Stephen Pope Comments: BP And The Banks: A Tale Of Two Stress Tests

July 24, 2010, Telegraph.co.uk

TWO stress tests have been running in tandem in the past few months - one very real and the other complete with the whiff of Eau de Phoney. The real one has involved BP, a company apparently at the top of its game that had to deal - suddenly and unexpectedly - with a catastrophic accident at the Deepwater Horizon well in the Gulf of Mexico. Result? Eleven terrible deaths, billions wiped off the share price, asset sales, cancellations of dividends and costs that amount to billions of pounds. Endless miles of expensive litigation now lie ahead.

The test with the whiff of phoney is the one undertaken by the Committee of European Banking Supervisors on 91 of Europe's banks. The CEBS (not a group of people you're ever likely to be inviting back home for a raucous knees-up around the piano) insisted that the tests were robust and significant. What would happen, banks were asked, if there was a significant downturn in economic growth, property prices plunged and interest rates spiked? Or, under another scenario, how would banks cope if there was another Lehman-style collapse?

The results were released at that highly convenient juncture for any organisation trying to "bury bad news" - the close of the markets on a Friday night. At that time, of course, everyone has already packed their bags for the weekend and market reaction was necessarily limited to those few bank shares which trade in America.

Unsurprisingly, 84 of the 91 banks passed the stress tests. Unsurprising, because the issue that the markets fear - bank exposure to a sovereign debt default by a country such as Greece - was elegantly avoided. Why? Because the politics of Europe demanded that no country be exposed to an accusation that such a default could even be countenanced, even in an Armageddon scenario.

"These are not tests at all," declared Stephen Pope, chief global equity strategist at Cantor Fitzgerald. The banks, rather than being "worked hard and placed under real stress" had been given a "SPA test", Mr Pope's acronym for a Soft, Pathetic Audit. Other analysts have been critical of the fact that the sovereign debt markdowns that were built into the tests were only applied to bonds set aside for trading (shortterm holdings) and not those being held until maturity (longterm holdings), therefore underplaying the risk to the systemic health of each bank.

Tougher tests could have meant that many of the banks that just scraped a pass (six in Spain, two in Germany and one each in Greece, Slovenia and Ireland) would have been handed a more worrying result.

All eyes will now be on the markets opening tomorrow and how they react. Probably with a shrug of the shoulders as the test results threw up no particular surprises and had already been priced into the share value of the main players. Those who are worried about the fundamental health of the banking system in Europe will have felt this was a missed opportunity, but they always knew that.

The €3.5bn (£2.9bn) now needed in extra capital for the banks that failed - from the markets or from the European Central Bank's rescue fund - is not a very high number. The markets will remain suspicious that there's a lot more murky exposure to risk in the banking system than the burghers of Europe would have us believe.

The kind of numbers - and stress - that BP is grappling with are of a different order altogether and how the market reacts to them when its half-yearly results are announced this week will be vital in gauging how the oil giant is performing.

As a marker of how fit the company was before the April explosion in the Gulf, many analysts are now falling behind a "buy" rating for BP. ING is predicting that the oil giant will announce profits of $5bn for the quarter and an operating cash flow of $30bn.

It describes the recent asset sales as "a more positive deal than the market appreciates" and says that another $45bn could be on the way as BP turns itself into a more focused oil company. Even with provisions for a $20bn "fine pot" to pay for the Deepwater disaster (which could, in any case, be too high) and the cancellation of the Q1 dividend and suspension of the dividend for Q2 and Q3 (a further saving of $8bn), BP has shown that, whatever the travails, oil is still a very lucrative businesses.