Thoughts & Comments
The Fed Figures Out A Way To Use Stress Test Results To Screw Bank Shareholders One More Time
Talk about creative accounting. . .

Thomas Brown  ( about me )
Posted 05/28/2009
bankstocks.com
tbrown@bankstocks.com

The Obama administration’s war on bank shareholders continues. This morning, the Wall Street Journal reports that the Fed, in putting the finishing touches on the administration of its misbegotten stress test on 19 big banks, now says that, no, banks that need to raise new capital can’t use their own estimates of the first three quarters’ worth of pre-tax, pre-provision net revenue to fill their holes. They have to basically use the Fed’s own, much more conservative PPNR estimates, instead.   

Oh, brother. If what the Journal is reporting is true, the Fed has succeeded in making a truly asinine, costly regulatory process even more asinine and costly than it was before. Which is saying something.

First of all, if history is any guide, regulators’ loss assumptions for the next two years will end up being way too high and its estimated PPNR for the banks way too low. Yet despite these overly conservative assumptions, regulators are still requiring that banks build capital to levels that are materially in excess of what the Fed says it believes constitute “well-capitalized.” Don’t ask me why the government keeps insisting on moving goalposts. The stress test is best understood if you simply assume that everything the government does is irrational, or soon will be.  The whole idea behind the stress test, and banks’ post-test action plans, has never made sense. This latest change, if true, makes the process crazier than ever. 

When the Fed announced the tests’ results on May 7, you may recall, ten of the 19 banks were deemed to be short of Tier 1 common equity (don’t get me started on that!).  The Fed then gave those ten institutions until June 8 to develop a plan to “fix” their shortfalls. They have until November to implement their plans.

At the time, managements were told they could count as prospective new capital their own forecasts for PPNR for the first three quarters of the year, rather than assuming the Fed’s own, more conservative forecast. That made total sense. The first quarter is already done, and the second quarter almost done. Results for the third-quarter, which begins in five weeks, are highly visible. 

So the companies have a pretty good idea how business is going. Yet in many instances, the differences between the companies’ assumptions and the Fed’s PPNR assumptions aren’t small. In the first quarter alone, for instance, the Fed’s forecast was $2 billion, or 25%, less than Wells Fargo’s estimate!

Now, though, says the Journal, as banks make up their capital plans, the Fed will only allow them to use better-than-Fed-estimate PPNR to make up just 5% of their capital shortfalls.  

Which means that a number of banks might have to unnecessarily dilute their shareholders by even more than they’ve had to unnecessarily dilute them already.  Wells Fargo, for instance, would be limited to using just $685 million if above-Fed PPNR in its plan. Which is nuts, especially considering that in the first quarter alone, the company’s PPNR $2 billion higher than the Fed had estimated!

If the Journal’s report is true, and Wells Fargo has to issue even more common equity than it already has in order to fill its “hole,” shareholders would be diluted by another 4%, at current prices. It would be more totally useless dilution! 

Here’s my prediction. By the end of 2010, the consensus view of the investment community will be that the 19 stress-tested banks are overcapitalized and carry excessive loan loss reserves. This will be a direct result of President Obama’s faulty premise that the banks aren’t lending enough, and that the way to get them to start lending is to force them to raise new capital as a buffer against feared losses. Phooey. The academics and economists who put this notion in the President’s head simply weren’t looking at the data. The unhappy result: value destruction for bank shareholders on a grand scale.

What do you think? Let me know!


  Add your comment

 

 

harry J. Weitzel Posted On 5/28/2009 5:10:37 PM

I couldn't disagree more. If we've learned nothing else from this crisis is that the "too big to fail" 19 have manipulated their 1st Q 09 earnings (remember GS' orphan month) to look as good as possible. In addition, the "Stree Test" itself was a joke. It was similar to being given a take home open book exam with the oppportunity to negotiate their final grade. Banks "too big to fail, must be broken up so that they no longer are a systemic threat.

CG Posted On 5/28/2009 5:11:13 PM

For the first time in recent memory Tom is dead on.

Erich Riesenberg Posted On 5/28/2009 5:12:10 PM

Tom, have you ever mentioned TARP? Are you aware of TARP? DId you rail against TARP? Have you mentioned the FDIC debt guarantees? Are you aware of that? Do you think Goldman was suckered into becoming a bank holding company? Yes, at some point the banks will be solvent and earning real money. That won't mean you have been right these past two years.

