Regulators Stress-test 19 Banks

123jump.com Staff
25 Apr, 2009
New York City

Fed and other regulators are testing capital adequacies at 19 banks for two alternative economic scenarios that may not be stressful enough. Banks may need additional $850 billion in capital as tangible equity ratios remain low, despite the Fed's assertion of adeuqate capital at these banks.

[R]6:50PM New York[/R] - The latest bank stress tests guidelines released by Fed included 19 banking institutions each with more than $100 billion in holdings. The capital adequacies at 19 banks were tested for two alternative economic scenarios that may not be stressful enough. Banks may need additional $900 billion in capital to meet Fed capital adequacy requirements.

According to the latest stress test guidelines released by the Fed, the banks’ capital needs will be tested based on two economic scenarios for 2009 and 2010 that includes growth or decline in economic activities, level of unemployment and fall in home prices.

The Fed officials are walking a tight rope in trying to calm financial markets and push banks to raise capital from private sources as banks look for ways to repair their balance sheets. The 19 banks involved in the test since February includes all the top banks, regional banks and some of the recently converted brokers to banks.

What Tests Are Designed For?

The Fed regulators are charged with the task of estimating how much capital banks will need and will the government need to bailout banks and which ones. The stress tests are designed to evaluate the solvency of individual banks. The results are expected to be announced on May 4.

The exact nature of what these results will be and how they will be released is still not clear. On the one hand Fed will like to maintain the confidentiality of their recommendations and on the other hand it will like to restore confidence in the financial system without causing any panic. Stress tests will not calm financial markets since the Fed has already mentioned that most banks have adequate capital but most investors are not convinced.

However, two-case tests assume mild economic decline in the current year and both scenarios assume economy to rebound in 2010, which may or may not occur. It seems that there in not enough stress applied in the tests. The housing market remains weak and despite low interest rates the new and existing homes sales have yet to bottom out.

Not Enough Stress in Tests

In the first scenario, GDP is expected to decline 2% in 2009 and rebound in 2010 at 2.1% rate. Unemployment is expected to be at 8.4% in 2009 and drop further to 8.8% in 2010. House prices decline, the root cause of the current financial malaise, is estimated to decline 14% in 2009 and additional 4% fall in 2010.

In the second scenario, the Fed’s worst case, the economy is expected to shrink 3.5% in 2009 and recover with 0.5% growth in 2010. Unemployment is expected to hit 8.9% in 2009 and increase to 10.3% in 2010. Home prices are expected to fall 22% in 2009 and drop additional 7% in 2010.

All domestic banks with more than $100 billion in assets are required to participate in the capital assessment program that will span between February 25 and April 29. In all, 19 banks participating in the program hold two-thirds of assets and more than one half of all loans in the U.S. banking system.

Losses at these 19 firms are estimated to be approximately $400 billion in the last six quarters. Stress tests are conducted to measure loan losses in 12 categories of loans held in two different economic scenarios till the end of the fourth quarter 2010.

How Many Are Involved

More than 150 regulators and examiners from various federal agencies are involved in the assessment. The Treasury and White House appear to be deeply involved in the current assessment, which is a departure from prior crisis management when the Fed and other regulators were left alone.

In particular, there were teams charged with examining loss projections for consumer portfolios, commercial and industrial and commercial real estate loan portfolios, securities portfolios, trading account assets, and counterparty credit risk, and teams examining projections of pre-provision net revenues and allowances for loan and lease losses coverage.

There were also advisory groups composed of specialists in accounting, regulatory capital, and financial and macroeconomic modeling.

The initial assessment of tests were informed to 19 banks and the final capital assessment will include first quarter results and other corporate activities including sale of assets or issuance of equity securities.

More Capital Needed

Supervisors relied on range of capital measures to determine the capital buffer and prefer the equity capital to be the ‘dominant component’ of Tier 1 capital. However, most banks that are tested have weak tangible common equity as a portion of total capital.

Citigroup has the least tangible common equity ratio of 1.7% and Bank of America has 3% tangible equity as part of total capital. Capital One Finance and American Express, the two credit card lenders have the highest tangible capital ratios of 6.4% and 7.3% respectively.

If all banks in the stress-test were required to have tangible equity capital ratios similar to that of American Express, 123jump.com estimates that these 18 banks will need at least $850 billion in additional capital. The Treasury still has $110 billion available in TARP funds but most of the capital will have to be raised by banks from private investors.

The IMF has suggested that banks will need between $275 billion and $500 billion but that assumes that banks earnings will recover by the fourth quarter of this year but 123jump.com estimates earliest possible earnings recovery in the first quarter of 2010. The administration is not in a position to ask for more money from the Congress as the public is weary of additional money for banks.

These 19 large institutions have substantial earnings power as loan fees to consumers and small businesses remain high and lucrative investment banking fees, though they have declined in the last two years still provide substantial profit. None of these banks have lowered fees for their customers in the recession or attempted to lower executive salaries.

Who Are These 19 Banks

The identities of the following eighteen of the 19 banks in stress-test were confirmed by 123jump.com.

J.P. Morgan & Chase Co. ((JPM))
Wells Fargo & Company ((WFC))
Bank of America Corp ((BAC))
Citigroup Inc ((C))

SunTrust Banks, Inc. ((STI))
Regions Financial ((RF))
KeyCorp ((KEY))
Fifth Third Bancorp ((FITB))
U.S. Bancorp ((USB))

Morgan Stanley ((MS))
Goldman Sachs Group, Inc ((GS))
State Street Corporation ((SST))
BB&T Corp ((BBT))

MetLife, Inc ((MET))
American Express Company ((AXP))
Capital One Financial Corp. ((COF))
PNC Financial Services Group ((PNC))
The Bank of New York Mellon Corporation ((BK))