Expectations were low back in February when the Federal Reserve and Treasury Dept. first announced their plan to conduct “stress tests” on big banks, to gauge their ability to weather a nasty recession. The test criteria weren’t all that stringent, for one thing, and the initial plan was to keep the results confidential anyhow.
Plans changed, and the government has now provided an unprecedented glimpse into the health of America’s 19 biggest banks. Overall, the Fed says 10 troubled banks need to raise $75 billion in additional capital, which is a serious bogey for the banks, but not as bad as some analysts expected (which might be one reason the Fed decided to release the results). The test results also include some detailed data on expected losses at each of the banks, loss rates on various kinds of loans, and varying degrees of exposure. Here are some of the revelations contained in the results:
The tests were “pass/fail” after all. The Fed didn’t deem any big banks insolvent, which some critics think would have happened under tougher criteria. And Fed Chairman Ben Bernanke and others have insisted that the tests weren’t intended to grade the banks, or identify good banks and bad banks. But that’s effectively what they’ve done. There was a definitive threshold—whether the bank met key capital requirements or not—and the Fed identified which banks fall above the threshold and which fall below it.
[See the best and worst bailed-out banks.]
Here are the firms that “passed,” and don’t need to raise additional capital: American Express, BB&T, Bank of New York Mellon, Capital One, Goldman Sachs, JPMorgan Chase, Metlife, State Street, and US Bancorp. Here are the banks that “failed,” and need to raise more capital: Bank of America, Citigroup, Fifth Third, GMAC, KeyCorp, Morgan Stanley, PNC, Regions Financial, SunTrust, and Wells Fargo.
We should feel relieved that the government is finally singling out the sick banks instead of treating all banks the same. That will allow healthy banks get back to business as usual, leaving regulators to figure out what to do about the rest. Now we have to wait and see if the stress tests accurately measured the health of the banks, or glossed over problems that might still be worse than acknowledged.
[See a list of banks most likely to pay back the bailout funds they’ve received.]
Citigroup isn’t the worst. There’s never been an official ranking, but Citigroup has generally been considered the poster child for rogue banking and horrendous risk-taking, with its shares pummeled by skeptical investors. But the stress tests highlighted other banks in even worse shape. Citi only needs to raise $5.5 billion in additional capital, for instance. Bank of America needs $34 billion, six times as much as Citi. Wells Fargo and GMAC both need to raise more than Citi, too.
That said, Citi has already made plans to convert billions in government-owned “preferred shares” to common stock, which made its numbers look better. Other banks may do the same, effectively shifting funds and changing their accounting to satisfy the government’s requirements.
There’s now an official estimate of total bank losses. The Fed estimates that the 19 biggest banks could lose up to $600 billion through 2010. That would bring total losses for these firms since mid-2007—when the housing bust first started to slam their earnings—to about $950 billion, according to the Fed. The 19 stress-test banks account for about two-thirds of all bank assets and more than half of all loans in the U.S. So by extrapolation, total U.S. bank losses from the financial meltdown could range from $1.4 trillion to almost $2 trillion, based on the Fed’s numbers.
That’s lower than other estimates. The International Monetary Fund, for example, estimates that total losses from the financial crisis could total $4 trillion, but that’s a worldwide figure that’s not limited to the banking sector. The majority of those losses could come at U.S. banks, though, so the IMF’s figure could be more pessimistic than the Fed’s. Regardless, the Fed has now put a benchmark figure on the table.
Loss rates at the banks are alarming. The financial crisis began with mortgage losses, and lately we’ve been hearing about other types of losses that could compound the banks’ problems as the recession progresses. The stress tests spelled out the risks. The Fed estimates that loss rates on all loans at the 19 banks over the next two years could reach 9.1 percent. That’s a scary number. Typical overall loss rates since World War II have run between 1 and 2 percent. In the 1930s they peaked at just under 9 percent. So the Fed is predicting loss rates WORSE than during the Great Depression.
Credit card losses could swamp housing-related losses. The Fed calculated the expected median loss rate on mortgages over the next two years at 8 percent. For credit cards, the median expected loss rate is 22.3 percent. KeyCorp has the worst exposure to credit cards, with an expected loss rate of 37.9 percent. Other banks with worse-than-average exposure to credit card losses: Wells Fargo, Bank of America, and Citigroup, which not surprisingly are also the biggest credit-card issuers.
Size helps. Citi and Bank of America have the biggest projected losses, but they’re also among the largest banks, with considerable resources to help absorb losses (including those federal injections). Some smaller banks have fewer resources relative to amount of losses they’re expected to absorb, which presents a different picture of which banks are most vulnerable. When measuring expected losses against the size of the bank and its ability to absorb losses, the weakest banks are GMAC, KeyCorp, Morgan Stanley, Regions Financial, State Street, and PNC.
That hints at another problem regulators may have to deal with soon: Losses that overwhelm dozens or hundreds of medium-sized regional banks. More stress tests may be on the way.