U.S. delays release of bank stress tests, fueling concerns

McClatchy NewspapersMay 1, 2009 

WASHINGTON — The Obama administration and the Federal Reserve have pushed back until May 7 the release of much-anticipated results on how the nation's 19 biggest banks performed under so-called stress tests.

The tests are designed to gauge how the banks' finances would hold up in an even tougher economic environment than the current dismal downturn. Results were expected Monday but were pushed back to give banks more time to argue their case that they shouldn't be forced to raise more capital.

"The government expects to announce information from the stress assessment exercise late Thursday afternoon," said a government source, who demanded anonymity because he was not authorized to speak publicly on the matter.

Since mid-February, the 19 banks with assets above $100 billion were subjected to an unprecedented evaluation that looked at the hypothetical performance of their loans and investments in an environment where the economy contracted 3.3 percent, unemployment shot up to 10.3 percent and credit card losses mounted to 20 percent.

If big losses were projected for a bank, it would be given six months to raise additional capital in order to buffer against those hypothetical losses.

The anticipated results are important because they'll give both investors and depositors a better sense about the strength of a particular bank's loan and investment portfolio.

The exercise, however, is fraught with risk.

The Obama administration wants to provide Americans enough information to draw reasonable conclusions about a bank's health but not so much information that it sparks a bank run.

"If they don't provide information that suggests differentiation across institutions, then the credibility of the exercise will be called into question," said Vincent Reinhart, a former top economist at the Fed. "But if you release too much information ... you have the possibility of a funding problem that puts an institution at risk — very tough line to walk."

Given the turmoil in the financial sector over the past 18 months, banks are thought to be vigorously challenging the stress-test results.

"In this environment, nobody in a financial institution wants to have anything released that differentiates it from the rest of the pack," said Reinhart, now a scholar at the American Enterprise Institute, a conservative think tank. "So it is entirely natural that self-interest would lead them to want to smooth away any rough edge."

Other analysts warned the test results might force banks to report worse-than-expected earnings during their routine regulatory filings.

"Doesn't this imply that banks that don't pass the stress test and must raise more capital should also report even weaker earnings to reflect greater projected loan loss provisions?" investment analyst Ed Yardeni wrote in a Friday research note.

Banks will learn on Tuesday just how the results will be presented on Thursday. There are plenty of unknowns, not the least of which is whether banks — now under a gag order to not discuss specifics — will be allowed to discuss the details of their stress-test result.

If a bank can't raise the enough capital in the private sector for the government-mandated buffer, pre-existing government loans to the banks could be converted into a special class of stock that would give U.S. taxpayers an ownership stake in the company. That frees up banks from having to pay the federal government the 5 percent interest rate on the taxpayer bailout.

Giant lenders Bank of America and Citigroup, already huge recipients of taxpayer bailout money, are challenging the test results. They were widely expected to need additional capital.

"There is a lot of talking," Bob Stickler, a Bank of America spokesman, told The Charlotte Observer this week. "We're working through the process."

Markets are already punishing regional bank stocks, assuming that these institutions are more exposed to an expected wave of defaults in commercial real estate tied to the economy downturn. These banks include Fifth Third Bancorp and Regions Financial Corp.

Financial services firm Keefe, Bruyette & Woods conducted its own stress test late last month on the banks and concluded that the sector will need to raise $1 trillion in new capital to meet the government's required buffer.

Meanwhile, the White House on Friday downplayed the delayed results.

"I think I would not read anything into the delay and results, except the notion that regulators and the administration want to get this right from the very beginning," spokesman Robert Gibbs said during his daily press briefing. "Obviously, these are very complicated. There's a lot of information that we want to get right and we want to ensure that when that transparency happens, that the information is correct."

The Federal Reserve and other federal bank regulators published on April 24 a special report, called a white paper, detailing the criteria that they are using to gauge a bank's health under the stress tests. This report showed the losses on residential and commercial mortgages are being assessed, as well as business loans, credit cards and a number of investments made in the securities and credit markets.

"The government will provide information, both in the aggregate for the institutions as a group and also institution by institution," said the government source. "That information will track what could in the white paper ... it will include estimated losses for those loans, resources for loans in scenarios where the economy performs worse than expected. This is not a solvency test, it's like a what-if experience."

Banks have frequently argued they are quite solvent. But last year's collapse of investment banks Bear Stearns and Lehman Brothers both involved institutions that were solvent on paper but saw their access to capital — sometimes called liquidity — disappear almost overnight. The clear lesson was that without an adequate buffer, a bank liquidity crisis can lead to insolvency.

(Margaret Talev contributed to this article.)

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