Ian Ormiston, manager of the Ignis European Growth Fund and Ignis Smaller Companies Fund, reacts to the results of the Friday’s stress test on European Banks. He believes whilst the test itself lacked much credibility, it could mark the beginning of a period in which the strong banks get stronger, at the expense of the weak.
“Friday’s stress-test results did not provide any major surprises for European investors. Although the results were better than consensus (only €3.5bn of new capital required as opposed to €37.6bn), the credibility of the test has been brought into question by many who think that the worst-case scenario used was too benign, especially considering what the global economy, and Europe in particular, have been through recently. A Greek sovereign default, for example was not part of the scenario. Additionally, the minimum threshold was 6% tier 1 ratio, rather than 6% core tier 1, which has become the de facto standard. Whilst this may seem something of a technicality, it means that banks can consider all sorts of assets, including government support, as akin to equity, thus making it easier for banks to pass the test. One could be forgiven for thinking that the ECB determined the result they wanted first, and then worked backwards, designing the test with their desired outcome firmly in mind.
“However, if the result is not revelatory, then the release of the related detailed data is more relevant. Most banks have broken down their assets with a granularity that allows interested parties to form a view on the strength and stability of their balance sheets, which had not been possible until now. The uncertainty surrounding the quality of the assets held by all banks was partly responsible for the malaise hanging over the sector as a whole. Almost all European banks were trading at a deep discount to their assets a month ago. Today, share prices reflect the difference in quality across the banking sector. Those organisations with solid, diversified businesses have been rewarded with a revaluation. Societe Generale, for example, is 24% higher at the time of writing than it was a week ago. Under the Committee of European Banking Supervisors (CEBS) worst case scenario, SG‘s Tier 1 ratio would fall to 10%, comfortably above the 6% threshold.
“Investors who have done their research and stuck with their convictions over the past few months could well have seen a bounce in higher quality banking stocks. We expect names such as HSBC, Santander, BNP Paribas, Societe Generale and Unicredit to continue to outperform, as they assert their relative strength and grow organically. Whereas in previous years, investors flocked to the smaller, fast-growing financial institutions to buy both their stock and their savings products, the current environment will be characterised by more cautious investors valuing stability and the potential for sustainable growth rather than racy, riskier returns.”