Stress test, schmess test? Hardly.
Yes, as I wrote last week in "Why the bank stress tests are bunk," there's a lot wrong with the government's analyses of major banks.
But investors are plenty concerned about the results of these stress tests.
This means the tests matter a lot -- because they will move stock prices. In some cases, speculation about the results has already had that effect. And a delay in their release -- originally scheduled for May 4, now expected a few days later -- heightens the tension.
"My clients are entirely fixated on this," says Christopher Whalen of Institutional Risk Analytics, a research shop that drills down on banks' financials to assess their strengths and weaknesses.
Whalen's clients have good reason to be nervous. A poor showing in the government tests will suggest that regulators are leaning on a bank to raise fresh capital or convert its government loans into stock. Either move could punish current shareholders by diluting the value of stock in circulation beforehand.
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The nation's biggest banks have been put under the microscope, with the results of these stress tests due out soon. The tests should tell us which ones face the most trouble.
No one knows how regulators will come down on each of the 19 banks identified as probable stress-test candidates. (Several news outlets offered lists; I used the one from ProPublica for this report.)
To make educated guesses, I blended two scores from Institutional Risk Analytics:
- One assesses capital strength, or how much capital a bank has behind its "bets," such as loans, home mortgages and investments. Sound financial strength is key here, as so many of these bets go bad.
- The second is a letter grade that assesses the strength of business. This is important as a measure of whether a bank will be able to "earn its way out of" its problems.
For example, Wells Fargo (WFC, news, msgs) looks thinly capitalized after its purchase of Wachovia, which brought with it big exposure to subprime mortgages. But a look at Wells Fargo's overall business strength suggests it can continue to make enough money to deal with the problems, says Whitney Tilson, a co-portfolio manager of the Tilson Focus Fund (TILFX). That is one reason he is long the stock.
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I also considered the opinions of banking sector analysts at Morningstar, brokerage Fox-Pitt Kelton Cochran Caronia Waller and SNL Financial.
It's important to remember that the government will not actually grade the banks as "pass" or "fail." Instead, it's going to rank them to determine which banks most need more government support. In that spirit, I've divided the banks into three categories that assess whether they face high, medium or low financial stress in a recession that has so many borrowers sending up the white flag on loans.
You'll find my ratings in an accompanying slide show, as well as the reasons behind them.
At the time of publication, Michael Brush did not own or control shares of any company or fund mentioned in this column.