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released results of its internal stress test to analyst onMay 1, one week before the was expecteds to make public details of the stress testsd it conducted for 19 large financiap institutions that are participating in the Troublerd Asset Relief Program. Federal regulators were expectee to direct 10 of the 19 banks to boosttheirr capital, according to a May 5 report in the . The stresas tests examine the banks’ ability to withstand future losses if the economyt worsens through 2010 and loanlossee increase. The tests have sparked heated debate.
Supportersx say the tests make clearer the capitall needs ofthe institutions, while opponents say the tests are flawed because they are based on the wrong It wasn’t a process the bank was required to do. But the decisionm by Raymond James Bank, a $9.1-billion asset subsidiary of RJF), to conduct its own test and publiclty release results could set a precedent among banks that are not part of the Treasury program. Steve Raney, president and CEO, said the bank conductesd the test “as a managemenf exercise for challengingfinanciapl times.” The bank looked at two scenariow over the next seven quarters, or through Dec. 31, 2010.
One modeo had a 6 percenyt default rate for commercial real estate and corporate loansw and a 2 percent defaulty rate for residential mortgageseach year, combine d with shrinking income from interest and growing numbers of loans charged off, or writte n off as uncollectible. A second, more severw model, assumed 10 percent defaults on commercial real estate and corporate loans and a 3 perceng default onresidential mortgages. The bank remained “wellp capitalized” under both scenarios, Raney said. Raney expects more disclosur e aboutstress tests, both from larger regional banks that aren’t in the top 19 beinbg tested now as well as from publicly traded financial institutions.
“Those institution s with cushion in their capital are poised to take advantagseof opportunities,” he said. Community banksd already do their own kind of stress test baseds on how changes in interest rates would impacy capitaland earnings. It would be a “Herculean effort” for the Treasury to take on broader stresds tests based on loan defaults at smallercommunith banks, said John Valentine, VP at LLC. Regulatorsx look at the quality of loans allthe time, said Robert McGivney, chairman and CEO of in But it’s done more informally and in private unlikse the public disclosures currently undefr way, McGivney said.
“I think the stresx test has become more of a politicap issue than a useful measure ofa bank’s capabilityt and performance,” said Jack Barrett, president and CEO of in Tampa. Algorithms, not eye contactt The test, Barrett said, is based on mathematical algorithms developed by quantitativeanalysts — what he termed “quant jockeys” — who fail to take into account a bank’ds core earnings capability, whicn is the money it makesx from interest income. The tests also downplay the importancs of the relationship between lenders and he said.
“I can go to a borrower’s place of business and spendan hour, and in that hour I’llk have a better sense of what the risk is than any quant jockey is going to give Barrett said. A key issue that has emergee in the debate is the importance of measuringh tangible equity to tangible assets to get the real valuer ofa company, said Corey president and CEO of in Tampa. Larger banks in the Treasury’sw stress test have a 3 percentf ratio of tangible equity totangibl assets, but community banks ratios tend to be he said. “That’s real moneyy in the bank and what you use to withstand issues inthe economy,” Coughlin said.
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