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Stress Test Finds Strength in Banks
Uncertainty Remains, but Officials Say Most Have Capital to Outlast Recession

By Binyamin Appelbaum
Washington Post Staff Writer
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.

Nearly all of the banks have enough capital to meet the first requirement, but many were unprepared to meet the narrower requirement.

The results, which will be released by Treasury Secretary Timothy F. Geithner and the heads of the major regulatory agencies, divide banks into three categories.

A small number of institutions need more money to buttress their reserves. A larger group of banks do not need more money, but will be required to raise additional common equity to strengthen their reserves. Some banks will receive a clean bill of health.

Regulators have been careful to note that all of the tested banks have enough capital at present; the question is whether they will maintain enough capital through 2010.

Banks that must take remedial action have until June 8 to develop detailed plans, officials said yesterday. The firms then have until Nov. 9 to meet the government's requirements before they are required to accept federal aid, or else they will be required to accept federal aid.

Officials say they are confident that most companies will not need additional money from the government, although companies that convert existing federal investments will be able to suspend dividend payments, potentially erasing billions of dollars in expected returns for the government.

Citigroup will be required to raise about $5 billion in additional capital, and to increase its holdings of common equity by about $50 billion, or more than 60 percent. That's the largest hole for any bank.

The company has announced plans to exchange common shares for $52.5 billion in preferred shares, including $25 billion held by the government, which would give taxpayers a roughly 36 percent stake. The firm is also selling a number of business units, including much of its operation in Japan.

Executives have expressed confidence that the company will not require additional federal aid.

Regions Financial of Alabama also will be required to raise additional capital.

The longer list of banks that need to raise common equity is headlined by Bank of America, which will be required to raise $33.9 billion, an increase of roughly 50 percent in the bank's common equity, according to a person familiar with the matter.

The bank could meet that requirement by converting a portion of the government's existing $45 billion investment, a step that would not involve raising any new money. But the bank is likely to consider other options, such as the sale of business units, because exchanging common shares for the preferred shares now held by the Treasury would give the government a significant ownership stake in the company.

Bank of America is shopping its mutual fund unit, Columbia Management, and also exploring the sale of its stake in China Construction Bank. The company also has about $33 billion in preferred shares held by private investors, which it could try to convert to common shares.

Regulators plan to require Wells Fargo to increase its common equity by $15 billion. The company has issued $25 billion in preferred shares to the government.

The list of banks judged by the government to have sufficient capital and sufficient common equity also includes Goldman Sachs, Bank of New York Mellon and American Express. Tests determined that Capital One Financial of McLean needs little, if any, additional common equity, sources said.

Several of these companies are expected to push for permission to repay the government's existing investments. The administration has said that it would only allow banks to repay that money if they also demonstrate that they no longer need to rely on another government aid program, administered by the Federal Deposit Insurance Corp., which allows banks to issue debt at lower interest rates by guaranteeing investors against loss.

All of the banks declined to comment yesterday, citing orders from the government not to speak about the test results.

Staff writers Neil Irwin and David Cho contributed to this report.

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