What is bank stress? The question is complex and anyone who attempts to simplify the answer probably is doing themselves more harm than good. There are operational stresses, financing stresses, and regulatory stresses that play like a noisy orchestra keeping bankers up at night and sadly sometimes driving them beyond the edge of despair.
In the U.S. government’s bank stress test, the question being asked is essentially “how well can a particular institution withstand the stresses of certain economic scenarios designed by the government”. As Fed Chairman Ben Bernanke stated in his testimony to Congress on February 25, these tests are not designed to pass or fail a bank. Rather, they are designed to help identify to what degree and in what areas each key institution participating in the stress process shows strengths or weaknesses so that the government can better determine how to use its’ resources to help alleviate the crisis.
That’s the plan and so far that’s also where the Federal Reserve and Treasury seem headed. We see no reason not to expect that a genuine attempt will be made to use the results of the stress testing process to help allocate government resources with greater precision.
Regardless, America and the world has a never ending obsession with picking winners and losers; or lacking closure, making odds. Right now if you want good odds probably better to place your bet on Susan Boyle. What follows is our response to the press asking for some way to shed a little more light on who likely stands where in the landscape.
Nothing in the list that follows represents an assessment by IRA as to how any of these institutions will fare with respect to the government’s stress tests. The question posed to us is how would IRA rank these nineteen banks relative to each other using our IRA’s independent benchmarking processes. It is quick analysis based on using some of IRA’s top level criteria to identify where these banks sit relative to each other in their ability to respond to the stresses we feel are of most concern under the current economic climate. At best, these figures could provide some visibility as to what the government may decide is the right individual prescription one by one.
Two Criteria, Three Buckets
For this we elect to focus on two criteria. The first is our IRA Bank Stress Index which is a measure of the operating stresses on a bank viewed as a going concern. The objective of this measurement is to identify whether an institution’s business model is working or potentially in need of adjustment. The criteria used are based on bank safety and soundness principles and have little to do with assessing the equity attractiveness of a bank. Remember only 900 or so banks are publicly traded out of the over 7,500 that report to the FDIC. The second criteria we focus on is financial leverage and for this we use another IRA proprietary measurement based on Economic Capital versus Tier One Risk Based Capital. The combination of the two gives a rough approximation of the business stresses a banker must contend with.
So from these two criteria we make three buckets – buckets that roughly align with the four buckets reportedly being used by regulators in the bank stress tests. They are:
• Upper Bucket – the institution metric measure well on both criteria.
• Middle Bucket – the institution is good on one out of the two criteria.
• Lower Bucket – the institution flags on both criteria.
We now present 4Q2008 information on 17 out of the 19 stress test banks. The arbitrary cut-off criteria for bucketing is the number 2. We did not have data for GMAC and American Express available for this snapshot.
Bank Holding Company
|IRA Bank Stress Index||IRA EC to T1 RBC Ratio||Is Stress Index > 2?||Is ECtoT1RBC > 2?||Probable Bucket||Simple Ranking via column B plus C|
|NORTHERN TRUST CORPORATION||0.66||1.484||No||No||Upper||2.144|
|SUNTRUST BANKS, INC.||1.49||0.885||No||No||Upper||2.375|
|PNC FINANCIAL SERVICES GROUP, INC., THE||1.36||1.576||No||No||Upper||2.936|
|BANK OF AMERICA CORPORATION||1.61||1.908||No||No||Upper||3.518|
|WELLS FARGO & COMPANY||1.47||2.146||No||Yes||Middle||3.616|
|CAPITAL ONE FINANCIAL CORPORATION||2.33||1.495||Yes||No||Middle||3.825|
|BANK OF NEW YORK MELLON CORPORATION, THE||0.81||3.963||No||Yes||Middle||4.773|
|STATE STREET CORPORATION||0.62||4.975||No||Yes||Middle||5.595|
|JPMORGAN CHASE & CO.||1.3||4.513||No||Yes||Middle||5.813|
|REGIONS FINANCIAL CORPORATION||21.11||0.715||Yes||No||Middle||21.825|
|FIFTH THIRD BANCORP||21.57||0.961||Yes||No||middle||22.531|
|GOLDMAN SACHS GROUP, INC., THE||20.6||7.905||Yes||Yes||lower||28.505|
Anyone familiar with the banking industry is unlikely to be surprised by the above relative positioning of these banks. Good operating performance combined with limited economic leveraging most likely translates into greater ability to withstand the stresses of economic shock scenarios. As combinations of leverage and operations positioning degrade there’s less business as usual wiggle room and thus greater need to implement more extensive strategies to respond to shocks. Do not count any of them out. All of these institutions are large businesses capable of a great deal of flexibility in responding to even the most massive business environment challenges.
Take Goldman Sachs. It sits at the bottom of the list because it’s a brand new bank holding company fresh from being an almost pure investment bank. It has little in the way of the kinds of classic bank operations that contribute to traditional operating stability and soundness measurements. More, it has no deposits to speak of and is entirely market funded, like American Express and Morgan Stanley. One could look at them and just as easily ask the question why they should be a BHC at all if they can find a business model that doesn’t require depositor backed lending engines to round out their operations.
The point is that the government is right to treat these institutions as individual cases each of which will have independent paths to journey their way back to being confident contributors to the economy.
Yes there will be commonalities and hopefully guidance templates that can use the information exposed by the process of close scrutiny to guide government policy with regards to other institutions beyond these nineteen few. That would be the best outcome of the process. We wish the government the best in their efforts and stand ready to assist in whatever way we can.
But if you plan to go long or short on any of the above, nothing in what you just read will mean much. Remember that at the start of this note that there were three stresses listed; operational, financial and regulatory. It’s the third one that’s the real wild card in the deck. Normal market forces are not the driving coefficient at the moment.