European Banks：Who's testing who?

DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON-US ANALYSTS. FOR OTHER IMPORTANT DISCLOSURES, visit www.credit-suisse.com/ researchdisclosures or call +1 (877) 291-2683. U.S. Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. 08 July 2010EuropeEquity ResearchBanks / MARKET WEIGHTEuropean Banks COMMENT Who's testing who? Figure 1: Bailout capital available Source €bnSoFFIN 50FROB 12Greek fund 10Total "Core Tier One" 72Italian government estimated capacity 8Rest of Europe estimated fiscal capacity (domestic) 40Rest of Europe estimated fiscal capacity (cross-border) 10Total "Other Tier One" 58EFSF (Article 122 element) 60IMF (commitment to Greece) 20Total "Upper Tier Two" 80EFSF (borrowing capacity) 440IMF (announced commitment to EFSF) 250Total "Lower Tier Two" 690Source: Credit Suisse estimates ■ The Committee of European Banking Supervisors (CEBS) will be publishing its stress tests on July 23. Following on from our indicative stress test note (“Euro zone stress test”, 18 June), we have expanded our analysis to include the Landesbanks and Cajas. ■ The most important point to make is that although it is the banking sector that is formally being tested, the real test is of the official sector itself]: Given the amount of information which is available already, it is not reasonable to suppose that the stress test will provide the bank funding market with important news about intrinsic creditworthiness. The important point being tested is the ability and willingness of the official sector to provide capital to firms which fail the stress test - it is this, not the capital position of European banks, which is the subject of severe market uncertainty, in our opinion. ■ We assess the total bailout capacity of the European official sector as being potentially as much as €900bn, with €130bn available with reasonable availability and certainty:. We would regard the stress test as a “success” in so far as it demonstrates that the political, legal and administrative structures are available to provide an effective lender of last resort to the euro area banking system. Our best case would be one in which it was demonstrated that the resources of the EFSF were available to fund bank bailouts; our worst case would be one in which no evidence was given of available funding. In either case, our favoured stocks would be BNP Paribas and Santander. Research Analysts Daniel Davies 44 20 7888 2653 daniel.davies@credit-suisse.com Jagdeep Kalsi 44 20 7888 0308 jagdeep.kalsi@credit-suisse.com Guillaume Tiberghien 44 20 7883 7515 guillaume.tiberghien@credit-suisse.com Andreas Hakansson 44 20 7888 6766 andreas.hakansson@credit-suisse.com Santiago Lopez Diaz 34 91 791 58 76 santiago.lopez@credit-suisse.com Niall O'Connor 44 20 7883 8761 niall.oconnor@credit-suisse.com Jonathan Pierce 44 20 7888 0811 jonathan.pierce@credit-suisse.com Robert Self 44 20 7883 7516 robert.self@credit-suisse.com Andrea Vercellone 44 20 7883 7988 andrea.vercellone@credit-suisse.com 08 July 2010 European Banks 2 Significant probability of a catalyst In our opinion, there is a significant possibility that the stress tests will provide a material positive catalyst for the sector, as the US stress tests did in 2009. We believe this despite the fact that many commentators, including ourselves, have expressed well-founded scepticism about whether the CEBS has the political will to create a “genuine” stress test corresponding to a true worst case in the euro area. Although we still doubt that the really bearish sovereign default and recession scenarios will be tested, we would note that plenty of commentators were saying exactly the same things in 2009 about the US stress test. The empirical facts are that although many criticisms of the US tests were valid – the unemployment assumption of 8.9% was significantly less severe than the outturn, and many securities saw significantly greater losses than the stress test assumption – the equity and funding markets basically did not care, and reacted to the announcement as if it marked an important development in the sector. Below, we explain why this seemingly illogical reaction actually made a lot of sense. Figure 2: US banks' share performance around stress test 01002003004005006007008009001/1/20091/1 5/2 00 91/29/20092/1 2/ 20 092/26/20093/12/20093/ 26 /20 094 /9 /20 094/23/20095/ 7/2 00 95/2 1/2 00 96 /4/ 20 096/ 18/ 20 097/2 /20 097