On May 7, 2009, the Federal Reserve released its Overview of Results of the Supervisory Capital Assessment Program (or Stress Test). The headlines regarding the Stress Test Results are likely to emphasize that ten of the 19 participating institutions are required to collectively raise $74.6 billion in new common equity, as follows:
- American Express – $0
- Bank of America – $33.9 billion
- BB&T – $0
- Bank of New York Mellon – $0
- Capital One – $0
- Citigroup – $5.5 billion
- Fifth Third – $1.1 billion
- GMAC – $11.5 billion (of which $9.1 billion must be new Tier 1 Capital)
- Goldman Sachs – $0
- JP Morgan – $0
- Key Corp – $1.8 billion
- MetLife – $0 billion
- Morgan Stanley – $1.8 billion
- PNC Financial – $0.6 billion
- Regions – $2.5 billion (of which $400 million must be new Tier 1 Capital)
- State Street – $0
- SunTrust – $2.2 billion
- U.S. Bancorp – $0
- Wells Fargo – $13.7 billion
Notably, only GMAC and Regions have to raise new Tier 1 Capital in order to satisfy the Stress Test standards; the remaining entities may satisfy the standard by converting existing Tier 1 Capital (such as the TARP Capital Purchase Program funds) into Common Stock. This can be accomplished under the TARP Capital Assistance Program without any additional use of Treasury funds.
For the 8,000+ banks that did not participate in the Stress Test, however, the takeaways are likely to be completely unrelated to the actual results encountered by the 19 participating institutions.
First, for banks looking to stress test their own portfolios, the Stress Test used the following range of indicative loss rates:
As noted in the Overview of Results, the estimated loan loss rates under the more adverse scenarios are high by historical standards. The overall two-year cumulative loss rate on total loans equals 9.1 percent in the more adverse scenario.
Second, the Stress Test introduces a new regulatory capital measure: Tier 1 Common to Total Risk-Weighted Assets. While the results emphasize that this is not intended to represent a new capital standard, it certainly re-emphasizes the importance of common stock vis-a-vis other forms of Tier 1 Capital. Tier 1 Common is defined as Tier 1 capital less non-common elements, including qualifying perpetual preferred stock, qualifying minority interest in subsidiaries, and qualifying trust preferred securities. Based on the Stress Test buffer, it appears that regulators will be looking for Tier 1 Common to be at least 2/3’s of overall Tier 1 Capital, a standard that most community banks will probably be able to satisfy.
Third, the Stress Test represents a fundamental departure from the standard practice of keeping examination information confidential. The Overview of Results explains this departure as a belief that greater clarity around the Stress Test process and findings will make the exercise more effective at reducing uncertainty and restoring confidence in our financial institutions. If this belief turns out to be accurate, one wonders what impact it may ultimately have on the bank examination process generally, which to date is confidential by statute. There may be political pressure on the banking regulators to provide more information about the results of the examination process generally, which could have a trickle down effect on all institutions.