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Bank industry to hear results of ‘stress tests’

Federal regulators on Friday will privately begin telling the nation’s 19 largest financial institutions how well they performed in stress tests to assess their soundness.
/ Source: The Associated Press

Federal regulators on Friday will privately begin telling the nation’s 19 largest financial institutions how well they performed in stress tests to assess their soundness.

Regulators trying to stabilize the financial system also will release the test methodology they used, which could provide clues about which banks may be in trouble — but also could unwittingly roil the industry.

The results of the stress tests won’t be publicly released until May 4.

The slow-motion rollout is intended to blunt market reaction to the news of which banks are healthy, which ones could fail if the recession worsens and which need more money to survive.

News reports, including a confidential outline of the tests first reported by The Associated Press this week, have led analysts to start handicapping which banks could fail. The speculation will intensify with Friday’s release of the test methodology.

“I’m worried about the overreaction — people selling every bank short and pulling out all their deposits and hiding their money in the mattress,” said Scott Talbott, a lobbyist with the Financial Services Roundtable, which represents the biggest financial firms.

It usually is illegal to reveal the results of bank examinations without regulators’ permission. The law was designed to keep fearful investors from staging runs banks perceived to be weak.

But this situation is different: The Obama administration bowed to weeks of criticism about the secretive process by agreeing to release the methodology — and later, the results.

Regulators have asked the banks not to disclose what they learn in meetings today at the various Federal Reserve banks, according to a regulatory official who requested anonymity because he was not authorized to discuss the process.

One reason is that the results could still change. Banks have a few days to process the data and potentially file appeals. Regulators also have not decided how much information will be disclosed May 4 — by officials or the banks.

Publicly-traded companies are required by the Securities and Exchange Commission to disclose material information, but bank examinations are a separate matter because they are so sensitive.

Regulators are striving to release enough information about the stress tests to inspire confidence. But they don’t want to give analysts so much detail that they can run their own tests on the banks before the official release of results.

It may be too late for that. Analysts already are releasing predictions of which banks are likely to fail, based on information gleaned from media reports.

Barclays Capital analyst Jason Goldberg wrote Thursday that three companies could miss the mark: Cleveland-based KeyCorp, Atlanta-based SunTrust Banks Inc. and Birmingham-based Regions Financial Corp.

Their share prices fell 5 to 10 percent in early trading Friday. Spokesmen for the three banks declined to comment.

The stress tests subject banks’ balance sheets to two scenarios. One reflects current forecasts for the recession. The other assumes the recession will worsen, according to the document produced by the Federal Reserve.

Officials also are examining the quality of banks’ loans, according to an industry official and a regulatory official who spoke on condition of anonymity because they weren’t authorized to discuss the tests publicly.

The goal is to see if banks have enough money reserved to withstand these losses. If they don’t, regulators will force banks to boost their capital, with private or government money, and will take other steps to strengthen their balance sheets.

Some experts fear the hypotheticals aren’t tough enough.

“The question is, will the market accept the stress test as a realistic case?” said Paul Miller, an analyst with Friedman, Billings, Ramsey & Co.

Recent economic indicators show the economy is approaching the more severe of the government’s two scenarios, Miller said.

Tension surrounding the announcements highlights the high-stakes nature of the stress tests, a centerpiece of the Obama administration’s plan for bolstering the financial system. For months, officials have put off questions about the banking system by saying they’re awaiting the test results.

The delays have led investors to fret: If the tests show every bank to be strong, they will look like a whitewash and won’t be taken seriously.

Yet once investors can distinguish stronger from weaker banks, they could start selling off weaker banks that remain stable but might falter if the recession got much worse.

That’s led some experts to question whether public tests were a good idea.

“I think it just snowballed,” said Mark Williams, a former Fed examiner and risk manager. “By saying ’we’re doing it,’ all of a sudden they have to provide this information, and they just increased uncertainty.”

When senior White House adviser David Axelrod was asked in an interview last week with The Associated Press about a separate plan to buy up banks’ assets, he replied, “Let’s see what happens once the stress tests are done and the capital needs of banks are determined.”

A draft report from top regulators said the government may end up acquiring a significant ownership stake in banks, according to an article Friday in The Wall Street Journal. However, the draft report from the Financial Stability Oversight Board says U.S. ownership of individual firms “is not an objective,” and that any such occurrence would be temporary, the Journal said.