Posted by: Ben Steverman on April 24, 2009
The U.S. Treasury today releases the methodology for its “stress test” of major U.S. banks, but the full results may not be known until May 4.
The results matter to investors even if a bank technically passes the federal government’s test. A weaker assessment could force banks to raise additional capital, which would dilute existing shareholders.
Investors and analysts are already betting on the results of the stress tests. An Apr. 23 report from Keefe, Bruyette & Woods (KBW) is particularly interesting in this regard.
KBW’s bank research team conducted its own stress test, making educated guesses at what Treasury would require. It tried to assess the credit fallout for banks of a 2010 unemployment rate of 10.3% and more serious credit deterioration for mortgages, credit cards and loans in home equity, commercial and commercial real estate.
One conclusion from KBW: Based on an analysis of the entire U.S. banking system, the industry eventually could need an additional $1 trillion of capital to meet certain credit benchmarks and meet regulatory definitions of “well capitalized.”
KBW individually examined 17 of the banks undergoing the first round of stress tests. It expects none will fail the tests.
But, Bank of America (BAC) “has a higher risk than its peers to be forced by the U.S. government to receive yet another round of government capital.” After a stress test of BofA’s loan portfolio, KBW estimates it could see another $78 billion in losses, 8.9% of its loan balance from the first quarter of 2008.
JPMorgan Chase (JPM) may need another $10 billion in capital, but will be able to raise that money in private markets without government help, KBW concludes.
The report says a “significant capital raise is needed to strengthen the balance sheet at Wells Fargo.” (WFC)
There is good news in KBW’s conclusions. U.S. Bancorp (USB) is “unlikely to require additional capital.”
Many of these assessments are already well reflected in bank share prices. For example, U.S. Bancorp’s stock is down 46% in the past 12 months, but BofA shares have dropped 76%.
Of course, the U.S. Treasury, relying on a larger staff and different methods, could reach very different conclusions from KBW or other experts. For bank investors, a big worry (and opportunity) is the unexpected. Stress test results could scramble our assumptions about which banks are truly weak or strong.