With Stress Test Results in Hand, Banks May Need to Boost Capital

By Binyamin Appelbaum
Washington Post Staff Writer
Saturday, April 25, 2009

The nation's largest banks yesterday learned how much money the government projects they will lose over the next two years, the result of stress tests to determine whether they need more capital to survive those losses.

The government hopes to reassure investors that most banks are in good shape. But at least one firm was told yesterday that it must raise more capital, according to a person with direct knowledge who spoke on condition of anonymity because of the sensitivity of the information.

Banks required to raise money have several months to find private investors before they are forced to accept federal aid. Other banks may be required to improve the stability of their capital reserves by issuing common shares to preferred shareholders. In some cases, the efforts to buttress capital could force companies to sell the government a significant ownership stake.

The public, however, remained largely in the dark. The government will not publicize its evaluations until the week of May 4. The Federal Reserve yesterday disappointed many investors by declining to disclose even the standards it is using to evaluate the banks.

In the absence of clarity, financial analysts continue to release their own evaluations of which firms will need to raise capital.

Concerns focus on banks that made large numbers of loans for commercial real estate development, because of a belief that losses on those loans will rise rapidly in the coming months. Such lending is a particularly important business for regional banks including Regions Financial of Alabama, BB&T of North Carolina and Ohio's Fifth Third.

Bank of America and Citigroup, two of the nation's largest banks, also are viewed as candidates by many analysts. Both banks already have taken two rounds of federal aid, and Citigroup has received permission to convert the government's existing investment to less onerous terms.

The stress tests have become an unwieldy challenge for the Obama administration, which hoped to calm investors simply by declaring that the banks were healthy.

It has become clear, however, that calming investors will require evidence. And this has forced the government into an awkward bind: If it says too little, investors may distrust the results; if it says too much, the weakest banks could sustain an irreparable loss of public confidence.

The proper calibration remains a subject of debate within the administration, even as regulators began yesterday to discuss the results with banks.

Meetings at the Federal Reserve Bank of New York began at 8 a.m. and ran into the late afternoon. Executives from seven banks were taken in turn to conference rooms where they sat across from regulators for about an hour, listening to the Fed's findings and then discussing the results. Other regional Federal Reserve banks hosted similar meetings.

The 19 banks were given until Friday to contest the government's conclusions.

The government had announced that it would release a detailed description of its methodology yesterday. Instead, the Federal Reserve published a 21-page narrative about the process of performing the tests. Numbers were notable by their absence. The report did not explain any of the specific assumptions used in the testing, save for repeating economic projections released previously.

The report also did not answer the most critical question: What level of capital reserves must banks maintain to pass the test?

"It was a little bit light on the details. They didn't convey loss projections. They didn't give any capital targets," said Jason Goldberg of Barclays Capital. "You still need more details to assess the impact."

Regulators considered whether banks have enough money in their capital reserves to cover projected losses on loans and other assets over the next two years. Banks in general are required to maintain at least $6 in capital for every $100 in loans and other commitments. Fed officials said the 19 banks would be required to maintain a higher level of capital over the next few years, but they declined to say how much more.

The banks also will be required to raise a minimum portion of their capital reserves from the most basic sources, such as quarterly profits or the sale of common shares. Fed officials declined yesterday to define this new secondary standard.

In adopting it, regulators are bowing to criticism from investors that the government's definition of capital has overstated the ability of companies to absorb losses.

"Lower overall levels of capital -- especially common equity -- along with the uncertain economic environment have eroded public confidence in the amount and quality of capital held by some firms, which is impairing the ability of the banking system to perform its critical role of credit intermediation," the Fed said.

Staff writer Neil Irwin contributed to this story.

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