STRESS TESTS: Government Using Little-Known Capital Measure
May 07 2009 - 11:50AM
Dow Jones News
The government stress test of the nation's largest banks
measures their strength based in large part on a little-known
regulatory benchmark that blends a traditional capital measurement
with the more stringent standard used by many stock market
participants.
The stress tests will focus on "Tier 1 common capital," in
addition to the Tier 1 risk-based capital measure commonly used by
regulators, and "reflects the fact that common equity is the first
element of the capital structure to absorb loss," according to a
joint statement released by bank regulators.
The shift to Tier 1 common reflects the reality that stock
market participants already ignore capital measures that put banks
in a more positive light. They focus instead on tangible common
equity, which is a direct measure of shareholder value and the
first to be hit by banks' mark-to-market losses on troubled
assets.
Many analysts had thought the stress tests would directly
measure tangible common equity. Focusing on Tier 1 common instead
may put the banks in a slightly better light, said Frederick
Cannon, an analyst with Keefe, Bruyette & Woods.
Cannon said Tier 1 common excludes "other comprehensive income,"
which includes mark-to-market writedowns on some assets, and that
since banks' risk-based assets were generally lower than their
total tangible assets, their capital cushions appear stronger using
a Tier 1 common measure rather than tangible common equity.
Cannon also said that after estimating historic levels of Tier 1
common, the 4% level required by the stress test would be far too
low if the economy worsens.
"Our analysis of the industry suggests that eventually the
industry will need to raise much more capital than the Treasury is
going to require today, unless the economy stages a rapid rebound,"
he said.
Bank regulators said Tier 1 common capital is measured by
applying the same adjustments to voting common shareholders' equity
that are used to calculate Tier 1 capital. Essentially, that means
adjusting common equity for a variety of factors, including
stripping out items like goodwill and net unrealized investment
gains or losses that are also stripped out in a company's Tier 1
calculation. You can also get the same result by taking a company's
reported Tier 1 capital figure and stripping out the value of any
preferred or nonvoting stock.
A least one other bank has used this measure before the Treasury
Department. The Dallas-based bank holding company Comerica Inc.
(CMA) has been using a measure called Tier 1 common since 2001, by
stripping out preferred equity from the standard calculation of
Tier 1 capital.
Comerica Chief Financial Officer Elizabeth Acton told Dow Jones
Newswires in an interview that the bank had created the measure in
order to highlight that it used a more conservative measure of
capital strength than its peers.
"We believe that, in a conservative and prudent way, focusing on
Tier 1 common allows us to weather recessions like this in much
better shape than other banks," Acton said. "I think tangible
common equity and Tier 1 common get at largely the same point,
which is that it's prudent to run with a high level of common
equity in our capital base."
Acton said Comerica wasn't consulted by regulators about using a
Tier 1 common measure. "We introduced this concept of Tier 1 common
to the marketplace years ago," Acton said. "I don't think there are
any other banks that report that way, so its interesting to see
that the regulators are using that same term."
A call to a Treasury Department spokeswoman wasn't immediately
returned.
At the end of the first quarter, Comerica reported a Tier 1
common equity ratio of 7.33%, compared with a tangible common
equity ratio of 7.27% and a tradition Tier 1 ratio of 11.08%.
Comerica is the only bank to publicly disclose a Tier 1 common
ratio.
-By Ed Welsch, Dow Jones Newswires; 201-938-5244;
edward.welsch@dowjones.com
(Paul Vigna contributed to this report.)