Market tense over stress-test results

Recent reports have suggested that Bank of America and Citigroup, in particular, are in need of more cash.

Both of the banks suffered from share price falls on the back of the news. From a level of $8.92 at closing on April 27, Bank of America had slumped to an intra-day low of $8 by 9.30am on April 28. It had rebounded to $8.15 by close on April 28. Meanwhile, Citigroup went from $3.07 at closing on April 27 to an intra-day low of $2.85 by 3.34pm on April 28. It closed at just $2.89 later that day.

The attention of some observers has been drawn elsewhere, as bank analysts attempt to predict the winners and losers.

A report by Morgan Stanley analysts on April 27 suggested several of the smaller banks involved could also be in need of capital, including Ohio-based KeyCorp, Alabama-based Regions Financial, Atlanta-based SunTrust, Wells Fargo and Wilmington Trust.

The details of the stress tests, conducted under the Capital Assistance Program, were released on February 25. Under the plan, banks have been asked to stress their holdings under two scenarios - a baseline case and an alternative 'more adverse' scenario.

The Morgan Stanley report speculated that the 19 banks involved in the exercise would be placed into three categories: those with sufficient capital, those needing more capital over time and those that need capital immediately.

In total, banks could require anything up to $60.9 billion, Morgan Stanley analysts said. The prediction is based on the government requiring banks to maintain a minimum Tier I capital ratio of 6%-8%.

Although regulators have required banks to make an effort to harmonise loss assumptions across 12 different categories of loans, it is not yet known what the exact figures are. As a result, analysts used loss assumptions reported in the financial press. They also assumed regulators would focus vigorously on Tier I capital, as opposed to other measures of core capital.

Across the institutions under scrutiny, Morgan Stanley analysts looked at total Tier I capital, Tier I capital excluding any funds received under the Troubled Assets Relief Program (Tarp), and Tier I capital excluding Tarp money and private preferred funding.

"On the basis of our analysis, the less-strong names on our list include SunTrust, Regions Financial and Wilmington Trust," the report said. So-called 'cuspy names' included Wells Fargo and KeyCorp, it added. Banks that ranked higher included Bank of New York Mellon, Citigroup, JP Morgan and State Street.

While the analysts considered the effect of some off-balance sheet exposures, they did not investigate the impact of shocks to trading books for banks with trading assets in excess of $100 billion - something that is included in the government stress tests. According to an explanatory note released by the Fed on April 24, the five banks with trading assets over $100 billion have been asked to simulate a shock to liquidity similar to that which occurred between June 30 and December 31, 2008.

The difficulty of forecasting the results of the bank stress tests underlines the high number of assumptions involved. "Without knowing the minimum levels of capital required by regulators in the stress test, it is difficult to have a high level of confidence in the capital requirements that we estimate," said the Morgan Stanley report. Equally, the assumptions used for losses on loans and other more complex assets are likely to have a big impact on the results, market participants said.

The report added that volatility in bank stocks should remain high until May 4 - the day the results are expected to be released.

See also: Fed divulges process behind bank stress tests

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