"Regulators Disclose Criteria for Bank ‘Stress Tests’
By ERIC DASH
"Federal regulators released the criteria they used to assess the financial health of the nation’s 19 biggest banks on Friday, but provided little new information for investors to distinguish the industry’s weak players from the strong.
In a 21-page report, the Federal Reserve regulators broadly laid out the tools they used to project bank losses if the economy worsens, and officials established an unspecified baseline to measure how much additional capital the banks should add as a buffer against higher losses. But they provided no concrete metrics to assess the depths of the troubles facing the industry or specific banks.
Still, the Federal Reserve report suggested that regulators are focusing on the amount of capital that they want banks to hold in common stock, which makes it easier for them to absorb future losses as the recession wears on. That could force at least a handful of the 19 banks to raise significant amounts of new capital and could lead to greater government ownership stakes in the banks.
“Losses associated with the deepening recession and financial market turmoil have substantially reduced the capital of some banks,” the Federal Reserve report on the stress test said. “Lower overall levels of capital — especially common equity — along with the uncertain economic environment have eroded public confidence in the amount and quality of capital held by some firms, which is impairing the ability of the banking system to perform its critical role of credit intermediation. “
Despite the limited details, Wall Street analysts and traders are already using whatever glimmers of information that have seeped out to conduct their own “stress tests.” Investors are making bets on which bank stocks may rise or fall even before the official exam results are announced. The stress test criteria were released as federal regulators started briefing top executives from the 19 large banks about how their companies fared on the examination. In closed-door meetings at the regional Federal Reserve Bank offices, the regulators plan to review their preliminary findings and inform bankers if they need additional capital. The banks will have until Tuesday to dispute any of the results before they are made public on May 4.
Wall Street has been buzzing about the stress tests since they were announced two months ago as a cornerstone of the Obama Administration’s plans to aid the nation’s ailing banks and overhaul the regulatory system. The program was designed to bolster confidence in the financial system, with regulators certifying which banks were healthy enough to start returning the government bailout money, and which banks needed additional capital.
But it has turned into a minor quagmire, putting regulators in the awkward position of picking winners and losers and setting off internal debates over how much of the confidential test information to disclose. Federal law requires banks to keep exam results under wraps.
Regulators have not yet formally required banks to increase their levels of core capital, or tangible common equity to protect against losses, but the additional capital cushion moves in that direction. Previously, regulators have suggested that banks maintain a tangible common equity ratio of 3 percent, and focused on a broader metrics of financial strength.
Regulators and investors want banks to increase the amount of tangible capital they hold so they can more quickly write down losses that many still expect from real estate, credit cards and other troubled assets.
Investors are paying close attention to the methodology. Even so, the new information is unlikely to provide a full picture of the banks’ financial condition, said John McDonald, a banking analyst at Sanford C. Bernstein.
The data, for example, does not reflect differences in each bank’s lending standards or their ability to generate revenue. Nor does it account for the fact that banks made more loans in areas like California and Florida, where the housing and job markets have been hardest hit.
Investors and the banks have been bracing for the official findings since early March, when the banks sent regulators their own results of a series of computer-run analyses that looked at what might happen if the economy deteriorated. The tests, overseen by the Federal Reserve, involved more than 150 banking regulators and asked the banks to analyze how a variety of hypothetical situations would affect their loss rates. Those include unemployment rising to 10.3 percent by next year, home prices falling an additional 22 percent this year, and the economy contracting by 3.3 percent this year and staying flat in 2010.
As part of the test, the banks analyzed each category of loans they held and compared their results with the ”high” and ”low” range of government loss estimates. If a bank expected fewer losses than the government did, the regulators asked the institution to explain why. The banks were also asked to project their earnings over the next two years to give the regulators a better sense of how much capital they would have to absorb the coming losses.
Over the last few weeks, top federal officials have been combing through the data to get a handle on the depth of the banks’ losses. They also tried to make apples-to-apples comparisons across all 19 banks before determining how much fresh capital each needs.
Banks will be given the chance to raise money from private investors first, but the fragile condition of some lenders and the short timetable before the results are made public makes it increasingly likely that they will return to the government for money.
Administration officials say that the banks may also be able to convert the government’s existing preferred share investments into common shares. That will allow the Treasury Department avoid returning to Congress for additional bailout money but it also could lead to greater government ownership of the banks."
Is there any good reason to follow through with the stress tests and actually release the results?
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