19 biggest U.S. banks start getting 'stress test' results

McClatchy NewspapersApril 24, 2009 

WASHINGTON — The nation's 19 largest banks began receiving results Friday of "stress tests" designed by federal regulators to gauge how they'd perform if the economy sinks further than projected. Several of the banks are widely expected to be ordered to raise more capital or face the prospect of partial government ownership.

The results of the stress tests won't be released until May 4. Even then it's not clear just how much detail of their balance sheets will be revealed. However, the Federal Reserve on Friday laid out the methodology used in the tests, which began in February for bank-holding companies with assets that exceed $100 billion.

Regulators put the banks under a gag order, giving them a week privately to challenge the findings and the required buffer of additional capital they'll need to raise from the private sector, accounting maneuvers or additional government support.

In a briefing for journalists, given on the condition of anonymity because results haven't been released, senior Fed officials hinted that several banks are being told to raise more capital as a buffer against the possibility of a deeper economic decline.

That will help banks survive what are expected to be mounting losses on their residential and commercial mortgage holdings, as well as deterioration of other assets.

Analysts long have suspected that two of the world's largest banks — Citigroup and Bank of America — are among the institutions that will need to raise more capital. They already have special arrangements with the government that allow their existing taxpayer-bailout loans to be converted into government-owned shares of the companies if necessary.

Although regulators took care not to identify the banks that'll need more capital, investors made their own calculations. Banks that were perceived to be healthy saw their shares rise Friday, with Wells Fargo soaring 6.17 percent, while troubled Citigroup lost 0.62 percent and giant regional bank Fifth Third Bancorp fell 2.88 percent.

To increase transparency, the Fed and other bank regulators posted a 21-page paper outlining the methods they used in gauging the banks' health and their economic assumptions for the "stressful" situation they simulated to gauge how banks would hold up. The assumptions included a 10.3 percent unemployment rate and an economic contraction of 3.3 percent this year.

"I thought it was 21 totally anticlimactic pages. What they told us is what we already knew," said Douglas Elliott, a financial specialist for the Brookings Institution, center-left research center. "In the end the numbers are going to depend on the supervisory judgment that was used. . . . Since they're not telling us anything about the judgment, there is no way to tell if this is going to be a tough test or not."

Elliott expects about a third of the bank-holding companies to be given six months to raise more capital, a figure in line with banking-industry expectations.

Some bank experts questioned the usefulness of the stress tests, especially since regulators already look forward in anticipating problems facing any bank. In addition, they've raised an expectation of firm public results. If the results aren't made public, the "stress tests" could lead to LESS clarity about the banks' health.

"I think they've really gotten themselves into a box on this that they don't know how to get out of. I don't think we're going to see hard ratings on individual banking companies," said Bert Ely, a consultant. "I think people are going to walk away from it and say, 'What was the point of it?' It muddies the waters. It certainly is not positive, but it may create some real credibility problems for the government."

Vincent Reinhart, a former top Fed economist, sees a different design at play. The tests, he said, build on a recent relaxation of accounting standards that gives banks wiggle room to shift the focus away from what distressed assets are worth. The stress tests look at the ongoing flow of profits or losses, not the present value of assets.

"It's all about what losses are you going to get on existing loans, not what is their current market value," said Reinhart, who's now a senior fellow at the American Enterprise Institute, a conservative research center. "If banks can generate income on a 'flow' basis, and we let them not look back, then we can delay when we actually recognize their losses."

The approach assumes that the banks eventually will outgrow the distressed assets on their balance sheets as the economy comes back to life, which also will enhance the value of those assets. Given that Congress won't provide any more bailout money, the tests will "emphasize current profitability and not losses sitting on the balance sheet," Reinhart said.

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