The headline news from the Fed’s 38-page report is that 10 of those banks could face capital shortfalls if the assumed future conditions become a reality. Moreover, the cumulative capital shortfall among those 10 banks totaled $75 billion.
A break from the traditional
The real story, though, is what’s behind that number. Most of the $75 billion shortfall is not attributable to Tier 1 capital deficiencies.
Tier 1 capital is a traditional measure regulators use to assess a financial institution’s health—but the SCAP tests dug deeper to analyze the composition of the banks’ Tier 1 capital. A specific area of focus for the Fed, and the source of the perceived shortfall, was Tier 1 common capital ratio. Although existing regulations don’t require it, the Fed now believes banks should maintain a large component of common equity within Tier 1 capital. As a result, the 10 banks will be asked to raise their common equity—even though their overall Tier 1 capital levels may be within the regulatory standard under the SCAP scenarios.
Regarding the Tier 1 common capital ratio requirement, American Bankers Association President and CEO Edward Yingling said in a press release, “The regulators are, in effect, changing the existing rules and requiring that a higher [common equity] percentage be held within the Tier 1.”
Officially, the common equity shortfall is being called the SCAP buffer, defined as Tier 1 common or contingent common equity.
In most cases, banks will cover the SCAP buffers by selling common shares or converting existing preferred shares into common. Should those efforts fail, the government has said it will convert its preferred shares in the affected banks from TARP’s Capital Purchase Program to the new Capital Assistance Program (CAP). The CAP program securities are TCE, simply because they are convertible preferred shares.
Bank of America, which is deemed to need $33.9 billion in common equity, has already made its plans known: the bank will hoard earnings and sell assets and common shares to comply with the government’s request. In a CNBC interview, CEO Ken Lewis said, “Our game plan is designed to help get the government out of our bank as quickly as possible.”
Some banks better than others
The Fed report provides estimated losses and SCAP buffer shortfalls for each of the 19 banks. The banks that are projected to have the largest capital shortfalls include Bank of America at $33.9 billion, Wells Fargo & Company at $13.7 billion, GMAC, LLC at $11.5 billion, and Citigroup at $5.5 billion. These four and six more will have to present the Treasury with a capital plan specifying how they will raise the additional capital.
The nine banks that “passed” the stress tests are Goldman, JPMorgan, Bank of New York Mellon, MetLife Inc., American Express, State Street Corp., BB&T, U.S. Bancorp and Capital One Financial.
Click here (http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20090507a1.pdf) to access the complete SCAP report.