Thursday, January 22, 2009

Synthetic eurotrash

On and off over the past few days we here at FT Alphaville have come across plenty of rumours concerning European banks. Earlier this week there was chatter of a huge equity placement at ING. Today we’re hearing of something similar at BNP.

All of Europe’s banks have problems to look forward to in the coming months. As we’ve detailed before, there is plenty of potential for hefty markdowns to come on a number of vulnerable structured asset classes: particularly synthetic CDOs and CLOs. European banks are also still surprisingly exposed to the monoline insurers.

There are other more idiosyncratic risks too: take Deutsche’s massive prop loss for example. Or even, this time last year, SocGen’s rogue.
What makes all of those threats particularly egregious of course, is the fact that Europe’s banks are all so highly levered. They’re all very prone to dilutive recapitalisation attempts.

We think it’s worth reprising an RBS note from late December, in which there’s a number of interesting graphs detailing Eurobanks exposures to risky asset classes, on the potential for further hits to capital ratios. Here’s how they see European banks capital ratios after they’ve run their stress tests (which assume monoline hedges failing and moderate writedowns against corporate CDOs and CLOs):
European banks capital ratios

Barclays and Deutsche are clearly the most vulnerable. Both see their tier-1 capital ratios dip below the crucial 6 per cent mark. (We’d stress that in some senses Barc has less to worry about since the note was written: measures last week should benefit their capital ratios in particular).

BNP Paribas, SocGen and Natixis are also pretty vulnerable: their core capital ratios are already low, and further markdowns or monoline losses could easily put them in a position where a capital raising was necessary.

In the chart above, we stress-test current core T1 ratios for a) monoline-related and b) total markto- market impact on a post-tax basis. Based on potential monoline-related (and trading book) markdowns, Deutsche Bank (5.7%) and the major French banks - BNP Paribas (6.0% pro forma), SocGen (6.2%), Natixis (6.2%) and CASA (6.6%) - remain most at risk of needing to raise further capital. This was the key driver behind our recent downgrade of BNP Paribas (Sailing close to the wind, 27 November 2008) as we believe that it lacks the capital cushion to absorb unexpected shocks and we cannot rule out dilution risk. If anything, the profit warning from BNP Paribas (announced 16 December) with a €1.6bn loss in the Corporate & Investment banking division over October-November increases this risk.

One final chart. The below shows potential markdowns to come from more stress at the monolines. We’d emphasise that monolines wouldn’t necessarily have to fail to precipitate such writedowns, which would be taken against changes to banks own internal valuation models.

monoline exposures

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