Congressional Oversight Panel: Losses Pose Threat to Small Banks

From MarketWatch: Small Banks May Need to Raise $21 Billion

According to a report from the Congressional Oversight Panel, which is charged with overseeing the $700 billion Troubled Asset Relief Program, or TARP, the 18 largest financial institutions with over $600 million in assets would "be able to deal with" whole-loan portfolio losses projected in an analysis the group completed.

However, the report's analysis of troubled whole loans suggests they pose a threat to smaller public banks, those with $600 million to $100 billion in assets.

"Using the same assumptions, it looks as if banks in the $600 million to $100 billion group will need to raise significantly more capital, as the estimated losses will outstrip the projected revenue and reserves," according to the report. "The capital shortfall for those relatively smaller banks is primarily due to the lack of reserves, which on average account for only 25% of the expected loan losses."

The report said that, based on a less pessimistic scenario, smaller public banks would need to raise between $12 billion to $14 billion in capital to offset their losses. However, it added that based on a more stressful scenario, these institutions would need to raise $21 billion in capital to offset their losses.

The model employed assumptions that were 20% more negative than stress-test assumptions employed by the Federal Reserve Board in an analysis it made earlier this year to examine how large financial institutions would handle a potential downturn in the economy.

Rep. Jeb Hensarling, the lone Republican member sitting on the COP, said he dissented on the August report, arguing that it employed assumptions that are excessively pessimistic. This was particularly so, he said, when it came to a model it employed examining the capitalization of smaller banks.

"As with any econometric model, input assumptions drive the output results and it is far from clear that future economic conditions will be 20% more negative than the 'more adverse' standard adopted by the Fed for the stress-tests," said Hensarling, R-Texas.

The panel took issue with a Public Private Investment Partnership program being rolled by the Treasury Department. The PPIP program is preparing to buy toxic mortgage securities from financial institutions, but the Treasury has delayed indefinitely a program to buy whole loans from financial institutions.

That has COP members expressing concern about a failure to address the issues of smaller banks.

"The problem of troubled assets is especially serious for the balance sheets of small banks," the report said. "Small banks' troubled assets are generally whole loans, but Treasury's main program for removing troubled assets from bank' balance sheets, the PPIP, will at present address only troubled mortgage securities and not whole loans."

The COP panel's analysis is based, in part, on stress tests conducted by bank regulators in May that evaluated the health of the 19 largest U.S. financial institutions. However, the COP report examined potential whole-loan losses at 719 banks, large and small.

The COP report argued that problems for small banks are compounded by the fact that they hold "greater concentrations of commercial real-estate loans," which pose a potential threat of high defaults.

"Small banks have more difficulty accessing the capital markets than larger banks," the report wrote. "Despite these difficulties, the adequacy of small banks' capital buffers has not been evaluated under the stress tests."

The report recommended having bank regulators repeat stress tests if conditions exceed those in the worst case scenario envisioned by the evaluations in May.

It added that Treasury and bank regulators should take steps to improve disclosure of the terms and volume of troubled assets on institutions' books, which would help "markets function more effectively."

Emphasis added