WASHINGTON — Federal regulators released more details Friday about how they did their stress tests — even as they sat down with bankers to tell them how they had performed.
Though the test results will not be made public until May 4, senior Federal Reserve Board officials made one thing clear: the tests showed that banks are well capitalized.
Here are frequently asked questions about the tests, their methodology, and the results.
So if banks are well capitalized, they don't need to raise capital, right?
Don't bet on it. The Fed officials were speaking generally, and it is a safe bet that several of the 19 banks tested will need more. Exactly which ones is debatable, particularly because the banks have until Tuesday to protest aspects of the stress tests.
But who is the most vulnerable?
Bank of America Corp. makes everyone's list. An analysis released last week by the FBR Capital Markets unit of Friedman, Billings, Ramsey Group Inc. said B of A's tangible common equity, or TCE, would slip to minus 0.2%, from its current 3% if unemployment rose to 12%, not a farfetched notion anymore. The Charlotte banking company's Tier 1 capital ratio would decline to 5.7% from the current 10.1%.
At Wells Fargo & Co., TCE would fall to 1.1% if unemployment hit 12%, and its Tier 1 ratio would drop to 5.7%, according to FBR.
Concern is also widespread about how several regional banking companies, including Regions Financial Corp. in Birmingham, Ala.; Fifth Third Bancorp in Cincinnati, and KeyCorp in Cleveland, might look under the test.
So is TCE the new capital standard?
Fed officials emphasized to reporters Friday that the stress test does not amount to a new capital rule, but it is clear that regulators are far more worried about banking companies' TCEs than they used to be.
Investors are increasingly looking at TCE as a no-frills measure of an institution's risk. By not establishing a clear TCE standard, some observers say, the stress-test criteria might further confuse or frustrate the market.
How did the test work?
Banks were told to estimate their potential losses on loans, securities, trading positions and pre-provision net revenue under two scenarios — a "baseline" assumption and a more aggressive "adverse" assumption. Beyond housing, gross domestic product and unemployment projections, the Fed did not say how it tested particular assets. But information obtained by American Banker said commercial and industrial loans, over two years, carried a 4% loss assumption under the baseline projection and 8% under the adverse approach. Losses on commercial real estate would be 7.5% under the baseline and 12% under the adverse scenario.
Baseline losses for first-lien mortgages would be 6% and second-lien loans, 12%. Losses under the tougher scenario would be 8.5% for first-lien mortgages and 16% on second liens.
For credit cards, examiners assumed a 17% loss under the baseline approach and 20% for more stressed periods.
What's the point of all of this?
Regulators are trying to encourage banks to increase capital cushions to absorb potentially larger losses. Though the Fed talks a lot about transparency, it refused to specify how big the cushion needs to be.
But more broadly, the banking agencies are aiming to take a more consistent look at the industry. Stress tests are hardly a new invention, but typically each bank designs its own, creating variations among institutions.
So this is it? Are we prepared for whatever may happen next?
The Fed officials warned that the stress test was not designed to prepare for the worst-possible conditions.
"The more adverse alternative is not, and is not intended to be, a 'worst-case' scenario," according to a white paper released by the Fed. "To be most useful, stress tests should reflect conditions that are severe but plausible."
Of course, this raises another question, one that we can't really answer: Who thought the current turmoil was "plausible" two years ago?