S&P: Banking Crisis Could Go on for Another 3 or 4 Years

Despite the cautious optimism creeping into the financial markets, in light of what some believe are better-than-expected results from the government stress testing of 19 large banks, Standard & Poor’s Ratings Services believes that “banks are far from a recovery, and the banking crisis has merely entered a new phase.”

…although our analytical time horizon for losses extends only through 2010 … there’s nothing to say that this banking crisis can’t go on for another three or four years. - Tanya Azarchs, managing director at Standard & Poor's

One thing is clear, however: banks will have a tough time surviving unless they have “more capital than even Basel envisioned,” according to Azarchs. The Federal Reserve Board’s stress testing, the results of which were announced May 7, found that 10 of the 19 largest banks need a total of $75 billion in capital to maintain at least 4% of common equity Tier 1 capital if the environment becomes a lot more adverse than experts currently expect.

This compares with Standard & Poor’s assessment of an $18 billion need for these 19 banks on the basis solely of credit stress testing. “Despite the significantly higher capital requirements determined by the Fed’s stress tests as compared to our stress tests, we do not see this as an unmanageable amount, and most management teams of the identified banks promptly issued statements about how they would raise the capital (see “The U.S. Federal Reserve’s Stress Test Results: The Beginning Of The End Or The End Of The Beginning For U.S. Banks?)

Standard & Poor’s completed its own base-case stress testing of banks’ loan portfolios, focusing on credit and earnings risks and their impact on capital adequacy (see What Stress Tests Reveal About U.S. Banks’ Capital Needs.) On May 4, S&P placed ratings on 23 financial institutions on CreditWatch with negative implications. The results, and the rating actions, are wholly independent of the stress testing regulators conducted and indicate widespread, though not necessarily severe, capital needs that could result in downgrades of several notches.

S&P says the Fed’s stress test has been just another step toward the eventual recovery of the global financial industry, but the industry still faces challenges presented by these developing trends:

• Industry risk is generally creeping higher rather than stabilizing;
• Losses during this downturn will likely be greater than the industry thought when it began;
• Franchise stability and market confidence are increasingly critical components of credit;
• There’s a greater focus on capital adequacy;
• Government support is now explicit in our ratings for highly systemically important U.S. banks;
• Hybrid securities appear to be riskier than we thought;
• The industry structure is changing;
• Volatility appears to be here to stay;
• The originate-to-distribute model is being rethought; and
• Regulation is generally increasing.