25-to-1 Leverage Earns Banks an 'A' on the Stress Test [View article]
Since Treasury did not release the stress test in a form that permits replication of the underlying math, we are left to rely upon comments and assurances from Treasury.
And since they have possibly conflicting objectives, I do not believe everything said by Treasury officials can be taken at face value.
Having had time to think about the outcomes of the stress test, it's very clear the test was designed in such a manner so as to allow banks to maximize projected earnings and minimize potential losses, permitting the banks to earn themselves out of this mess.
Under consolidated results, banks will offset 60% of expected losses through projected earnings for the years 2009-2010. By keeping TCE at 4% as opposed to 5%, it allows banks to use more of projected earnings to offset potential losses while at the same time remaining in compliance with the "strict capital ratio standards" imposed by Treasury, FDIC, OTS and COC.
Banks Negotiate Watered Down Stress Results [View article]
Here is another gem from Calculated Risk who quotes Roubini, confirming my suspicion about giving extraordinarily wide birth to the banks for estimating "earnings" over the next twop years. The IMF calculates the entire industry will earn $300 billion while Treasury is content, if not happy, to accept $362 billion as a working estimate for the nineteen largest banks. The quote from Calculated Risk:
"Second, the capital/needs of these banks depend on a race between retained earnings before writedowns/provisioning that will be positive given a high net interest rate margin and the losses deriving from further writedowns. It appears that regulators have overestimated the amount of such retained earnings for 2009-2010. The IMF recently estimated that retained earnings (after taxes and dividends) for all US banks – not just these 19 ones – would be only $300 bn total over the 2009-2010 period. The stress tests – instead – assumed much higher retained earnings - $362 bn - for these 19 banks alone for the 2009-2010 period in the more adverse scenario. Since these 19 banks account for about half of US banks assets if one were to use the IMF estimate of net retained earnings for these 19 banks their net retained earnings for 2009-2010 would be $150 bn rather than the $362 bn assumed by the regulators. While the IMF may have been too conservative in its estimates of net retained earnings it appears that regulators may have been too generous to these 19 banks in forecasting their earnings in an adverse scenario. Thus, ex-post capital needs will be significantly higher if net retained earnings turn out to be lower than assumed in the stress tests."
Banks Negotiate Watered Down Stress Results [View article]
Thanks John.
I was frustrated with both the outcome and its presentation; after downloading the file from the Fed, I could not reverse engineer the math used to calculate the SCAP requirements. Part disclosure and part politics.
Picking up on your theme, the original SCAP buffer estimated for BAC, WFC, FIFT and C was $105 billion; this was later negotiated down to $54.3 under the now familiar arguments abouts earnings and the ability to sell stuff. This accomodation, which results in a reduction of required additional capital to the tune of 48%, dilutes the the integrity of the entire exercise.
It was either in Time or the WSJ that someone quoted as saying these reduction are reflective of the entire process, suggesting the exerecise was unterdtaken more to calm jittery markets than it was to really discover and repair the health of the nation's banking system.
Using Fed numbers from the stress test, we can under the adverse scenario, which is now the expected case, look forward to an additional $600 billion in bank losses through 2010. We can also expect banks to offset $362 billion of this number through earnings; this represents annual returns on risk weighted assets of 2.3%. BAC earned 2.2% in 2006 and 1.1% in 2007.
In addition to fudging the numbers to make everybody happy, we are essentially desiging a system wherein the banks can earn there way out of this mess. And in constructing the system, we probably have maximized the potential for bank earnings and, perhaps, understated likely losses.
25-to-1 Leverage Earns Banks an 'A' on the Stress Test [View article]
And since they have possibly conflicting objectives, I do not believe everything said by Treasury officials can be taken at face value.
Having had time to think about the outcomes of the stress test, it's very clear the test was designed in such a manner so as to allow banks to maximize projected earnings and minimize potential losses, permitting the banks to earn themselves out of this mess.
Under consolidated results, banks will offset 60% of expected losses through projected earnings for the years 2009-2010.
By keeping TCE at 4% as opposed to 5%, it allows banks to use more of projected earnings to offset potential losses while at the same time remaining in compliance with the "strict capital ratio standards" imposed by Treasury, FDIC, OTS and COC.
Banks Negotiate Watered Down Stress Results [View article]
"Second, the capital/needs of these banks depend on a race between retained earnings before writedowns/provisioning that will be positive given a high net interest rate margin and the losses deriving from further writedowns. It appears that regulators have overestimated the amount of such retained earnings for 2009-2010. The IMF recently estimated that retained earnings (after taxes and dividends) for all US banks – not just these 19 ones – would be only $300 bn total over the 2009-2010 period. The stress tests – instead – assumed much higher retained earnings - $362 bn - for these 19 banks alone for the 2009-2010 period in the more adverse scenario. Since these 19 banks account for about half of US banks assets if one were to use the IMF estimate of net retained earnings for these 19 banks their net retained earnings for 2009-2010 would be $150 bn rather than the $362 bn assumed by the regulators. While the IMF may have been too conservative in its estimates of net retained earnings it appears that regulators may have been too generous to these 19 banks in forecasting their earnings in an adverse scenario. Thus, ex-post capital needs will be significantly higher if net retained earnings turn out to be lower than assumed in the stress tests."
Banks Negotiate Watered Down Stress Results [View article]
I was frustrated with both the outcome and its presentation; after downloading the file from the Fed, I could not reverse engineer the math used to calculate the SCAP requirements. Part disclosure and part politics.
Picking up on your theme, the original SCAP buffer estimated for BAC, WFC, FIFT and C was $105 billion; this was later negotiated down to $54.3 under the now familiar arguments abouts earnings and the ability to sell stuff. This accomodation, which results in a reduction of required additional capital to the tune of 48%, dilutes the the integrity of the entire exercise.
It was either in Time or the WSJ that someone quoted as saying these reduction are reflective of the entire process, suggesting the exerecise was unterdtaken more to calm jittery markets than it was to really discover and repair the health of the nation's banking system.
Using Fed numbers from the stress test, we can under the adverse scenario, which is now the expected case, look forward to an additional $600 billion in bank losses through 2010. We can also expect banks to offset $362 billion of this number through earnings; this represents annual returns on risk weighted assets of 2.3%. BAC earned 2.2% in 2006 and 1.1% in 2007.
In addition to fudging the numbers to make everybody happy, we are essentially desiging a system wherein the banks can earn there way out of this mess. And in constructing the system, we probably have maximized the potential for bank earnings and, perhaps, understated likely losses.