Was the Bank Stress Test Leaked? It Appears So.

I first heard about this Monday morning that the bank stress test being conducted by the Treasury was leaked on Sunday. The AP released a story Monday evening basically stating that they received the stress tests results on Sunday. Below is a summary of their comments.

By the way if you are interested in a much more inflammatory version of the stress test try TRN. I do NOT support many of the views given on their site and I do not know how reputable their stories are but it is another version.

Text in bold is my emphasis.

The government is giving Wall Street banks a helping hand. But this time it's not a handout.
The federal bank "stress tests" rate the individual loans held by big regional banks as riskier than the complex troubled assets held by the industry titans, according to a Federal Reserve document obtained by The Associated Press.

That approach could threaten some major regional banks while making the national banks appear in better shape when the government releases the results of the tests next month.
Regulators are administering the tests to 19 large financial firms to determine which banks are healthy, which need more help and which might fail if the recession worsens.

Under one scenario, the tests assume banks will see "no further losses" on the complex securities, according to the document obtained by AP. By contrast, it estimates that individual loans will lose up to 20 percent of their value.

Regional banks are holding more individual loans and fewer of the securities Wall Street giants specialize in — complex derivatives backed by huge pools of mortgage-backed loans and other debt.

Analysts say regulators are probably favoring the largest banks because if even one failed, it would pose a grave financial risk. Banks that deal in securities are more connected to other corners of the global financial system.

Regulators also face pressure to highlight the weaknesses of some banks. Otherwise, critics will dismiss the tests as a whitewash. That could undermine one aim of the tests — restoring confidence in the banking system.

The approach spelled out in the Fed document "certainly penalizes those banks that are more involved in traditional banking, which frankly have been performing better in recent months," said Wayne Abernathy, a former Treasury Department official now with the American Bankers Association.

He said banks' loan portfolios have lost only about 5 percent of their value so far, while the values of complex securities are down 30 to 40 percent.

The securities are held mostly by banking titans like Citigroup, JP Morgan Chase, Bank of America and Goldman Sachs. Their value is based on the performance of vast pools of underlying loans.

As defaults on the underlying loans spiked last year, investors lost confidence in the value of the assets. Individual loans have lost less value because their prices are tied more closely to actual defaults.

A Treasury Department spokesman referred questions to the Fed. A spokesman for the Federal Reserve declined comment.

Scott Talbott, a banking industry lobbyist with Financial Services Roundtable, said it's hard to conclude that the method discriminates because there are vast differences among all the companies on the list, regardless of size.

Regulators are administering the tests to all financial institutions with assets of at least $100 billion. The 19 institutions on the list include an insurer, Wall Street brokerages and regional banks, such as Cincinnati-based Fifth Third Bancorp and Cleveland-based Keycorp.

A spokeswoman for Fifth Third Bancorp said the bank would not comment. Keycorp did not respond to requests for comment. The bank said Tuesday it lost $488 million in the first quarter, partly from a large increase in what it sets aside to cover loan losses.

Some other regional banks on the test list also reported disappointing quarterly earnings Tuesday, reflecting steeper losses as people fell behind on loan payments. U.S. Bancorp's profit fell 61 percent, Regions Financial's 92 percent.

The Fed document obtained by AP doesn't mention any bank by name. And no sources or regulators would discuss any bank's performance on the tests. But some analysts have said a poor showing on the test could hammer a bank's stock or the broader market.

"The market is now pricing in an expectation that these reports are going to be pretty good," said Lawrence Brown, an accounting professor at Georgia State University. "So I think the downside risk is bigger than the upside potential."

Douglas Elliott, a former investment banker at JPMorgan now at the Brookings Institution, said only test results that reveal "substantial capital needs" will have credibility.

Once the results are announced May 4, regulators are expected to put the firms into three groups: those that are healthy, those that need more money to stay healthy and those at risk of failure.

The approach in the Fed document could help keep the largest banks out of the weakest category. That would avert the risk that bad news about the biggest banks could set off a market panic.

But it won't help the banks lower on the list. They could face pressure from speculators using share prices, futures and options to set off a wave of selling. Investors "already are preparing their strategies," Abernathy said.

Treasury Secretary Timothy Geithner told a congressional panel overseeing the federal bailouts that "the vast majority" of banks have more capital than they need. He said regulators would decide when banks will be allowed to pay the government back.

In the stress tests, regulators are putting banks through two scenarios. One reflects forecasters' expectations about the recession. The other assumes a more severe recession than expected.

Both tests measure losses that banks could face over the next two years against the cash cushions they hold to protect against those losses.

For the test that uses current expectations for the recession, banks can value securities as they have in recent filings. But losses for loans are estimated to range between 5 and 12 percent for mortgages and as high as 17 percent for credit cards.

Under the test that assumes a more severe recession, loan losses are projected at 7 to 20 percent. Securities in that test would be marked down based on market disruptions during the second half of 2008.