Product launched to help hedge funds perform stress tests on banks

Date: Wednesday, August 31, 2011
Author: Martin Leonard, COO Connect

A New York-based consultancy has launched a service to help hedge funds perform stress tests on banks.

The Invictus Consulting Group’s offering will provide hedge funds with reports determining whether a bank stock is over, under or fairly valued in relation to its peers.

“Hedge funds rely on complex algorithms that, in turn, depend on public data to value their bank stock holdings,” said Kamal Mustafa, chairman and chief executive officer at Invictus.

“The problem, we have found, is that the source data for these algorithms, particularly the key ones of capital and earnings are incorrect as generally presented and must be adjusted on a correct and consistent basis across all of the banks to make the data useful. Our proprietary methodology provides the means to do this,” he added.

The firm has developed a methodology that stress tests more than 7,500 US banks’ Tier one capital levels. Unlike the stress tests banks perform themselves, Invictus utilises all publicly available data and its findings are based on actual asset trends as opposed to earnings predictions.

Given the wide disparity of portfolio composition and geographical footprints among banks, Mustafa noted that the difference between audited bank financials and the value of a loan book under stress could be as much as 20% or 30% off the mark meaning that hedge funds might be getting inaccurate data – something, he added, given the shaky economic recovery, was a major cause for concern.

Furthermore, the methodology is designed to identify and quantify inherent weaknesses in bank asset portfolios including their magnitude and timing, which is not always evident in traditional bank accounting and Federal Deposit Insurance Corporation (FDIC) call reports, the firm said.

“The senior management at a lot of hedge funds are incredibly interested in this product, and we have plans to expand globally, particularly as we have an office in London,” said Mustafa.

“Europe presents a slightly different set of problems. The banks in Europe conform to Basel, making the analysis easier compared with US banks. On the other hand, the publicly available data is not as robust and more difficult to procure. Ultimately, that combination of our methodology and accessible data is what provides value in the analysis for hedge funds in Europe,” he added.