Waiting for the EU Stress-Test Results

This week on Nikkei CNBC programs I need to speak a lot about the EU Stress-Test results scheduled to be released on July 23. Many investors are also anxious about them. Here are interesting articles. Just FYI.
Cheers, Kosuke

91 Banks + 20 Nations = Stress Test Overload

Next Friday, news screens may be straining with information overload as stress test results are published.

The publication of stress test results for European banks looms large as midsummer’s event for financial Europe next Friday. It also could make for a few frightful hours if the results are released helter skelter from myriad sources, as early information suggests.

Banking sources are beginning to shed early light on how the results will be disclosed. If true and left unamended, it could involve a blizzard of releases from national regulars and the individual banks at 1600 GMT.

In Spain, for example, banking industry sources say that the local banking associations representing Spanish banks and the savings banks will post the test results of individual members on their websites. The Spanish central bank will then publish a report on how the sector did as a whole.

Multiplied by the 91 banks and 20 nations being tested by the Committee of European Banking Supervisors (not including Switzerland), the event will have news screens straining with information overload.

Final disclosure plans are still pending. But some could argue that a more controlled, uniform and consolidated release source could smooth market absorption and the chance of error.

“Hopefully,” economists at UniCredit write to clients, “the exercise will be handled professionally enough to avoid a major accident.”

WEEKEND INVESTOR
JULY 17, 2010.

Playing the EU Stress-Test
By BEN LEVISOHN

Sometimes stress can be profitable.

On July 23, European regulators will release the results of its "stress tests," designed to gauge the ability of Europe's banks to withstand future economic shocks. If all goes well, the tests could signal an end to the crisis of confidence in Europe and global markets in general, at least in the short term.

Traders already are placing bets on a European bank rebound. The Markit iTraxx Europe Senior Financial Index of credit-default swaps on 25 banks and insurers, which tracks the cost of insuring against a bank default, fell 0.33 percentage point during the past month and is near its lowest level in almost three months. The financial-services sector of the Russell Developed Eurozone Index, meanwhile, has risen 14% this month through July 14, after having fallen 30% during the first half of 2010.

Investors should tread carefully, however. When the U.S. conducted similar stress tests in early 2009, bank stocks rallied for two months before the results came out—then fell 14% over the following two months, even though the results were mostly positive.

"We see relative strength as a good opportunity to take profits," says Chad Deakins, portfolio manager of the $250 million Ridgeworth International Equity Fund, which is overweight European financials.

But by differentiating between the strong and the weak, the stress tests may help to restore confidence in higher-quality European banks, which should benefit longer-term investors. In the U.S., bank stocks as a group were 12% higher on the one-year anniversary of the stress tests. U.S. Bancorp jumped 29% during the period, while BB&T rose 27% and Capital One gained 59%.

Despite strong capital levels and exposure to markets outside Europe, banks such as Spain's Banco Santander SA and France's BNP Paribas have been tarred with the same brush as weaker competitors on the Continent. Although they have gained as much as 43% during the run-up to the stress tests, they seem attractive over the long term, says Fred Rizzo, a London-based European bank analyst at T. Rowe Price.

A broader way to play Spanish banks in general and Santander in particular is via the iShares MSCI Spain Index exchange-traded fund, which has 47% of its portfolio in financials and one-quarter of its assets in Banco Santander. If Spain's publicly traded banks come through the stress tests better than expected, these stocks could give the fund a boost.

Thanks in part to Europe's banking woes, the entire Spanish market looks cheap on a valuation basis, says Leila Heckman, a Chicago-based senior director at Mesirow Financial, which manages more than $35 billion in assets. Stocks there are trading at a price-earnings ratio of 10, compared with a long-term average of 14 times.

The Netherlands, which has few of the issues plaguing its peripheral peers, is a safer play, Ms. Heckman says. The iShares MSCI Netherlands Investable Market Index ETF provide exposure to the Dutch market and Dutch banking giant ING Groep makes up 11% of its portfolio.

"Just a month ago, the fear was that Europe was taking everything down with it," says Michael Hasenstab, who oversees the $35.4 billion Templeton Global Bond Fund. "That won't be the case," he predicts.

Investors wary of buying stocks or funds outright could hedge their bet using a "covered call" strategy. It boils down to buying a stock while selling a call option, or the right to buy the stock at a certain price. The main drawback: If the stock rallies too much, you will be forced to sell below the peak. But the "premium" you rake in from selling the call can mitigate a loss should the stock price fall.

Even the shares of Allied Irish Bank, one of the most troubled of Europe's banks, seem more attractive in a covered-call trade. In Friday's market, the stock fetched around $2.28 on the New York Stock Exchange. By selling a February call with a strike price of $2, an investor can rake in a premium of 65 cents a share, or $650 per 1,000 shares. That is a 23% return if AIB is trading above $2 a share when the option expires. On the flip side, shares of AIB can drop to $1.63 before investors take a loss.

"We think Allied will come back," says Vic Schiller, president of options-research service InvestorsObserver. "But by using the right covered-call strategy it can drop 28% and you won't lose a penny."