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Report: 1 in 8 Banks Would Fail Stress Test

One in eight banks wouldn't be able to maintain adequate capital in a stressed economic environment, according to a ""Trepp"":http://www.trepp.com/ report.


The analytics firm released the results of its first Capital Adequacy Stress Test (T-CAST) of banks across the country, adapting the Federal Reserve's Comprehensive Capital Analysis Review (CCAR) Stress Test used on the 19 largest banking institutions in March. The tests are designed to measure a bank's ability to maintain regulator-defined capital ratios in adverse conditions across 12 variables, including unemployment, home prices, real GDP growth, and more.

Using data from Q2, 784-12.7 percent-of banks tested failed to meet capital adequacy requirements. For banks that failed the test, Trepp estimates an additional $25 to $27 billion of combined capital would be needed to achieve a passing grade.

A test rendered using the increased capital ratio requirements under Basel III yielded more alarming results, with 23.5 percent of banks failing to keep adequate capital.

""A significant number of banks are at risk of falling short of capital adequacy requirements unless they take some type of corrective action,"" said Matt Anderson, lead bank analyst for Trepp. ""The report shows that the industry still has a way to go before a full recovery.""

Performance in the T-CAST appeared to depend largely on bank size. Out of all the banks that failed the test, the highest percentages of failure were for banks with less than $10 billion in assets. In fact, 12.1 percent of banks with assets between $1 and $10 billion failed, while 12.9 percent of banks with assets less than $1 billion failed.

Geography was also a key concern, with banks located in states hit hard by the banking crisis faring worse than those in states that came through relatively unharmed. For example, 17.2 percent of banks failed the T-CAST in Illinois, a state that has reported seven bank failures so far in 2012.

In Illinois, Georgia, Florida, and Minnesota-the four states that have seen nearly half of all reported bank failures since 2007-less than 84 percent of banks tested would be able to maintain adequate capital.

Exposure to commercial real estate (CRE) also emerged as a ""significant driver,"" with 39.1 percent of loan losses coming from CRE for banks that failed the test. According to Trepp, the overexposure to CRE was the primary source of distress for most of banks that have closed since the credit crisis.

Commercial and industrial lending was the secondary source of distressed for banks that failed the T-CAST, making up 24 percent of forecasted losses.

In its analysis of the data, Trepp said the high fail rate stems from a skewed perception of what's ""normal"" for the banking industry since the credit crisis.

While some may point to an uncertain regulatory environment as the cause of the problem, Trepp says the responsibility is on banks to prepare.

""Regulatory scrutiny will not fade quickly and banks will continue to be encouraged to increase capital levels. Improvement in the pass rate of future stress tests will come as a result of institutions taking the steps to achieve regulatory compliance, not as a result of deregulation,"" Trepp wrote.