Stress Test Finds Strength in Banks
Thursday, May 7, 2009
Long-awaited results of the government's stress test of 19 major banks show that nearly all, including several that verged on collapse during the financial crisis, now have enough money to weather the recession, the Obama administration plans to announce this afternoon.
In an outcome more positive than many investors had expected, the tests concluded that the banks have enough capital in reserve but may need to strengthen the ability of those holdings to absorb losses.
The report is expected to show clear distinctions among the nation's largest banks, according to sources familiar with the findings. J.P. Morgan Chase will not require additional capital, clearing the way for the bank to repay the government's investment.
Bank of America and Wells Fargo also do not need more money, but will be required to strengthen their reserves, potentially by converting tens of billions of dollars of other forms of capital to common equity, the most dependable form of capital. Bank of America will need to increase these holdings by about $34 billion and Wells Fargo by $15 billion, sources said. Citigroup, the weakest of the giants, will be required to raise about $5 billion in new capital and take additional steps to strengthen its reserves.
The formal unveiling of the results scheduled for this afternoon marks the end of a months-long process designed by the Obama administration to restore confidence in the banking industry, in part by forcing some banks to accept additional capital.
The markets responded to early reports of the results yesterday with a euphoric burst, bumping up shares of Bank of America by 17 percent, Citigroup by 16 percent and Wells Fargo by 15 percent. But it might not be clear for some time whether the government has succeeded in restoring confidence, a prerequisite for economic revival.
Auto-financing giant GMAC may be the company most likely to require a new federal investment, according to sources familiar with the situation. Sources said the government would require GMAC to increase by $11.5 billion its holdings of common equity -- money raised from the sale of common stock and retained from profit. The company, with only $5 billion in government money that can be converted to common equity, has struggled to attract private investors and may be forced to accept additional federal aid. The government already is planning to pump billions of dollars more into the company to help it replace Chrysler Financial as the primary source of loans for Chrysler dealers and car buyers.
The 19 banks, which together hold two-thirds of the nation's deposits, were required to provide regulators with reams of data detailing loans and other commitments. The banks also estimated loan defaults and losses through the end of 2010, based on a moderately bleak economic forecast provided by the government. Finally, regulators adjusted the findings to ensure comparability among firms.
Some economists have warned that the recession may prove even more severe, raising the prospect that banks still won't have enough capital.
Prevailing regulations require all banks to maintain a capital reserve equal to 6 percent of their outstanding loans and other commitments, so the bank can absorb unexpected losses. For the purpose of the stress test, regulators also required that banks keep most of that reserve in the form of common equity.
The change is a concession to investors who are concerned that banks increasingly hold capital from less dependable sources, such as the sale of preferred shares, which are structured like loans that must be repaid. This problem was exacerbated by the government's investment in banks, which came in the form of preferred shares.