The AP article suggests that the Treasury is taking a much harsher stance on loans than structured securities, hence the bias against smaller, regional lenders (with more loans) as opposed to bigger banks with larger portfolios of more complex assets. Here’s the AP story again:
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.
We’re still sceptical of the actual stress contained in the government’s stress tests, but the emphasis on loans would be a good one, in our view.
Loans tend to be held at their original cost, minus a reserve that banks create for potential future losses. Their value doesn’t fall in tandem with market prices as much as structured products tend to (caveat mark-to-market accounting shenanigans etc.). Bloomberg’s David Reilly put it well back in March:
Yet these loans still produce losses, thanks to the housing meltdown and recession. In fact, bank losses on unmarked loans are typically bigger than mark-to-market losses on securities like bonds backed by mortgages.Related links:
Exclusive: Fed tests harder on regional banks - AP
Stress testing the stress test reports - FT Alphaville
Geithner sparks banks rally - FT
