Sunday, April 26, 2009

The Bank Stress Test - What We Know So Far

Let's keep a tally of the statements that have come out recently about the banking industry in the US. By the way, I omitted most of the optimistic statements (except for profit reports) due to the large fluff component:

1. Lending is down since last fall.
2. The Treasury is talking about converting the bail-out money to equity
3. The Treasury will tell the banks when they can re-pay the TARP money
4. According to the IMF the banks are still not half way through their losses
5. President of the KC Fed thinks some financial institutions should be allowed to fail
6. There is talk of the the break-up of the large banks.
7. The banks need more capital (see below).
8. Most large banks turned a profit in the first quarter
9. Foreclosures continue to grow
10. Most banks still have weakening credit card and commercial real estate loans to address

Does this sound like a healthy banking system to you? Note one thing - no helathy banking system - no recovery. Text in bold is my emphasis. From Yahoo News:

The top 19 U.S. banks need to hold a "substantial" amount of capital above regulatory requirements to weather a potential worsening of the economic recession, the U.S. Federal Reserve said on Friday.

The Fed said so-called "stress tests" that regulators conducted at major banks are aimed at ensuring the institutions have enough capital in reserve to continue to lend in potentially bleaker conditions, and are not a measure of banks' current solvency.

"It is important to recognize that the assessment is a 'what if' exercise intended to help supervisors gauge the extent of capital needs across a range of potential economic outcomes," the Fed said in a white paper outlining the methodologies regulators employed.

The concept paper is a precursor to release of the results of the stress tests on May 4. A closely-watched outcome of that exercise will be to determine which of the banks, which include Citigroup Inc, JPMorgan Chase & Co, and Wells Fargo & Co, need to raise more capital, possibly with government help.

The paper did not quantify the size of the buffers banks may need to build, or say how the results would be presented.

"The market may be disappointed by the lack of details, as there is not much new in the report, but at the margin, it does sound as if regulators will give each company a real review, rather than a rubber stamp of approval for the group," said Paul Miller, an analyst with FBR Capital Markets in Arlington, Virginia.

The White House said it expects some banks to release their own results.

"Our strong inclination is to provide transparency," White House spokesman Robert Gibbs told reporters. "I think you'll see some banks release on their own some of the results and we'll release what we deem applicable."

Most U.S. banks have capital levels well in excess of the amounts required to be well capitalized, the Fed said. However, lower overall levels of capital, especially of common equity, and the uncertain economic outlook have impaired bank lending, it added.

Officials said the size the additional capital buffer would vary, depending on the riskiness of institutions.

The paper outlined the underlying concepts or variables used in the tests of how the 19 largest banks would fare if the economy -- already in the throes of one of the longest and deepest recessions in decades -- took an even sharper turn for the worse.

A senior Fed official said on Friday that although some see signs the recession may be ending, doubts remain.

The Obama administration's goal is for the stress tests to restore confidence in the U.S. banking sector, which has been battered by losses from the collapse of the housing market, a spike in credit defaults and the painful recession.

The tests could also require some institutions to come clean about weaknesses and commit to a course of action to regain health. Those salvage plans could include seeking further government assistance and, at the extreme, result in the firing of senior managers.

Treasury Secretary Timothy Geithner announced the tests on February 10 as part of plans to purge toxic assets from the U.S. financial system and restore credit flows.

Examiners subjected banks to stresses stemming from a scenario in which the economy shrinks by as much as 3.3 percent this year and in which unemployment goes as high as 10.3 percent next year. Some analysts have criticized those parameters as not stringent enough.

The institutions undergoing stress tests also include: Bank of America Corp, Goldman Sachs Group, Morgan Stanley, MetLife, PNC Financial Services Group, US Bancorp, Bank of NY Mellon Corp, SunTrust Banks Inc, State Street Corp, Capital One Financial, BB&T Corp, Regions Financial Corp, American Express Co, Fifth Third Bancorp, Keycorp, and GMAC LLC.

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