"I wonder could you comment on Europe's corporate bank bonds in particular AIB and Bank Of Ireland bonds?"

Eoin Treacy's view Thank you for this question which I'm sure will be of interest to other subscribers. This press release from the Committee of European Banking Supervisors listing the 91 European stress test banks is topical. Here is a section:

The scope of the stress testing exercise has been extended to include not only the major EU cross-border banking groups but also key domestic credit institutions in Europe. The banks that have been included in the exercise are listed in the Annex. In each EU Member State, the sample has been built by including banks, in descending order of size, so as to cover at least 50% of the national banking sector, as expressed in terms of total assets. For the EU banking sector as a whole, the 91 banks represent 65% of the EU banking sector. Banking groups have been tested on a consolidated level. This means that subsidiaries and branches of an EU cross-border banking group have been included in the exercise as a part of the test of the group as a whole.

From the above we can deduce that the banks included in the stress test are those that either are systemically important to their respective countries, partake in significant cross border activity or as in the case of the Spanish Cajas present a significant risk to their domestic economy. Both AIB and Bank of Ireland fit into the 1st and 3rd categories.

The US stress tests identified just how much money was needed to recapitalize the systemically important banks. The government through the TARP provided the cash. Investors appear to be somewhat preoccupied with whether the ECB will expand its balance sheet to an extent that will allow these institutions to be recapitalized but what choice does it have? The alternative would be to allow them to default or massively restructure resulting in Northern European banks taking huge losses on peripheral European liabilities. Europe has been at pains to avoid such an outcome and it would be surprising if they were to allow if occur now. There has been a great deal of talk at European Commission level about bailout packages but the time seems to be swiftly approaching when verbal commitments will need to be followed up with hard cash. Until it becomes clear just where the money is going to come from for bailouts, sentiment towards the European banking sector is likely to remain uncertain.

Rather than looking at individual bonds, CDS are probably a more suitable indicator of the perceived risk attached to individual credits. Bank of Ireland subordinated 5yr CDS are currently testing the upper side of the 10-month range and a sustained move below 550bps would be required to question scope for a successful upside break. The Equivalent AIB spread has accelerated to 500bps over the last month and needs to sustain a move back below 400bps to suggest investors are taking a more sanguine view of the credits. I also added a number of other European Bank CDS spreads to the Bond Yields section of the Chart Library today.

Notable by its absence from the UK list of stress test banks is Standard Chartered, whose business is focused in Asia. In fact, according to this page from Bloomberg, it was growing in every one of its markets as of 2008. The share price continues to consolidate in the region of its 2007 high and it rallied from the 200-day moving average again last week. A sustained move below 1400p would be required to question potential for continued higher to lateral ranging. (Also see Comment of the Day on February 26th).