washingtonpost.com
U.S. to Wind Down Help for Some Banks
Stress Tests Find Most Can Absorb Losses

By Binyamin Appelbaum and Neil Irwin
Washington Post Staff Writers
Friday, May 8, 2009

The government signaled yesterday that its financial rescue efforts may have reached their high-water mark, announcing that the much-anticipated "stress tests" of 19 large banks showed that only one, GMAC, was likely to need additional taxpayer aid and that it would begin to unwind assistance for the healthiest firms.

Despite a deepening recession and projections that banks will continue to lose money, the government will require the firms to increase their combined capital by as little as $9.5 billion. The government will require the banks to further strengthen their capacity to absorb losses by adding $74.6 billion to the portion of their capital that comes from common equity. Banks are likely to raise some of that money from investors and some by converting other forms of capital.

The announcement at the Treasury Department yesterday culminated a three-month process designed to show that banks are returning to health after a crisis that left much of theindustry dependent on federal aid.

Officials said that banks continue to hold vast quantities of ill-considered loans and could suffer losses totaling $600 billion over the next 20 months as the borrowers default. But in showing that the banks can absorb those losses, the administration hopes to restore investors' confidence. If banks can start raising money again, they can increase lending to consumers and small businesses, a critical piece in the government's broader strategy for renewing economic growth.

"With the clarity provided by today's announcement, banks should be able to get back to the business of banking," said Treasury Secretary Timothy F. Geithner.

First, however, the banks must respond to the results.

The government's demand that 10 of the banks raise billions in common equity creates a virtual referendum on nationalization. The banks have six months to persuade private investors to buy new shares of their common stock, or else the firms could be forced to grant the Treasury a voting ownership stake.

Financial analysts said they regard the success of those stock sales as a critical indicator of whether the stress tests have restored the market's confidence in the companies. The government hopes to show it does not need to take a stake in banks beyond Citigroup and GMAC.

There may not be a long wait to find out. Two banks said last night that they would issue $8 billion in common shares immediately.

While the banking industry will remain on federal aid for the foreseeable future, officials also said they would now allow some of the healthiest banks to repay the government's initial capital investments. Nine of the 19 banks were found to have sufficient capital reserves. Firms that repay the government no longer face restrictions on executive compensation.

Applicants will first be required to show that they do not need the shelter of a Federal Deposit Insurance Corp. program that helps banks raise money at lower interest rates. But banks may continue borrowing from the Federal Reserve's emergency programs, which do not impose pay restrictions.

Geithner said yesterday that regulators saw the Fed programs as serving a different purpose.

"They're for the benefit of the economy as a whole," he said.

The results also were greeted with relief by Treasury officials who have worried that banks would need more than the $110 billion remaining from the $700 billion rescue program authorized by Congress. That now appears highly unlikely. Indeed, officials are now considering the revival of rescue programs shelved for a lack of funds, according to sources familiar with the discussions.

The stress tests were an unprecedented effort by banking regulators to project the future performance of the nation's largest banks. Regulators found that all but two had enough resources to absorb projected losses through 2010 while still complying with the standard requirement to maintain a capital reserve of at least 6 percent of loans and other commitments.

GMAC, the nation's largest auto financing company, fell short by the largest margin, needing $9.1 billion in new capital to meet this basic requirement. The company is expected to get a $7.5 billion capital infusion from the government next week, according to people familiar with the matter who spoke on condition of anonymity because it has not yet been announced. Regions Financial of Alabama was found to need $400 million in additional capital.

Regulators also subjected banks to a new test, requiring a second, 4 percent capital buffer of common equity -- money derived from the sale of common shares or retained from past profits.

Common shareholders dislike other forms of capital, such as money raised by selling preferred shares, because those investors have first claim to the company's profits and are more sheltered in the event of a bankruptcy. Banks with too much capital from other sources have seen their stock prices drop as a result, in some cases threatening their viability. Regulators imposed the new requirement to appease common shareholders.

Ten of the banks failed this second test. Bank of America was told to raise about $34 billion in additional common equity.

Wells Fargo, which needs almost $14 billion, said last night that it would sell $6 billion in new shares to investors and raise the rest from future profits.

Morgan Stanley said it would sell $2 billion in common shares.

"It's a test of the credibility of the results, and it's a test of the strength we've seen in the bank market lately, to see if they're willing to put the money in," said Frederick Cannon, a financial analyst with Keefe, Bruyette and Woods.

Banks also can increase common equity by issuing common shares to investors who hold preferred shares. The government is the largest such investor, holding $152 billion in preferred shares in the 10 companies.

But the banks and the government are eager to avoid converting these shares, which would give the government greater control over the companies.

Citigroup, which needs to raise $5.5 billion in common equity, said it would instead issue common shares to private investors who hold preferred shares.

"We are seeking nothing further from the government," said Edward Kelly, Citigroup's chief financial officer, adding that the company's capital concerns could finally be put to rest. "This is a milestone for us and the industry."

Staff writer Tomoeh Murakami Tse in New York contributed to this report.

View all comments that have been posted about this article.

© 2009 The Washington Post Company