G3 Recap 7-18-11

Main Items:

  • EU policymakers have agreed to a conference call on Wednesday among EU finance ministers, followed by an emergency EU summit on Thursday to discuss the European debt crisis (the summit was initially planned for last Friday, but was delayed at the request of Germany).
  • NAHB Index improved to 15 in July as exp vs 13 prev.
  • Several banks downgraded US growth forecasts over the past few days.


  • This FT article summarizes sovereign debt exposure by bank
  • Further analysis from various banks on the stress tests:
  1. Capital shortfall would be EU17.5b vs EU2.5b if haircuts increased on debt of Greece, Ireland, Italy, Portugal, Spain based on CDS spreads, ABN Amro says in note.
  2. JPMorgan ran an acid test for 27 banks on Basel 3 including haircuts on sovereign exposure. In their test, 20 of the 27 banks would fall below the 7% hurdle rate, resulting in a capital deficit of EUR 80bn
  3. 27 European banks would need to raise a combined €82 billion in new capital to maintain core Tier 1 ratios above 7% if Greek, Irish, Portuguese, Spanish and Italian government bonds were written down in line with market prices, according to Credit Suisse
  4. GS: if we factor in haircuts across peripheral sovereign exposures, 18 banks would fail to clear a 5% Core Tier 1 (CT1) hurdle rate; we estimate a €26 bn recap would be required. Extending this stress to include a 10% theoretical haircut to Italy and Spain would push the number of failures higher still, to 27 banks, and the capital shortfall to €30 bn. Both scenarios allocate the vast majority of losses to banks operating in periphery countries, rather than the core.
  • Trichet repeated that the ECB would be unable to accept defaulted paper as collateral.


  • The market voted on whether it thought the EU bank tests helped clarify anything, and it was a pretty clear negative. Despite being awash in dollars, expected Libor-OIS spreads hit a high for the year:

    2yr Schatz yields are trading below 1m Euribor for the first time since March 2009. 2yr Italy BTPS is now trading at 3.30% above Bunds. For reference, the on the run 5y ITraxx HiVol index, consisting of the 30 widest European non-financial investment grade names, is trading at just 200bps.
    To me, the market appears to be pricing in some rather extreme outcomes. Against this backdrop, we should remember that what can’t happen, won’t happen. The EU authorities, despite all the mistakes they’ve made, are not going to let the Euro fail. In particular, the ECB won’t let it happen. Furthermore, the case for intervention now appears pretty good. Unlike Greek debt a year ago, short term Italian debt is quite surely ‘money good.’
    In the near term, however, things may very well get worse until a market placating solution is found. Given the size of the problem, ECB involvement will be required. That the ECB continues to be reticent suggests that things need to get much worse before they ‘come around.’ This all suggests that we may be seeing the last move down in risk assets, but it could be big.