There is a rather curious lead story up at the Financial Times website tonight. I’m generally a fan of the FT, but I am beginning to wonder if its standards are slipping.
Headline: “Smaller US banks need additional $24bn” But what the story tells us is that “research conducted for the Financial Times” which was carried out by Sandler O’Neill.
The problem with this report is that without supporting detail, it’s hard to know what to make of it. First, we’ve been dubious of the stress test methodology from the get go. As Saturday Night Live marvelously summarized it, the grading system was pass/pass. The notion was to appear tough without actually being tough, since the objective, stated openly at the outset and repeated during the course of the tests, was to “restore confidence” and prove the big banks to be solvent. The oft-cited beers were that the adverse case wasn’t dire enough, that the exam did not make enough allowance for the about-to-strike commercial real estate implosion, and that it was also tougher on loan portfolios (ex CRE) than on risky trading exposures.
So let us go through our litany of issues with the FT article:
1. The FT headline and even the first make the need for $24 billion seem more definitive than it really is.
2. It serves to dignify the stress tests, which were a dubious exercise
3. Smaller and regional banks often have very high construction loan exposures, and those can deliver much greater losses that other types of loans. In other words, there is better reason with these banks to think that the downside could be more serious than for big banks with more diversified portfolios.
4. The FT gives no detail as to how Sandler O’Neill arrived at its conclusion. Why no link to a report or a chart with more detail? The story is oddly vague and Olympian.
From the Financial Times:
Small and medium-sized US banks must raise some $24bn to meet the capital standards set by the government in its stress tests of large institutions, research for the Financial Times shows.
News of the potential capital shortfall could increase pressure on many of the 7,900 US banks that form the backbone of the US financial system.
Yves here. Now this is pretentious. The FT is saying research it commissioned could pressure banks (“news of the potential shortfall” meaning this news). When equity analysts say bad thing about a company, it isn’t normal practice to crow “My grim report could push the company to do Y.” Back to the story:
As many as 500 more banks could close, according to investment bank Sandler O’Neill, which carried out the research…..
The government’s stress-case would result in capital shortfalls for 38 per cent of the 200 banks below the 19 largest financial institutions, leading to a deficit of around $16.2bn in common equity, according to Sandler O’Neill.
Applying similar criteria to the remaining 7,700 banks in the US would result in a further $7.8bn capital deficit.
The banks have to repay a combined $27bn in aid from the Troubled Asset Relief Programme (Tarp) but they could do that from internal resources rather than raising more funds.
The US Treasury has said that it does not intend to extend the stress tests beyond the 19 top institutions it examined. But analysts say that the public release of the government’s test methodology and capital adequacy philosophy means that the tests’ standards will become a model for the rest of the US banking system. “This will ultimately migrate down the banking industry no matter what Treasury says,” said Robert Albertson, chief strategist at Sandler O’Neill. “It’s like telling bank examiners to close their eyes and not to think of a chicken.”…
The application of the large bank stress tests could make some smaller banks vulnerable, say analysts. Some smaller banks may either struggle to raise capital or have less flexibility to do so. That, in turn, could lead to a flurry of takeovers.
“At some point there’s going to be massive consolidation,” said one industry banker. ”But for now, a lot of banks are going to raise as much capital as they can.”
The logic is spurious. The smaller banks, with perhaps a handful of exceptions among the biggest of the rest, are of a size with makes it possible to do a reasonably detailed exam. There is no reason for a cooke cutter approach like the stress test. There is no particular reason to believe the stress tests will be extended to other banks, particularly since we are likely to be on to a new plan in six to nine months anyhow.