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The SCAP Hammer Falls
The long-awaited results of the Supervisory Capital Assessment Program (SCAP), aka government stress tests, were finally released by the Federal Reserve. The results seem to show a need for capital by some of our institutions that is manageable given current conditions in the capital market.
IN PICTURES: Top 7 Bank Failures
The Test
The purpose of the exercise was to determine the capital needs of the 19 largest banks, "if the economy weakens more than expected". Banks that need more capital have a month to come up with a plan, and then they must implement that plan by November. The government's assessment used two scenarios - a baseline scenario that assumes the economy follows the consensus forecast, and a more adverse scenario that involves a further contraction in the economy.
The Results
The SCAP concluded that the total capital needed if the adverse scenario plays out is $74.6 billion for the 19 bank holding companies. Nine institutions don't need any capital under the government's parameters. These include JP Morgan (NYSE:JPM), Goldman Sachs (NYSE:GS), American Express (NYSE:AXP) and Met Life (NYSE:MET).
The largest shortfall of capital is for Bank of America (NYSE:BAC), at $33.9 billion, and Wells Fargo (NYSE:WFC), which has a shortfall of $13.7 billion. Citigroup (NYSE:C), which many investors presumed was the worst off of all, only needs $5.5 billion. However, a closer look at the report shows that the assessment includes the effect of conversion of preferred stock into common for Citigroup that was announced February 27.
Investors should note that these capital needs are what are required if the adverse economic scenario is realized, and despite the doom and gloom psychology, it is far from certain that this scenario will be realized.
Stress Tests Remove Uncertainty
The government has been preparing the market for several weeks for the assessment results, with high-level government appointees trying to spin the report to its advantage.
The value in the stress tests is not simply the results but how it removes the element of uncertainty in the financial sector. Investors may take solace in knowing that the government has reviewed the books of our largest financial institutions and quantified the capital needs given various problem scenarios.
One problem the markets have had to face in the last year has been the number of "experts" out there who make blanket proclamations about our financial system without necessarily having the facts to arrive at such a conclusion.
The government also chose the perfect time to release the results, during a powerful market rally off the early March bottom in the stock market. This rally seems to be losing a little strength, and this may be what it needs to kick-start it to higher levels.
Bottom Line
The SCAP assessment may have the intended effect of calming the market hysteria over the state of the U.S. financial system. Some make the argument that this is even more important than the actual content of the report and will go a long way toward ending the bear market.
Read Buy When There's Blood In The Streets to learn how contrarian investors find value in the worst market conditions.
IN PICTURES: Top 7 Bank Failures
The Test
The purpose of the exercise was to determine the capital needs of the 19 largest banks, "if the economy weakens more than expected". Banks that need more capital have a month to come up with a plan, and then they must implement that plan by November. The government's assessment used two scenarios - a baseline scenario that assumes the economy follows the consensus forecast, and a more adverse scenario that involves a further contraction in the economy.
The Results
The SCAP concluded that the total capital needed if the adverse scenario plays out is $74.6 billion for the 19 bank holding companies. Nine institutions don't need any capital under the government's parameters. These include JP Morgan (NYSE:JPM), Goldman Sachs (NYSE:GS), American Express (NYSE:AXP) and Met Life (NYSE:MET).
The largest shortfall of capital is for Bank of America (NYSE:BAC), at $33.9 billion, and Wells Fargo (NYSE:WFC), which has a shortfall of $13.7 billion. Citigroup (NYSE:C), which many investors presumed was the worst off of all, only needs $5.5 billion. However, a closer look at the report shows that the assessment includes the effect of conversion of preferred stock into common for Citigroup that was announced February 27.
Stress Tests Remove Uncertainty
The government has been preparing the market for several weeks for the assessment results, with high-level government appointees trying to spin the report to its advantage.
The value in the stress tests is not simply the results but how it removes the element of uncertainty in the financial sector. Investors may take solace in knowing that the government has reviewed the books of our largest financial institutions and quantified the capital needs given various problem scenarios.
One problem the markets have had to face in the last year has been the number of "experts" out there who make blanket proclamations about our financial system without necessarily having the facts to arrive at such a conclusion.
The government also chose the perfect time to release the results, during a powerful market rally off the early March bottom in the stock market. This rally seems to be losing a little strength, and this may be what it needs to kick-start it to higher levels.
Bottom Line
The SCAP assessment may have the intended effect of calming the market hysteria over the state of the U.S. financial system. Some make the argument that this is even more important than the actual content of the report and will go a long way toward ending the bear market.
Read Buy When There's Blood In The Streets to learn how contrarian investors find value in the worst market conditions.
by
Eric Fox
Eric J. Fox, CFA, is a freelance financial writer and has previous experience working in the asset management industry as an equity analyst and portfolio manager on the buy side. His favorite area to write on is the energy sector and he keeps current on the industry by reading Haynesville Shale, Permian Oil and Gas and various other blogs.
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