Market: Don’t Stress Over Stress Tests
May 7, 2009
Market participants say the leverage finance markets shouldn’t stress about the government’s stress tests. Though some say you shouldn’t put away the medication just yet.
Some market participants fret that the stress tests might cause the tested banks, which are some of the largest players in leverage finance, to curtail lending because they will have to preserve capital.
The official results of the stress tests were not made available before Bank Loan Report’s Thursday deadline. But preliminary results from the tests showed that at least seven of the 19 banks tested will need approximately $65 billion in fresh capital. Those banks that need an infusion include Bank of America ($34 billion), Wells Fargo ($13 billion to $15 billion), GMAC ($11.5 billion), Citigroup ($5 billion) and Morgan Stanley ($1.5 billion). Those that will not include the Bank of New York, JPMorgan, Goldman Sachs, Capital One Financial, American Express and MetLife. The other banks that were tested are KeyCorp, Suntrust, Regions Financial, BB&T, Fifth Third Bancorp, US Bankcorp, PNC Financial Services. Banks in need of capital will have a certain window to raise the money via private fundraising or through another round of taxpayer bailouts.
Market participants worry criticism will follow those banks receiving additional taxpayer dollars and that this might hinder them from participating in new deals.
“We were in the market with a financing transaction, and one of the groups that we were speaking to was looking at providing mezzanine (this was a division of one of the large banks that had accepted money from the Troubled Asset Relief Program and was being tested). They really liked the transaction, but they turned it down because they needed to conserve capital to pay back TARP,” said Robert Horak, a managing director at Lincoln International. “That is just one case, but I think that’s probably a decision that some of the institutions in the same position are going to make. And in the short-term that may cause them not to do a deal that they would otherwise have done.”
In spite of these fears, most market participants believe the stress tests will not hugely impact a bank’s willingness to lend. They say the purpose of these tests is to make sure banks have a strong enough cushion if the market deteriorates further, not to curtail lending.
“I really don’t feel that the results of the stress tests will have any significant impact on bank lending. Each of the affected banks has whatever net capital it has, so it is what it is so to speak,” said William Welnhofer, a managing director in Robert W. Baird’s investment banking division. “The stress tests have no impact on net capital and thus the ability or inclination to lend. If a bank had thin net capital before the stress test, and thus was reluctant to lend, it will most likely still be reluctant after the stress test.”
Since the Obama administration introduced its version of the financial rescue plan, the government has been conducting stress tests on the country’s 19 largest banks to assess their ability to cope with worse-than-expected financial conditions.
“In the optimistic case, passing the stress tests will encourage increased confidence among and lending by the ‘in order’ banks, while at least temporarily slowing down the ability of the weaker (marginal or insolvent) banks due to the likely associated cost burden imposed,” said Gene Phillips, a director at PF2 Securities Evaluations.
While market participants debate the positive and negative scenarios resulting from the stress tests, most are clear that the tests will not likely change the fact that banks are hording capital and are only lending to borrowers they deem important to the bank. Part of the reasoning behind this, they say, is that banks don’t know how bad loan losses are going to get, what hoop they will have to jump through next or what will be seen as unfair by the general public, sources said.
“Banks are not underwriting deals now anyways,” one analyst said. “So, from what I can see, the tests will have no material impact.”
Craig Noell, managing director of Signature Capital Partners, added, “Senior bank debt would be trading down from par no matter what. The reality is that the disappearance of the CLO-type entities investing in leveraged bank debt is the biggest factor impacting the availability of credit in the leveraged bank loan market.”
This could change, however, if the performance of underlying credits and the credit profile of the transactions they are looking at improve, sources said. “Banks have to see stability and visibility in performance,” said Horak. “If those two things return, the banks will be more willing to make these loans.”
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