Stress Tests – Impact on industry will be significant at first blush

I found this recap interesting in American Banker today. Does anyone have more details on stress tests and if the banks are going to need more private equity anyone know what terms are even available out there? I think the need for private equity and the ability to actually get it will be more difficult than the government realizes. Investors are wary and will need a real reason to participate. I believe debt pools can be one solution, but interested in others….Shelly Schwieso, Sphere LLC, President

Stressful Friday: Unnamed sources told the Post that regulators are using a new capital standard similar to tangible common equity in the stress tests of the nation’s 19 largest banking companies. “Companies that fall short — even those with enough capital under the traditional regulatory standard — will be required to meet the new standard… For banks that have trouble raising additional capital from private investors, the only available option could be a sale of common shares to the federal government. In some cases, the government would swap its preferred shares for common shares. Other companies might get additional federal money.”

FT said the inclusion of an assessment of counterparty risk on derivative contracts in the stress tests could mean that banking companies will “be forced to hold more equity than initially expected.”

The Times said: “Analysts are already betting that the stress tests will show that banks need to raise significant amounts of new capital, as profits made in the first three months of the year give way to more losses, tied to credit card, commercial real estate and corporate loans.” The paper categorized companies by strength, grouping institutions like JPMorgan Chase and U.S. Bancorp among those that might be able to “weather the storm,” and institutions like B of A and Citi at “the other end of the spectrum.”

A story in the Journal said a draft report by the Financial Stability Oversight Board, an interagency body of regulators, acknowledged that the stress tests and subsequent capital injections could lead to government holdings of large equity stakes in banking companies but that “Treasury will maintain the goal of keeping the period of government ownership as temporary as possible.” “Heard on the Street” highlighted the importance of cap rates – or the income a property produces each year divided by its value. The column said that analysts believe many banking companies are using a long-term median cap rate of 7.5%. “But they warn that figure likely is too low given that this downturn is anything but median. … A change in cap rates, combined with other factors such as an approximate drop of 15% in property cash flows, means commercial-property values overall might have fallen more than 30%.” That might translate to a default rate of at least 5% — compared with the 1.6% banking companies posted at the end of last year — “partly due to the inability of owners to refinance. It also would reduce recovery rates.”