Could the Stress Tests Hurt Regional Banks?

It seems that the upcoming "stress tests" could favor big national banks over smaller regional players.

Under one scenario, the test assumes banks will see "no further losses" on these complex securities at the heart of the credit crisis. By contrast, it estimates that the banks' individual loans will lose up to 20 percent of their value.

The methodology "certainly penalizes those banks that are more involved in traditional banking, which frankly have been performing better in recent months," said Wayne Abernathy, a former Treasury Department official now with the American Bankers Association.

He said banks' loan portfolios have lost only about 5 percent of their value so far, whereas the value of complex securities are down 30 to 40 percent.

It makes sense thought that since complex securities are down 30-40% they will probably not fall much further. However since loans are only down 5% so far they could have further to drop. So a "stress test" will have to make that scenario more probable then a further 20% drop in complex securities. It is bad for regional banks since most of their balance sheets are made up of loans and the "stress test" will see if they can absorb a full 25% loss on their portfolio.

However, if these complex securities were valued at only 40% to 50% of their initial value then you could call just about any large holder of them insolvent. I think the Treasury is setting these assets up to be just toxic enough for the banks to get rid of them with that toxic asset removal plan. But they don't want the assets so toxic that the bank will hold onto them rather then take them off their books. It's quite a balancing act with lots of moving parts. My guess, however, is that regional and national banks will pass the "stress tests" with no problems.