Erich Riesenberg Posted On 5/28/2009 5:34:50 PM

Tom, have you ever mentioned TARP? Are you aware of TARP? DId you rail against TARP? Have you mentioned the FDIC debt guarantees? Are you aware of that? Do you think Goldman was suckered into becoming a bank holding company? Yes, at some point the banks will be solvent and earning real money. That won't mean you have been right these past two years.

JOEEXEX Posted On 5/28/2009 6:04:17 PM

Don't know about anyone else but i'm sure had it up to here with the fed going on with the changes evey week sure wish they would change all the fed heads with ones with common sense. And stop talking about changing all the bank CEOs .

johnamcn Posted On 5/28/2009 8:13:04 PM

managements should be learning a lesson that should not be forgotten for a generation. conduct your affairs so that you will not have the gubmint as a partner.

Hondo Posted On 5/28/2009 8:28:15 PM

You're wrong......the Feb assumptions are WAY to low...........but, they're still screwing shareholders but no more than management and shareholders have screwed themselves.

broadbrook Posted On 5/28/2009 9:11:34 PM

"In for a penny, in for a pound." The Government is destroying investor value across whole industries. Just ask Chrysler bond holders. Why stop with autos.

Mike Posted On 5/29/2009 10:10:31 AM

Track corporate earnings at Fortune500Earnings (http://www.fortune500earnings.com).

Matthew Stichnoth butt-kisser Posted On 5/29/2009 10:16:07 AM

Best website ever: www.hotchickswithdouchebags.com. Check it out, and then send tom your money so he can lose it all. LOL

Ali Posted On 5/29/2009 2:21:43 PM

Tom, you called this one. The entire stress test process was a travesty of justice. Incompetent Fed examiners, who don't know the business (and can't do arithmetic) are now in charge of our entire financial infrastructure. May the good lord have mercy on the USA.

Ali Posted On 5/29/2009 2:21:57 PM

Tom, you called this one. The entire stress test process was a travesty of justice. Incompetent Fed examiners, who don't know the business (and can't do arithmetic) are now in charge of our entire financial infrastructure. May the good lord have mercy on the USA.

Angry Taxpayer Posted On 5/30/2009 3:22:13 PM

Earth to Tom - how diluted would shareholder values be if these 19 banks would have been allowed to fail? As a taxpayer that will be responsible for worrying about the enormous deficits created to fund the special programs that have supported these banks - I'm pleased these banks will have to raise private equity to absob additional "surprises" down the road. If we have learned anything then we know that the best models, forecasts and projects can be dead wrong. Can anyone say with complete certainty the Fed's ultra conservative stress tests are indeed ultra conservative in light of what's happened in the last 8-12 months? In short, cash and capital are king for the near term and I'm happy the weakest banks will need to raise private equity instead of increasing the government's debt position.

batman Posted On 5/30/2009 6:16:00 PM

i think you are correct Tom but you also must realize that many of the top 19 banks have been using govt subsidies to issue the fdic backed debt at levels that they could not raise on their own. this is a benefit that you do not mention.

Miss Christine Posted On 6/1/2009 3:12:22 AM

Tom: This whole process has been ridiculous. First the Govt. tells the banks to relax their accounting methods and use mark to market, So let's play let's pretend. The stress tests do nothing other than make the strong banks weaker and those that were to big to fail are going to be carried for another two years at the most when the big bomb will drop, you have seen nothing yet.

Jim C Posted On 6/1/2009 4:14:46 PM

Tom: It's June 1st- and JPM is raising another $5 billion to satisfy regulatory concerns vis a vis repaying TARP Jamie said within the last 2 weeks that they didn't need to raise more equity. Yet here they are going to the well once again. Seems like the governement is extracting a pound of flesh to the detriminet of the current shareholders..

Jester Posted On 6/2/2009 9:19:23 PM

Dead on Tom The 2010-2011 period will see these banks make way too much money !!!

jbperry Posted On 6/3/2009 2:03:41 AM

Breaking News: Banks must now prove that they can raise capital by holding a bake sale before they can return the TARP money, and only the proceeds of the bake sale can be applied toward TARP repayment.
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