfall, and a positive surprise in Greece, where there were no significant capital shortfalls.

Spanish banks came out very well as we expected. For investment implications, we expect there to be a rally in the majority of bank stocks and contingent convertible bonds (CoCos) in the coming week. The CoCo universe is heavily dominated by some of the strongest eurozone banks, a group that has fared very well in both the ECB’s Asset Quality Review and the stress test.

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