BANKS & STRESS TESTS

May 18 -- While the scale isn't quite as big, an interesting stat/report came out this morning. The stress tests were limited to the top 19 banks in size (needing about $75 billion in additional cap). If the test were applied to the next 200 biggest banks, 38% of them would face capital shortfalls. The report indicates that that amounts to a need for an additional $16 billion in capital. Now just like with the stress tests, that number may be too low because of inadequate assumptions. And while that numbers isn't likely to "break the bank" or banking system, it does continue to underline how widespread the ripple effect of the situation is. Nearly 40% of the top 200 banks don't have enough capital. Whether this recession "recovers" anytime soon or not is one thing, but even if it does, it's becoming abundantly clear that what we "recover" to will be far from strong growth known in days past and more like a sludging growth that might still feel like a recession.

May 4 -- Good news is banks are staying alive, for now. There are questions about the assumptions of the stress tests but we'll just have to wait and see how bad credit losses prove to be. So the bottom (conservative) line here is don't play the banks. And if you do, go purely best of breed. I'm talking Goldman and JP Morgan here. There might be more rewards elsewhere but more risks too, especially with questionable accounting practices, unforeseeable and unknown future credit losses, and the TARP hands of the government involved in daily affairs. I do disagree with folks that say we now have weak banks and strong banks. I think that there will always be investors and they look for banks that have risk without serious risk of failing. I dont think the government will let these guys fail. they might take'em and reorganize or recapitalize them but not totally fail. so basically, investors see these banks not as weak, but as plays for quick money and trades....which is exactly why I don't think they fit for someone's investment portfolio given I view investments as a long-term (3-5-10 yr) horizon.

Bad news = Apparently Citi - which only needs $5 billion of capital raising according to stress test results - really needs $35 billion and its amount was reduced only after getting regulators to count future assumed capital gains as legit. Such reductions were not limited to Citi. As a whole for the 19 tested banks, the same logic was used to reduce the overall amount of capital needed from $185 billion to $75 billion. Assuming future gains during such serious and speculative times = risky in my opinion.

More bad news = if you recall stories about how banks got in this problem with excessive leverage ... lending out 30 or 40 dollars for every 1 dollar they had in the bank. Well that leverage was excessive in comparison to the average banks used to run in the mid 90s...around 15 or 20 bucks to every 1 they had in capital/on hand. The stress test assumptions of a 3% tangible common equity ration would mean that banks would have a leverage degree of 25:1. Not really going all the way back to the safe old days, are we? As you can imagine, requiring 6% or more tangible common equity would mean lower leverage, but it would also mean the banks would need to raise more on hand capital... so those lower stress test results numbers would jump and scare everyone again.