No News is Good News

Story Highlights:

• Regulators released the methodology behind stress tests designed to evaluate the balance sheets of the country's largest banks.
• Few changes were made to earlier announced details, and investors cheered the lack of new news.
• Until the test results are released on May 4, uncertainty will continue to surround financial shares.
• But the core business of banking should continue unabated.

_____________________________________________________________________________

The bank stress test saga continued today as the Federal Reserve, FDIC, and the Office of the Comptroller of the Currency released much anticipated details of the Supervisory Capital Assessment Program (SCAP), designed to evaluate the balance sheets of the country's largest banks. Alas, there wasn't much new information to glean from today's announcement, and that was a relief to investors who were possibly expecting another round of ambiguity regarding banks' fates. No news is sometimes good news, after all. Especially when regulators' track record of delivering such information is spotty at best.

Communication about stress tests has been a source of investor angst from their introduction in February. In his first public address in office, Treasury Secretary Geithner laid out vague plans to "stress test" banks. The plan was poorly received due to scant details about the tests and the ramifications for banks not passing muster. As more details have been revealed, investor concern has abated. But until the results are finally released to the public, clouds of uncertainty will undoubtedly hover over financial firms.

Today's announcement disclosed details about the methodology behind the tests without much change to the economic assumptions that will shape the test results. As promised, regulators evaluated banks' balance sheets – including likely losses on investments, mortgages, credit cards, and other types of credit – based on likely future economic conditions as well as an alternate set of "more adverse" conditions. These more adverse conditions aren't intended to be a worst case scenario, simply a less likely but possible outcome. To many, the more stressful scenario doesn't seem all that stressful, increasing confidence many banks have sufficient capital to weather the hypothetical storm.

The state of banks today is nothing if not perplexing. Just weeks ago many of our largest financial institutions were feared on the verge of nationalization, only to report billions of dollars in first quarter profits. The current environment for banking is actually exceptionally positive. Interest rates are low and yields curves are steep. That's a recipe for bank profitability. But banks stocks are still mired in a bog of regulatory uncertainty, with repayment of TARP funds being disallowed and numerous compensation and other restrictions still in place.

It's not yet known to the public which banks fared well and which will need additional capital. Although the stress tests are now complete, results won't be made public until May 4. Banks themselves will receive the results next week, and it's possible some could announce results early, although regulators have urged them not to. Results are still be a risk to bank stocks as those deemed in need of additional capital will likely have to sell shares to investors or the government or convert preferred shares to common shares, diluting existing shareholders. But the government had made it clear all banks will be supported no matter the test results, so the business of banking – an essential component of an economic recovery – should continue to improve.