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Saturday, 02 May 2009 05:00

Reggie Middleton Slashes Financial Jargon with Weapons of the TRUTH! Here are the Stress Tests

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reggie_middleton_flying_swords_to_behead_the_financial_villains.jpgBelieve it or not, the TRUTH can and will set you free - or get you locked up. I guess it all really depends on the perspective. You don't necessarily need swords and daggers to cut to the truth. I normarly use spreadsheets and forensic analysis, although every now and then a Katana or two doesn't hurt.

Extensive Simulated Government Stress Tests Released!

I'm putting some more truth out today. Here is the first of a series of the government simulated stress tests that we have completed. This is normally high level subscriber-only material, but since these tests are so widely anticipated, I thought I would give the world a taste of what we do behind closed doors.

Be aware that I don't necessarily agree with the methodology and assumptions of the government's version of the stress test. For one, they don't risk weight earnings, only assets. Some of the investment banking operations take significant risks to generate earnings (see "Goldman Sachs Banking Secrets Mr. Geithner May Not Share With You! ), and these actions pose significant risk. In addition, I believe that the "stated" assumptions are much too lax to be considered a rigorous stress test, eg. unemployment is already higher than the baseline assumed unemployment. I do not know if the government modified its assumptions in the actual implementation of its tests. I have rectified the problem by creating a scenario analysis that covers multiple assumptions, thus the readers can decide for themselves which set of assumptions to use.

I stress, evaluate and value companies differently, thus my internal forensic analysis may very well bear different results than these government simulations. That being said, these are simulations and not necessarily an attempt at getting to the truth, the whole truth and nothing but the truth - just the government's version of the truth. Do you remember what Jack Nicholson told Tom Cruise when he asked for the truth in "A Few Good Men"? He said, "The TRUTH! The TRUTH! You can't handle the TRUTH!!!!". Well, in my opinion ladies and gentlemen, the TRUTH is that quite a few of the banks that are the subjects of my analysis are insolvent. That's just my opinion, but I actually believe that my opinion is money good.

The Sun Trust Bank Stress Test Results

The following is a summary of my simulated government stress tests based upon the white paper released in the latter part of April 2009. See The Supervisory Capital Assessment Program: Design and Implementation 2009-04-30 02:16:44 286.90 Kb and Bank of Finland Recessionary Stress Testing Methodology 2009-04-30 02:18:39 306.64 Kb for methodology. For my personal accounts, I am assuming a 4% bar for Tangible Common Equity and a 6% bar for Tier One Capital. The actual bars have not been released publicly, to my knowledge. It has been stated in the media and dated government documents that the base case government estimates for unemployment was 8.4%. We believe that to be unrealistic (given that the latest government figures show 8.5% unemployment and trending upwards), hence we have used the more stringent RGE Monitor macro assumptions for the base case scenario and have reserved what we perceive as the government's stated parameters as the optimistic scenario.

Click any chart to enlarge

sun_trust_tangible_equity_ratio.pngsun_trust_tangible_equity_ratio.png

sun_trust_tier_1_ration.gifsun_trust_tier_1_ration.gif

Please be aware that this is an illustrative analysis only, and we are not privy to the same access and information that may have went into the government's analysis of these companies. In addition, the government may have wavered from the stated implementation in the whitepaper released above.

The Scenario Analysis Summary for Sun Trust

2010 End	Base Case	Adverse case	Optimistic case

Risk weighted Assets	152,937	150,791	155,063
Tier 1 risk-based capital	13,653	12,358	14,959

Tangible Assets	165,245	162,825	167,642
Tangible Equity	5,121	3,826	6,427

Tier One Capital	8.9%	8.2%	9.6%
TEC	3.10%	2.35%	3.83%
Sun Trust Share price	13.71

Assuming the government requires a 4% minimum tangible equity capital ratio, we foresee Sun Trust being in need of roughly $1.5 billion of additional capital causing approximately 31.7% in dilution among existing equity investors.


Base Case Scenario	Min Tangible Equity Capital Ratio	Capital to be raised ($ mn)	TEC $ mn (post add capital )	Tangible Assets $ mn (post add cap)	No of shares (mn)	Dilution Impact
2010 estimates	3.1%	0	5,121	165,245	0.0	0.0%
	3.5%	687	5,808	165,931	50.1	14.0%
	4.0%	1,551	6,672	166,796	113.1	31.7%
	4.5%	2,424	7,545	167,669	176.8	49.6%
	5.0%	3,307	8,428	168,551	241.2	67.6%
	5.5%	4,198	9,319	169,443	306.2	85.9%
	6.0%	5,100	10,221	170,345	372.0	104.3%
	6.5%	6,011	11,132	171,255	438.4	122.9%
	7.0%	6,931	12,052	172,176	505.6	141.7%

I have made the full 36 page report available for all to download here: Sun Trust Banks Simulated Government Stress Test 2009-05-04 13:38:04 1019.01 Kb. I plan to publicly release stress tests on American Express, PNC Bank, Morgan Stanley, Goldman Sachs and Wells Fargo before the government releases their results Thursday. Stay tuned...